Employees get paid an amount per hour multiplied by how many hours they work at the end of the week. That amount does not change whether they have an extremely busy and productive week, or if they only had one small assignment due the entire week.
Employee pay is consistent and secure so long as the company stays in business, the employee’s performance is adequate, and their role is still needed by the company.
On the other hand, the business owner (investors and shareholders) gets paid in direct proportion to the output and performance of the business. So if the business has a bad year, then employees get their same pay per hour while the owners bear the financial burden.
Owners have equity which is a risk-based instrument. With equity, you get paid everything that’s remaining after all the people who are guaranteed money are paid first. In the hierarchy of money in a business, employees have the highest security—they always get paid first. In legal proceedings of a company running out of money, the government will go after board members to pay salaries. In exchange for the security employees have, they don’t have access to the company’s surplus profit.
Second in the hierarchy are debt holders, often bankers, who loan money to the company for operations in return for a fixed rate. These debt holders don’t get much upside beyond their fixed rate. Lastly, the equity holders receive what’s left. Once the salaries and the debt holders are paid, whatever remains goes to the equity holders. This amount can theoretically be infinitely high but also infinitely low, too.
The downside to this infinite potentiality of equity holders is that if there isn’t enough money to pay salaries and debt holders, then the equity holders get nothing.
On the flip side, when business is booming, then employees still receive their same salary while the owners pocket the extra profit. A big difference between the employer and the owner comes down to risk and earning potential. To be an owner, you must understand that you absorb most of the downside that happens to the business.
However, employees are not untouchable. They may get fired or replaced, sometimes by surprise or without good reason, and they may lose their job to the business going bankrupt. But their losses aren’t really a loss, rather it’s more of a loss of income. When a business goes bust, the employee loses their job. So they don’t lose money, they just stop getting paid. But when a company goes bust then the owners lose all their invested money and time.
The reason owners are willing to take risks in business is for the infinite potential upside. If a business happens to have the right product at the right time with excellent employees, then the owners are the ones who are rewarded the most for the risk they put into the business. They are essentially risking their time and capital for a society-benefiting project that is more likely to fail than work.
Employee salary is linear and more stable. However, they typically have a ceiling to how much they can earn.
Earnings for an owner compounds (both positively and negatively) and is more volatile. But with the risk comes unlimited potential upside. This is why all of the wealthiest people in the world are owners and not employees.
Ownership explains how Jeff Bezos once gained $13 billion in a single day, but has also lost $7 billion in a day.
Here’s an extreme example, but to put salary vs ownership in perspective: If you earned a salary of $2 million every week from the day Jesus was born until today, you would almost have as much money as Jeff Bezos. The difference is it took you over 2 millenniums, and it took Bezos 27 years.
To be an owner, you don’t have to be as risky as Elon Musk in order to reap the rewards of compound interest. Not everyone aspires to be super wealthy, and some prefer the security of an employee. Regardless of what you choose, it is good to understand the differences.