By: Jen Bilik
Entrepreneur Jen Bilik learned a lesson the hard way when she trusted the wrong person.
The day I confirmed that a friend and mentor had stolen $1.5 million from me was one of the worst of my life. Beyond the betrayal, I wondered how I could have been so naive. Where had I gone wrong?
When I started Knock Knock, I was like a lot of new entrepreneurs. I knew how to publish books and create our brand of witty gift and stationery products, but I didn’t know how to run a business. Because we were fortunate that many of Knock Knock’s offerings were immediate hits, our challenge wasn’t failure–it was filling the orders of success.
Most of the products from our 2002 debut had either slim profit margins or lost money. It quickly became clear to me that we needed to manufacture overseas. But without prior experience in international manufacturing, I had no idea where to begin. Not to mention that I was working 90-hour workweeks with acid running through my veins and countless balls in the air–something had to give.
Enter the Broker
Just as Knock Knock was ready to explore overseas possibilities, a manufacturing broker moved into the suite next door. His experience? China and paper products. How much would it cost for him to make our entire Fall 2003 product line happen? Just a 5 percent commission. What did I give him? A handshake and an order worth a couple hundred thousand dollars.
In mid-2006, however, it was obvious that Knock Knock was not nearly as profitable as it needed to be. A consultant I hired to help identify problems said, “You’re paying way too much for manufacturing.” I could, he told me, request customs records on our past orders through the Freedom of Information Act. These would allow me to compare what the broker had paid for our products versus the amount he’d charged me.
After a painful forensic-accounting slog, the verdict was in: rather than paying the quoted 5 percent, we had forked over an average of 34 percent, totaling an extra $1.5 million over three years. And the broker’s take had actually gone up over time–he’d clearly exploited my naiveté. Worst of all, we had no choice but to keep working with him! The broker had been handling all our manufacturing, and Knock Knock needed products to sell. While we ferociously investigated independent sourcing, it took more than a year to cut him out entirely.
How to Protect Yourself
One of the things business offers that personal life doesn’t is instruments by which to govern relationships: contracts, formal negotiation, competitive pricing. Because I was so overwhelmed by everything else, I just couldn’t turn down–or clearly analyze–the too-good-to-be-true promise of one-stop manufacturing shopping. In other instances, I insisted on contracts for deals worth as little as $500. How did I manage to let this situation get so far away from me? (I mean, aside from believing that people are generally good and don’t steal or lie.) Here are seven lessons I learned from my $1.5 million mistake:
1. Get it in writing. Although the broker had verbally quoted me a 5 percent commission, there was no contract governing our business relationship, my biggest mistake. That made suing him almost impossible. Plus, a contract would have revealed that his business was incorporated in Hong Kong, another issue that made litigation tough. The estimate to sue him and almost certainly lose? At least $250,000, not counting all the time, energy, and emotion Knock Knock would spend on the case.
2. Don’t put all your eggs in one basket. Single-point failure is always a huge risk when services aren’t diversified, but, more importantly in this case, my company was doing no competitive bidding. The broker shared with us the competitive bidding he was doing, but we had no independent sense of what things actually cost.
3. Ask for original documentation. I was paying a “commission” without seeing original invoices. If something is a variable cost based on another cost, it’s vital–and typically expected–that you see the documents that comprise the basis of your percentage payment.
4. Business is business, not friendship. A few smart, experienced people had warned me that this broker wasn’t a good guy. My response? “He’d never do that to me because we’re so close.” Not only did I ignore red flags, but considering the broker to be a friend and mentor allowed me to neglect addressing our affairs as business.
5. The bigger the project, the longer it takes to change course. When I discovered what the broker was up to, I wanted to have a temper tantrum and tell him to go to hell. But our company needed product, and I’d created a situation for which we had no other options. The fix didn’t take weeks or months: it took over a year. (Sort of like how divorces take longer than informal breakups, especially if there are kids involved.)
6. If it sounds too good to be true… Yep, that old nugget. I felt the 5 percent commission was so low compared to the service the broker was giving us that I constantly paid for shared travel and meals. I even wrote him verbose thank-yous and gave him gifts. The thought of all that makes me shudder with shame.
7. No matter what mistakes you make, you have to forgive yourself. These mistakes embarrassed me and ignited my propensity for self-loathing, but that doesn’t help anything. At the time, I was in way over my head and it was all I could do to hold it together. Fortunately, the $1.5 million mistake didn’t kill my company.
It’s hard to admit that I paid $1.5 million to learn that an entrepreneur ignores basic business principles and instruments at her own peril. If someone with whom you want to do business balks at formalizing the arrangement, you should never, ever do business with that person. Like me, most entrepreneurs end up figuring out how to handle themselves after a few bad deals. I just wish that it had cost me a little less.