32. Frequently when a corporation is organized, stock is issued to a promoter as payment for his services. An enterprise may have great latent possibilities provided sufficient capital can be secured for its development, but until the possibilities for making a profit can be clearly shown, it is difficult to interest the investing public. To interest investors in an enterprise yet to be developed requires a special talent not possessed by the average owner of a patent, mine, or process. There are men who possess this special talent and who make a business of promoting companies.
In many cases—probably most cases—the owner of the thing to be promoted has no money with which to pay the promoter. Consequently, the promoter first satisfies himself that the enterprise actually holds possibilities of profit and then agrees to accept all or a part of his fees in the stock of the company. The portion of his fee that he is willing to accept in stock, and the number of shares demanded, is governed largely by his own faith in the enterprise. His fee may be a certain per cent on the stock sold, or it may be an arbitrary sum represented by a certain number of shares. When he accepts his entire fee in stock, it may represent from 25 per cent to 50 per cent of the entire capitalization, and while the fee may appear exorbitant when represented by the par value of the stock, its actual value to him is represented by the real value of the stock, or the price at which he could sell it.
Volumes might be written on the subject of promotion, but our special concern is the proper treatment of promotion fees on the books of the company. Strictly speaking, promotion fees are as much an expense as the cost of printing the company's prospectus, but to immediately charge it to expense would, in many cases, cause the accounts to show an impairment of capital at the outset. Suppose, for example, that a corporation is organized with a capital of $100,000.00 all paid in cash. The promoter is paid a fee of $15,000.00. Profits earned—trading profits—in the first year are $8,000.00, but we have a charge of $15,000.00 for promotion in the expense account. The books show that the company is insolvent, the liabilities being $7,000.00 in excess of the assets, while the business actually is in a healthy condition.
Expenses paid in the regular course of business are expected to be off-set by earnings. When we pay rent for a store or office we expect that, by reason of our occupancy of that store or office as a place of business, our earnings will be increased in an amount greater than that paid for rent. Promotion expense cannot, in itself, produce earnings. The cash, or other form of asset, received from the sale of stock—the direct result of promotion expense—is off-set by the stock liability created. Earnings to off-set promotion expense must come from future operations of the business.
It has become quite the general custom, therefore, to allow the expense incident to the organization of the company to stand on the books as a fictitious asset, under some such caption as promotion expense, promotion fund, or organization expense. The amount is gradually reduced by charging a stated per cent to profit and loss each year.
There is another special reason why it would be manifestly unfair to immediately charge promotion fees to expense. Suppose a promoter receives 20% of the stock for his services, while the holders of the remaining 80% have paid cash for their shares. Since the 80 per cent paid in cash must earn dividends on the entire 100 per cent of stock, it would be unjust to the holders of the 80 per cent to withhold dividends until the par value of the 20 per cent of stock shall have been added to the assets of the company from profits earned.
The Entry. A patent is owned by Geo. Davis, who secures the services of Wm. Lane to promote a company to undertake its manufacture. The corporation is capitalized at $500,000.00. Davis sells the patent to the company receiving $250,000.00 stock in payment, and Lane receives $25,000.00 stock for promotion, when he has secured subscriptions for the remaining $225,000.00 at par. The entries to record the issue of stock to Lane for promotion are:
The entries for the shares issued to Davis and those sold are the same as previously explained and illustrated.
SURPLUS AND DIVIDENDS