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When a bunch of ambitious people get together and decide to start a company, they often start out by deciding who owns what share of this new entity. Long before the invention of the “Limited company”, this sharing was directly proportional to the revenues of said company.
If you started a small bakery with a friend back in the 1800’s, the math was simple. Let’s assume the only one time cost for this bakery was an oven that cost $700. If the store made $1000 in revenue each month and the spend on yeast, flour, electricity and marketing was $300; then simply put – the store was at a $700 profit (we’re going to avoid talking about tax and a bunch of other concepts for simplicity here).
In the first month, neither you nor your friend would be able to take any money home, as you’d spend almost all of the profits on paying back the cost of the oven. In month two, you’d make a tidy profit which would’ve been split between both owners of the bakery. Assuming the split between both owners was 50–50, each owner would walk away with $350 month on month. If the business grew, that value increased. If the business did poorly, the take home amount for both owners dropped.
All the way back in 450 BC, the concept of a fixed salary was invented. At that time, salt production was strictly controlled by the monarchy or ruling elite. Salt from a person was synonymous with drawing sustenance, taking pay, or being in that person’s service. The Latin word salarium linked employment and salt. In the modern world, a salary is typically a fixed compensation given to an individual to perform certain duties.
In the scenario of your bakery, the concept of a fixed salary offers some advantages and disadvantages to you, the owner. As you scale and have more customers, it becomes imperative to:
a) Buy more ovens
b) Have enough staff on hand to serve customers
Ovens are machines and typically have a fixed cost (or if loaned, a significantly lower cost than a salaried employee). Ovens don’t need to eat, pay rent or watch movies, which is why they are significantly cheaper than hired hand. However, to add more staff, you’d need to convince your partner (and yourself) to distribute a share of the revenue to other people.
The problem with these potential hires was that they don’t particularly care about the business and want to work so that they can eat, pay rent and watch movies (movies didn’t exist in it’s current form back then, but you get the point). What ended up happening was that both your partner and you decided to not give a chunk of revenue share, but instead a salary — a fixed monthly expense, like rent. If the business grew, then the salaried employee would not benefit from that growth (because they had no stake in the business). If the business failed, then your partner and you would be in trouble because this was a fixed cost you would incur each month that had to be paid regardless of performance of the business.
Most salaried employees at that point were hired because they had to do repetitive tasks, something that owners did not want to continue doing as the business got bigger. This could be the accountant at the bakery manually entering in each customer’s name or the bakers, who would manually prepare each batch. New structures of companies were formed that included both a share capital structure and a salary/dividend structure.
It seemed like a good deal. The people who were willing to take the risk of starting something new had the ability to scale faster thanks to available talent, and talent found opportunities to make money and have relatively stress free (but monotonous) lives. So what was the problem?
Two words — Artificial Intelligence.
Remember those repetitive jobs that these employees were performing day on day? Circa 2010, supervised learning algorithms combined with the already popular internet hit mainstream. Accountants were replaced by computers, bakers were replaced by fancy bread making machines and customers were found online via advertisements that optimized themselves rather than traditional marketing. Employees that did repetitive tasks were replaced by machines like the oven.
Significantly cheaper, never complain about the commute and never make mistakes — what more could you ask from your employees? Also, there’s no need to give an AI bread maker a 401(k) or health insurance.
So how does this affect company structure in the future?
While larger businesses will still choose to incorporate as a Private Limited, the whole ball game changes for smaller businesses. Think about:
- A small, distributed team that wants to build a CRM sold as a SaaS.
- A small team that wants to run a dropshipping store.
- An offline bakery that is run by 2 people.
A Private limited or even an LLC is total overkill for situations of this kind. With 1000’s of dollars of initial investment depending on jurisdiction, annual auditing and the necessity to have a lawyer on hand if things get rough. Let’s not forget taxation. While LLCs are more favorable with “Flow-through” taxation (individuals pay their own tax, the entity doesn’t), there’s still a long winded process for dispute resolution and manual revenue sharing (someone has to use bank transfers to split revenues between partners).
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