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Agency problem

All the Hows of a First-Time Business Owner: There is a thin line between bankruptcy and the freedom to be an entrepreneur: An idea for a present for yourself (or to any entrepreneur).
An idea of a present for yourself (or to any entrepreneur).

If you occasionally spend holidays abroad, at least once you wasted money on something, and later realized how easy was to avoid the mistake. Maybe you ate the courtesy breadbasket in a Portuguese restaurant, without knowing it was not for free. Maybe during your last ski trip, you took a taxi to the slopes, just to discover later that there was a free shuttle for anyone with a ski pass.  Tourists have a fair share of oh, why I did not see this before! Followed by the regret of losing a few bucks. The culprit of most of these situations is the same: an agency problem.

              Agency problems also torment, with a surprising frequency, entrepreneurs. This leakage of small sums, drops of money wasted that at the end of the year could fill a bucket, is the difference between a profit and loss.

What is agency problem?

Agency problems are conflicts of interest found in any relationship where someone is supposed to act in another\’s best interests. 

Examples of agency problems are:

  • The relationship between someone selling a house (principal) and a real estate broker (agent). The owner of the house expects the broker to sell it for the best price. The broker, however, may be interested in selling it as quickly as possible, meaning that he may sell cheaper. This is an agency problem.
  • A CEO (agent) should manage a company in the most beneficial way for the shareholders (principal). But if the executive is going to retire next year, he may take actions that pump the short-term results (therefore, increasing his end-of-year bonus), and damaging, in the long-run, the shareholders\’ equity. This is an agency problem.
  • A mechanic (agent) is entrusted by the client (principal) to fix his car. But the mechanic may leave hidden problems to bring the client back in few months and make more money in the process. This is an agency problem.

Agency problems also happen with entrepreneurs, who can be simultaneously agents from their investors, and principals if they are also shareholders.

It gets worse when a project has deep-pocketed investors, as more and more startups are in this age of venture capital. If scarcity is a catalyst to optimize investments, abundance can make it dumber.  It is not rare to see tech companies with barely a place in the market and not making any profit, throwing lavish celebrations because of some vanity metric (like page views or clicks).

                The best way to avoid the tourist mentality and not waste money on trip mistakes is to not withdraw your maximum holiday budget. In the same way, when starting a business, do not look at all your raised capital as disposable capital. Countless companies could avoid debacles if only they reserved a part of their initial money for disasters.  To have this financial backup for emergencies is the first step, so once you made it, the next stage is to tap the leaks where the money drops out.

How to mitigate Agency problem?

Understand what is expensive and assimilate the costs

In my first book – Moving Out, Working Abroad and Keeping Your SanityI wrote about how specific advice for living far from home or in places full of particularities. So when I tell you to understand what is expensive in your new location, it means to do relative cost research. Visit tools like Numbeo or Expatistan and check how prices differentiate between your new and old markets.

This is not time wasted, but invested. The money you will save will compensate each second.

 Does your new base have expensive square meters, making the office space maintenance costly?  Invest in remote work. Since the 2020 pandemic, technological tools to facilitate home offices have unlocked this option to several new areas.

Is it difficult – or expensive – to hire people for support functions? Outsource it. Websites like Upwork or Fiverr make it easy to find specialists for almost all remote tasks. But be careful to not outsource your core activities – the potential for creating agency problems when outsourcing core (or revenue-generating) activities is enormous.

Are the paperwork costs too high? Are you wasting too much time signing and sending forms? Use an electronic signature and avoid lines in the post office and public offices.

Are you spending afternoons trying to understand new regulations in your sector?  Look for someone that already deals with them and ask for an ad hoc consultation. LinkedIn is a good place to find specialists.

This last instruction goes in line with a thing I learned in a hard way:

Do not let the lack of knowledge destroy your leverages and create an agency problem

Or:

Do not be fooled.

Dishonest taxi drivers (agents) cheat tourists (principals) by doing longer paths because the victim lacks familiarity to realize all the unnecessary turns. Deceitful mechanics will test the client\’s understanding to see how far they can invent problems and rip them off. In these and many other situations, your lack of knowledge destroys your customer leverages and creates the money leaks mentioned at the beginning of this article.

If you are opening a business, potential providers will assume that you have money to invest, plus the need to purchase services and materials. While I believe most people have good intentions, a capitalized entrepreneur is attractive for predators disguised as partners. When starting my business, I fell prey to an SEO (Search Engine Optimization) agency that charged me an absurd amount for very subpar service.

Realizing how money leaked out to SEO agencies, I learned the subject and discovered better alternatives. Digression: In fact, I found SEO so interesting that I created a new website just to test the things I was learning. Cool stuff, besides saving some money by assimilating this cost, I discovered a new hobby and gained an extra skill.

Be humble. Before spending hours planning targets, invest time in chats with more experienced (in your market and location) entrepreneurs. Besides discovering details like the best suppliers, you will also see how the successful ones in your field are: what are their characteristics, personalities, and abilities.

With such expertise, you may even re-evaluate the path to develop the needed skills for your triumph.

A great way to avoid an agency problem is to not start a pet shop if you are allergic to fur

Currently, recruitment happens at striking speeds. Automation helps with the most boring tasks. One may think that entrepreneurs no longer need to know how to perform their core business activities since it is so easy to hire, train and automate, creating autonomous business systems (which are often good by the way).

In other words, some people now think that individuals allergic to fur should run pet shops. People think that you could be always a remote entrepreneur, as long as you hire a good manager.

This belief ends with the sign of the first agency problems – conflicts of interest inherent to relationships where one party act in another\’s interests. If you despise your core activity – or if it can kill you, like in the example of the allergic-to-fur entrepreneur – how to create the incentives necessary to avoid agency problems and motivate a superb manager?

How do you expect to select a good manager to perform a task you scorn? Even if you are not turning the dough yourself in your pancake restaurant, you still must be able to test your own product.

In this matter, if I could give only one counsel, would be this: even if the opportunity looks great, even if you see immense suppressed demand, do not start a company in a market you loathe. Be fond of your core business and try your core product. This is more than the way to avoid any agency problem. This is the way to excellence.

Interested in learning more about cutting-edge business techniques? Check this article with 5 Books Every Entrepreneur Must Read

Starting Your Own Business Cover - How to identify and solve an agency problem.
This was a chapter from the book Starting Your Own Business Far From Home: What (Not) to Do When Opening a Company

One way to avoid the agency problem is to use decision-making tools. Learn about them in this video.


If you liked this article about agency problems, you may also check:

How a Virtual Assistant Can Help Your Business?

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Antifragility: A Taleb Concept To Help You This Year


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Levi Borba is the founder of expatriateconsultancy.com, creator of the channel Small Business Hacks and the same website for Small Business Owners, and best-selling author. Subscribe to my articles (for free) and receive (also for free) the ebook “The Blueprint for First-Time Business Owners”.

1 thought on “Agency problem”

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