MANAGEMENT ADVICE FROM THE CREATIVE BUSINESS NEWSLETTER

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In the below article, originally published in the Creative Business newsletter and reprinted here with their permission, editor Cameron Foote introduces readers to a novel way to structure a growing creative organization. It provides many of the benefits of ownership to employees without the necessity of principals surrendering their hard-won equity. (Contact and subscription information for Creative Business is at the end of the article.)

A BETTER WAY TO STRUCTURE YOUR FIRM?

Let's look at a hypothetical organization we'll call Schwartz & Associates Inc., a two-person design firm owned by Sam and Sally Schwartz. They have been in business three years.

Sam and Sally's workload has increased steadily and new business opportunities continue to come their way. Thus, they've decided it's finally time to stop depending on occasional and unreliable freelance help and add a full-time designer.

It is the first step in fulfilling their dream of growing a design business based upon their distinctive and much-in-demand style.

GROWTH MOTIVATIONS
Like most individuals in their situation, Sam and Sally are driven by two motivations. Both will affect their relationships with future employees.

Money. Sam and Sally want to make additional profit, so there is a strong motivation to hire young, talented, but not very expensive individuals and keep them very busy. For example, if an employee is paid $15 an hour ($600 weekly), and his or her time is billable at $100 an hour (up to $4,000 weekly), there's some good money to be made.

Ego. This is the second motivation, a big element in how design firms hire, although less so among editorial companies, ad agencies, and PR firms. In our example, the Schwartz name is on their business' door, so Sam and Sally insist that anyone they hire also reflect their style.

EMPLOYMENT CONCERNS
Now let's look at what actually happens when Sam and Sally become employers.

The right talent. The Schwartzs discover right off that finding someone with their style who also has good "commercial" design sense is difficult. The individuals they can afford are mostly young and inexperienced.

Profitability. After hiring they also find that there's less money to be made than they thought. Typical employees are actually productive (have billable time) only about 50% to 75% of a work week. And, of course, meeting a payroll puts tremendous pressure on cash flow.

Training. No matter how talented a new employee is, he or she must go through a learning curve before becoming fully productive. New software and procedures also require on-going training - also non-billable time.

Turnover. After finally getting an employee up to speed, the Schwartzs now worry that he or she - experienced and confident now - will up and leave for a competitor. In other words, that they will have to start all over again.

If Sam and Sally had tried to hire experienced staff they would find the process similar, and the risks even greater. There would be less training and faster productivity, but a higher salary would leave less room for profit, and there would be more pressure to keep the employee busy.

And because the employee would have more confidence and experience, he or she would be more likely to quit on short notice - perhaps to form his or her own shop, taking along some clients.

GROWTH CONCERNS
Becoming wedded to a style. If Sam & Sally hire employees with a style very similar to their own, they will probably exclude themselves from consideration by some clients with different taste buds. Good business opportunities may be missed.

Moreover, because styles and tastes change, the reputation of Schwartz & Associates may be tied to a "look" that goes out of fashion in the future. In addition, their much cherished and refined style will probably have a negative effect on a potential buyer if they ever try to sell their company.

Uncontrolled overhead costs. As their organization grows, Sam and Sally will most likely also discover how difficult it is to be both manager and creative person (left brain/right brain conflict). The tendency is to make up for this by hiring nonbillable support staff, but then staff overhead jumps, cutting further into profitability.

Also, since they consider it important that their office location and its decor reflect their firm's distinctive style and image, as they grow into larger space their facilities overhead jumps.

No equity. Despite future growth, Schwartz & Associates will probably accumulate little or no financial equity. Since Sam and Sally are the business, little salable "business good will" will exist separate from them. In other words, there will be little opportunity for them to sell the business they've developed to anyone else. Whatever financial benefit Sam and Sally obtain from being business owners will be on a year-to-year, "salary" basis.

This is in sharp contrast to that of most other businesses, including such comparable ones as architectural firms and law practices, where owners take out relatively small yearly salaries and plow whatever profits they can back in to the business. By so doing, they build equity for future sale and usually pick up some tax deferral and lifestyle (retirement) benefits in the process.

Design shops in particular, partially because they are often associated with individuals and their particular talents and styles, have little market value. About the only opportunity for future sale comes from selling the operation to an employee, and that's often negotiated from a position of weakness, not strength. Anyone who has ever tried to sell a design studio (and many editorial firms and advertising and PR agencies) knows there is virtually no outside market.

"ASSOCIATION" ALTERNATIVE
Despite its name, Schwartz & Associates, Inc. is not a true association. (Dictionary definition: "Those joined together as partners or colleagues in a business enterprise.") Their so-called "associates" are simply employees working for a paycheck.

So now let's take a look at a true creative association and why it might just be a way to avoid some of the aforementioned problems. Perhaps a better structure for the Schwartz's, and your, organization.

Creative Business's definition. As used here, an associate structure is a way to have employees without many of the financial and management headaches of doing so. For employees, it is a way to enjoy many of the benefits of freelancing without many of the risks.

A mutually-beneficial triad. There are three components to a company operating in this fashion:
1) the firm, which gives the association a home and structure...
2) sales associates (perhaps also the principals in a small organization), who find new clients, handle account service and oversee all jobs... and
3) creative associates (designers/illustrators/ programmers/writers/photographers), who are assigned ultimate responsibility for each individual job, including getting it done on time, on budget and to the client's specifications.

Although the three are not equal partners in a business structure sense, they certainly are equal partners in a business opportunities sense.

No noticeable change. Viewed from outside, this arrangement makes little or no difference to clients. In the case of Schwartz & Associates, Inc., for example, a changeover would be totally transparent. The firm's legal structure (corporation) remains unchanged, as are its taxable obligations. Sam and Sally will still own the company and have full management responsibilities, including hiring, firing and quality control.

What will change, however, is the relationship Sam and Sally have with employees, and how their firm's income is distributed.

Hiring creative employees. In the associate arrangement, each new creative employee is hired for a salary at or slightly lower than what he or she would normally be paid. It is understood, however, that this is a temporary situation, and that he or she will be considered for promotion to "associate" status later.

When promotion will occur depends - very productive and talented individuals within a few months, those less so usually within a year. At the end of the stated period, the individual will either be promoted, be asked to leave the firm, or possibly left on salary.

During this period assignments are provided, and the employee is involved in all aspects of each job - from estimating and proposal writing, to client contact, to billing and collecting. Once an assignment is turned over, it is considered his or hers to develop creatively and manage financially. This project management process not only gives the employee an opportunity to learn how to assure that a job is profitable, but also demonstrates to shop principals when he or she will be ready for promotion.

What "associate" status means. Once up-to-speed, and the new employee accepts associate status, the automatic paychecks stop. Instead, the new associate will start receiving a large percentage of the creative billings of every job he or she handles. Each job (and possibly client) is also considered his or hers, now and in the future, for better or for worse.

How jobs are obtained. A sales associate (or shop principal in the absence of one) solicits new clients and services existing clients. Likewise, his or her only compensation is the commission paid on work completed.

Inasmuch as both the sales and creative associates have a stake in not only getting a job, but in also completing it profitably, estimating the price and what will or will not be provided, is a joint exercise. Only when they both agree is a proposal written and a commitment made to the client.

How the money is distributed. The percentages of gross billable income given below for each of the three principle components of the association are approximate and can be tailored to meet a firm's specific needs. Experience does show, however, that they are in the right range - enough incentive to attract and hold good personnel, while also providing a fair return on a firm's investment in facilities and support staff.
15% of the creative billings go to the sales associate - his or her "salary." He or she also gets 15% of any markup on outside services.
50% of the creative billings go to the creative associate - his or her "salary."
35% of the creative billings go to the "house" - to cover overhead and provide profit. Additionally, the firm makes a profit by marking up outside services - service bureau charges, photography, writing, illustration, printing - by 20% to 25%.

BENEFITS TO THE "EMPLOYEE"
Money. The associate system provides the opportunity for good creative and sales people to earn what their talent is worth, regardless of seniority or experience. The good ones earn far more than they could in any other "employment" relationship, possibly even more than they could by freelancing or starting their own shop. Six figure incomes are possible.

Office and expenses. The associate gets a rent-free office, all equipment and supplies (including computer), and office support services. In addition, all non-billable expenses related to a job - cab fares, delivery charges, client lunches - are covered.

Sales support. Creative associates can concentrate on doing and managing creativity, not worrying about where the work will come from. There is no need to find and make initial contact with clients, although "selling" in the sense of establishing a personal relationship with the client during the assignment is, of course, necessary.

Company benefits. Life, health and disability insurance can be provided, or not, at the firm's discretion. Experience indicates that a 50/50 split between associate and firm is usually appropriate. In any case, the ability to buy insurance through a group plan is a benefit. The firm may also agree to pick up the administrative expenses of a 401(k) (retirement) plan.

Lifestyle. Because their compensation is directly tied to their output and availability to meet with clients, associates are pretty much free to make their own working arrangements. This freedom within a structure is a particularly strong attraction to working parents and those who want independence, but not isolation. The only requirement of the firm should be that the associates' hours are predictably regular, and that time records be kept so that work flow and expenses can be properly allocated.

And unlike freelancers who often suffer from the isolation of working alone, associates have the company of peers while retaining much of their independence.

BENEFITS TO THE COMPANY
Reduced turn over. It is hard to estimate what turnover costs any organization, but it is always substantial, and usually far more than recognized. It is a major bane of creative services organizations. The more productive an employee becomes, the longer employed, the more it costs. If an employee takes a good client with him or her, the combined loss can be doubly painful.

In the associate system, associates are not only well rewarded, but they play the major role in deciding what work to take, how to approach it creatively, and how much to charge. This participation eliminates nearly all the reasons to go to another shop (few pay better, or offer more stimulation), as well as most of the reasons for considering setting up their own shop (many more risks with only marginally more opportunity).

Keeping the long-term loyalties of key employees can, of course, be addressed by incentive (profit sharing) programs. Non-compete contracts can reduce the chances of an employee stealing business. But both are imperfect solutions.

Few profit-sharing programs give employees anywhere close to what they would get from a direct piece of the action, and thus not enough incentive to stay on if really talented. Non-compete clauses can be hard to enforce. Plus, both require considerable structure and the paperwork that accompanies it.

With the associate system it is not unusual to have employees with ten or twenty years seniority still happily and productively working at the same desk.

No non-performing employees. Except for support staff, employees - sales and creative - are hired with the expectation of becoming associates within a given time frame. If they make the grade, they are, by definition, contributors to the common good of the association as well as themselves. If they don't make the grade, they leave.

This weeding out eliminates the need for performance evaluations and the common plaint of principals in larger shops that a few good employees carry most of the others. A side benefit is that everyone working in the association is a big-league pro, which produces internal esprit de corps, and helps enhance the firm's external reputation.

Less cash flow concern. Each associate is paid his or her percentage of billings only after the appropriate client pays. Associate payday can be bi-weekly or monthly, when all the income received since the last payday is distributed. Because only support staff payroll and overhead expenses are paid automatically, the cash-flow crunch that plagues many firms with hefty professional payrolls is substantially reduced.

By reducing the need to cover payroll expenses, the firm also reduces the need to carry a substantial bank balance, or have access to an expensive line of credit. In addition, any expansion is more or less capitalized by the new associates hired. Aside from the expenses of carrying a new employee until he or she reaches associate status, there is no pay obligation unless he or she performs.

Managing less important. Every organization in our business reflects the personality of its founders. But as an organization grows, this typically leads to problems. If the principals are better at creativity than managing, which is often the case, costly inefficiencies abound. Or administrative staff is hired to allow the principals to do less managing and more creating.

The associate system reduces this problem because it is pretty much a self-governing organization, even at a relatively large size. While earnings records must be kept and taxes withheld, there's no need for the other, costly trappings of most organizations - job descriptions, performance reviews, raises or bonus calculations. All associates have equal stature and take care of much of the routine administration of each job they work on.

The skills and style of the principals in an association are mostly important in selecting new associates and in setting the tone of the organization. Any management inefficiencies the principals may have are much less critical.

In addition, because the associate system is essentially a loose collection of individuals, it offers the opportunity to diversify into other related areas, or to move move away from a particular "look," by hiring new associates who represent a wider selection of styles and experiences. This allows the firm to attract a broader selection of clients and types of assignments.

Reasonable profit margin. The association structure is not a way for a business principal to get rich quick. Indeed, it is entirely possible that the principal may actually make less money than some of his or her associates.

If you find this unacceptable, or your ambition is to "make big money and run," stay away from this arrangement.

But if running an association is not a way to get rich quick, it is, nonetheless, a way to make an acceptable profit without many of the headaches of managing an organization. And if the principals are also associates (sales or creative) they can supplement what they take out of the firm in profit with their assignment commissions.

Annual net margins up to 10% of sales are possible from the association's business activities. Although not high, the margins are comparable to many other service businesses, including advertising and PR agencies. Plus, the principals can also benefit from any build-up of equity.

Accumulation of equity.
It is difficult for any company in the business of creativity to accumulate the type of financial equity that will allow it, or a principal's portion of it, to be sold off at a handsome profit in the future.

The chances of this happening increase in direct relationship to how little of the business is tied to the principals, and how long the firm has been around. The business' value is directly proportional to how much it can be shown to a potential investor or partner to have a distinct and separate life, earnings potential and "business good will."

A collection of associates working within a loose structure under a common name can accumulate the attributes of value (equity) much easier that a more traditionally- structured creative organization.

Further, it is a truism that the longer a service business has been around and the better known it is, the easier it is for it to get work. So the benefits of an association structure can pay off both everyday, and possibly in the future.

It makes sense. The best way to end a description of the associate system is to consider it from a purely logical perspective.

The traditional employer/ employee system assumes different level of abilities (management and labor), value added through experience, and more or less predictable market demand. It is a system designed around and best applied in traditional product manufacturing and sales environments.

By contrast, creative businesses are comprised of individuals with more or less comparable skills, whose talents do not appreciably become more valuable with experience, providing services with highly fluctuating market demand.

For these reasons, it does not seem logical to have a management/labor structure, to reward individuals based on seniority, or to pay them the same in times of high and low activity. (Or, worse yet, to pay them a regular salary when they are not busy, and to pay them overtime or farm work out to freelancers in times in extreme activity.) For these reasons, perhaps you should consider adopting a system more in keeping with that used by your professional service counterparts - consultants, lawyers, and accountants. This is what the associate system is, and it is well worth a look by any individual or firm seeking growth, stability, and long-term financial success.

Note: For ease of illustration, this article uses a small design firm as an example. The associate system is equally suitable for larger design firms, or other project-based creative organizations.

©1992/2002 Creative Business (Reprinted with permission)

The Creative Business newsletter, from which the above is taken, is the only publication 100% devoted to running a small design studio or marketing communications agency. In addition, Creative Business publishes management books and CD-ROMS and conducts business management workshops and roundtables. For more information on Creative Business products and services, click on this link.