Best Practices: Sustaining Growth

Structuring for Growth

According to TEC speaker Ian MacDougall, organizations must perform four essential management roles in order to succeed over the long term:

• Produce results (P). The P role produces the results that enable the organization to meet the needs of its customers. It focuses on what needs to be done.
  
  
• Administrate (A). The A role ensures that people do the right things at the right time and in the right manner. It focuses on how things need to be done.
  
  
• Entrepreneur (E). The E role takes the organization into the future and makes it proactive rather than reactive.
  
  
• Integrate (I). The I role changes the consciousness of the organization from mechanistic to organic.

At the same time, all companies go through an organizational life cycle that consists of distinct stages of growth and decline. The key to planning for growth, says MacDougall, involves knowing which management roles dominate in each growth phase and structuring the organization accordingly. The growth stages include:

• Infancy. The business is launched and struggles to survive. Everyone in the company focuses on getting the product out the door. The ideal management profile for infancy is Paei, meaning a strong focus on the P role, with less attention given to the other three.
  
  
• Go-Go. The business develops a solid base of customers and earns enough income to more than cover expenses. Flush with its early success, the business grows very rapidly and begins to seek new opportunities. The ideal management profile for go-go is PaEi.
  
  
• Adolescence. The company is still growing, but the lack of systems and procedures begins to cause major problems internally and externally. The company needs to begin focusing on how it gets things done. The ideal management profile in adolescence is PAei.
  
  
• Prime. At the peak of the growth cycle, the company now has strong, profitable growth and good systems and controls. The ideal management profile for a prime company is PAEI.
  

Managing the Predictable Problems of Growth

Each phase in the organizational life cycle has a unique set of highly predictable problems that befall all companies who enter it . By knowing where your business stands in the life cycle, says MacDougall, you can identify these barriers to growth before they occur and take steps to minimize their impact.

• Infancy. The primary challenge in infant organizations is survival. This manifests itself in the following organizational problems:
  
  
• Running out of cash
  
  
• Making a fatal mistake
  
  
• Loss of commitment from the founder
  
  
• Personal problems
  
  
To work through these inevitable problems in the infant phase:


• Keep the cash flow positive at all costs.
  
  
• Don't give up control of your business.
  
  
• Track cash flow before profits.
  
  
• Avoid premature delegation.
  
  
• Go-Go. The predictable problems in go-go include:
  
  
• Lack of controls
  
  
• Midas Touch syndrome (the owner thinks he/she can do no wrong)
  
  
• Lack of resources/founder spread too thin
  
  
• "More is better" syndrome (emphasis on growing sales at the expense of other areas)
  
  
As a result of these problems, says MacDougall, every go-go company eventually makes a major mistake or encounters a disaster of some kind. If the company is lucky, the disaster serves as a wakeup call. If not, the company goes out of business. To keep damage in the go-go phase to a minimum:


• Stay focused on the core business.
  
  
• Don't spread yourself too thin.
  
  
• Keep your ego in check.
  
  
• Adolescence. Predictable problems during adolescence include:
  
  
• Resistance to the new policies and procedures
  
  
• Improper organizational structure
  
  
• Changing goals
  
  
• Lack of information systems
  
  
• Role clashes
  
  
• Founder's trap (inability to delegate authority)
  
  
In an attempt to deal with the adolescent growing pains, the founder often brings in a professional manager (someone strong in the A role) to implement systems and controls. However, cautions MacDougall:


• Don't bring in the A role when the company is in a financial crisis.
  
  
• Don't bring in the A role when you can't afford to be distracted from external activities.
  
  
• Don't bring in the A role without a very clear organizational structure.
  
  
• Prime. Prime organizations have one major challenge -- staying there. Achieving this goal involves two courses of action:
  
  
• Continually redefine what business you are in.
  
  
• Continuously decentralize the organizational structure.
  
  
"To stay in prime, you have to keep the E role alive," insists MacDougall. "You do that by constantly redefining the business and by structuring the organization to reflect each new definition of the business."

Keeping the Growth Alive: How to Avoid the Organizational Aging Syndrome

Organizations age when they lose the E role. According to MacDougall, four factors cause this to happen:

• Failure to properly define the business. Defining the business by the product rather than by customer needs.
  
  
• Mental age. Senior management thinks like a declining, rather than a growing, company.
  
  
• Improper structure. The organizational structure is set up in a way that squeezes out the E role.
  
  
• Style of the leader. The founder or CEO has an innate orientation that conflicts with the E role.

To prevent the loss of the E role and keep your organization young at heart:

• Define your market carefully.
  
  
• Stay mentally young.
  
  
• Make sure your organizational structure supports the E role.
  
  
• Check your own management style.

"Organizational aging is not a function of time or size," concludes MacDougall. "It's an attitude about your company, your customers, your market and what you expect from the business. Pay close attention to the E role, make sure the organizational structure supports it, stay mentally young, and you can stay young and growing for a long time."

Financing Rapid Growth

According to TEC speaker and capital finance expert Gordon Tunstall, most entrepreneurs make three huge mistakes when planning for growth:

• They limit their growth based on access to a common commodity -- cash.
  
  
• They limit their thinking to traditional "secured" financing.
  
  
• They attempt to acquire capital in increments rather than getting all they need at once.

The solution? Determine the full extent of your capital needs and acquire the financing all at once rather than piecemeal.

"When planning for growth, most entrepreneurs ask, 'How much capital do we have in the company and how can we best allocate it?'" explains Tunstall. "In contrast, high-growth companies ask, 'What could we do with the business if we had all the money necessary to grow it to its full potential?'"

Laying the foundation for obtaining growth capital starts with three basic steps:

1. Develop a credible business plan.
   
   
2. Let the professionals structure the financing.
   
   
3. Have a defendable strategy.

Today's capital markets offer a wide variety of financing tools. The most common include:

• Secured. A bank or commercial finance company loans the money based on a percentage of AR, inventory and/or hard assets.
  
  
• Anticipated future cash flow. Mezzanine lenders take an unsecured position based on the anticipated future cash flow of the business. It gets repaid with current cash flow.
  
  
• Subordinated debt. Also called "convertible" debt, this form of financing gets repaid with future cash flow.
  
  
• Equity. Equity can include many different forms of preferred and common stock, as well as certain types of convertible debt.

According to Tunstall, slow-growth companies generally limit themselves to secured financing. In contrast, most high-growth capital deals contain a mixture of all four types of lending. By creatively applying today's multifaceted lending tools, you can escape from traditional capital restraints and achieve exponential growth.

When financing high growth:

• Do not include a term sheet in your business plan. Instead, let the lenders propose the deal to you.
  
  
• Give away as little equity as possible.
  
  
• Don't get hung up on the valuation of the company when the money comes in. Instead, worry about adjusting the ownership based on actual performance when the money goes out.

"Currently, there's a lot more capital looking for high-growth companies than there are companies to absorb it," concludes Tunstall. "If you have a good story and you look in the right places, you can find a way to finance your dreams of growing the company."

Six Principles for Financing Growth

Before approaching the capital markets, says Tunstall, make sure you know the ground rules for success.

1. Match your financing needs with the correct financing product. In order to pick the financing products that meet your capital needs:
   
   
• Do the research.
  
  
• Get crystal clear about your financing needs.
  
  
• Get professional help.
  
  
2. Minimize risk. Entrepreneurs often think they have to bet the farm in order to obtain financing. On the contrary, financing your growth should involve less risk, not more. To minimize risk:
   
   
• Look for lenders willing to structure flexible agreements.
  
  
• Build in a cushion in case things go wrong.
  
  
• Don't take out a second lien on your house, give any kind of personal guarantee or give up control of your company.
  
  
• Never give away opportunities to protect yourself.
  
  
3. Adjust your lending agreement for actual performance. Most lenders will discount your performance projections because they have no guarantee you will achieve your business plan. However, you can (and should) negotiate a clause that adjusts the terms should you hit all your objectives in the agreement.
   
   
4. Conduct a very broad search of lending institutions. When looking for growth capital, start with about 100 lenders and work your way down to a final "short list." In particular, look for lenders who specialize in your industry and type of company.
   
   
5. Never give up control. Many financing transactions require you to give up some equity in exchange for the money. Some equity is okay, but if you have to give up control to grow your company, don't do the deal.
   
   
6. Write a world-class business plan. The quality and credibility of your business plan has a huge impact on the quantity and quality of the financing you get. In order to get the best possible deal, create a business plan that lenders can't resist.

How To Avoid "Growing Broke"

Growing broke -- outstripping the company's ability to pay its bills even though sales are increasing -- presents a real risk for every entrepreneurial business. In fact, says TEC speaker Catherine Gibson, if you're growing at a sustained annual rate of 15 to 20 percent or higher, running out of cash probably represents your biggest threat.

Financial deterioration usually occurs when the entrepreneur focuses on top-line sales at the expense of more meaningful performance indicators. Maintaining healthy (i.e., profitable) growth requires protecting your balance sheet, which starts with an understanding of three fundamental principles:

• When your business is growing its sales, its balance sheet is also expanding.
  
  
• Because balance sheets and income statements work together, how you manage your business determines how big a balance sheet is needed to support a given level of sales. Just one more dollar of sales will force an incremental expansion in the assets on the balance sheet in order to support that additional dollar of revenue.
  
  
• For every additional dollar of "forced" asset growth, a business must find a way to fund it.

Protecting your balance sheet also involves tracking key balance sheet percentages relative to sales rather than total assets. As sales increase, certain variable assets -- cash, accounts receivable, inventory and pre-paid expenses -- automatically increase. To manage growth, you need to understand how these variable assets change relative to sales and how those changes impact your balance sheet.

The final step in protecting your balance sheet involves looking into the future to see how an increase in sales will impact it. To forecast your balance sheet, simply plug in all your variable asset percentages based upon your projected sales growth. The percentages will tell you how much your total assets need to grow in order to support the new level of sales. From there, you can determine where and how to come up with the funding to support the additional assets.

"Smart CEOs and business owners never forecast sales without also forecasting the balance sheet," cautions Gibson. "If you can't get the funding to support your desired level of sales, either find a way to cut costs (so you can self-fund the growth) or else bite the bullet and scale back your sales objectives."

The Entrepreneur's Dilemma: How to Get Through No Man's Land Without Blowing Yourself Up

Entrepreneurial companies face many obstacles in their journey from new kid on the block to established player in the market. One of the deadliest is No Man's Land -- that difficult area between when you are too big to be small and too small to be big.

According to TEC speaker Doug Tatum, making it safely through No Man's Land requires a transition in four key areas:

• The economic model
  
  
• Marketing
  
  
• Management
  
  
• Money

In the early stages of most growth companies, the value proposition is built around the "cheap, high-performance labor" provided by the founder and one or two senior executives. Making it through No Man's Land requires developing a sustainable value-added proposition beyond high-performance cheap labor. To determine whether you have a sustainable economic model:

• Study your competitors.
  
  
• Project your economic model going forward.
  
  
• Understand your cost/revenue relationships.
  
  
• Manage your business by looking ahead, not backward.

By nature, early stage growth companies are market-driven, which makes them simple to do business with. As the company grows, the entrepreneur becomes less involved with customers, and problems develop. According to Tatum, symptoms of this inevitable growth problem include:

• Customers only want to deal with the entrepreneur.
  
  
• Margins and sales shrink for no apparent reason.
  
  
• Sales and operations are constantly fighting with each other.
  
  
• The entrepreneur turns his or her attention to new products and services to avoid dealing with the growing pains.

To reverse this trend and make the company simple to do business with again, the entrepreneur must do two things:

• Institutionalize his or her expertise throughout the organization.
  
  
• Build a solid management team.

Even if you successfully navigate the first three transitions, you still need money to grow. Most entrepreneurs manage to scrounge up enough money to get the business off the ground. As the fledgling enterprise grows, however, it runs head-on into the "capital gap."

The problem with the capital markets is they're not set up to provide financing until the company needs at least a million dollars worth of capital. As a result, capital between $250,000 and $1 million costs so much that most growing companies can't afford it. This capital gap represents one of the most dangerous points in No Man's Land. In their attempts to close the gap, many entrepreneurs take too much risk or end up giving away control of their companies. They try to raise money by selling the upside of their businesses when they need to focus on lowering risk.

Assuming your value proposition can sustain itself in the marketplace, you can get through No Man's Land by doing the following:

• Acknowledge the problem. Accept that your company is entering a very fragile point in its growth cycle and manage the business accordingly.
  
  
• Manage the four M's. Pay close attention to each transition -- economic model, marketing, management and money. Recognize that the correct strategies in these transitions are often counterintuitive.
  
  
• Never grow just for growth's sake. Companies don't get large and make money by luck; there has to be a sustainable, bottom-line reason for growth. Never forget that you can grow yourself right out of business.
  
  
• Surround yourself with the talent to get there. Hire at the senior level first and fill in the gaps in the middle as you grow. When going through No Man's Land, the organizational chart should look like an hourglass -- wide at the top and bottom and skinny in the middle.

Finally, figure out what you do best and position yourself to do it. "Sometimes the highest and best use of your time does not involve running the business," concludes Tatum. "If so, hire an experienced manager to run the company so you can focus on doing what you do best. Never forget, however, that the more the company depends on your unique skills, the more you limit its ability to grow."

Contributing Experts:

Catherine Gibson

Catherine Gibson is a senior manager, consultant and trainer with Moss-Adams, L.L.P., the 13th largest accounting and consulting firm in the U.S. A former vice president at the Bankers Trust Company in New York, Gibson specializes in strategic planning and business succession matters, and has trained and advised more than 1,000 business owners and bankers around the world. She has also taught continuing education courses in management at several Seattle community colleges. She currently speaks to TEC groups on the subjects of "Financial Management Insights" and "Growth: The Silent Killer."

Ian MacDougall

Ian MacDougall is the founder and professional director of Corporate Lifecycles, L.L.C., an international consulting firm that helps companies implement large-scale organizational change. He has consulted with government agencies and organizations worldwide in a diverse range of industries, including manufacturing, publishing, retail, high technology, financial services, higher education, social services, defense and telecommunications. A TEC speaker for more than a decade, MacDougall has addressed TEC groups throughout the U.S., Canada and Australia, consistently earning high ratings for his enthusiastic presentation style and keen insights into organizational structures and the decision making process.

Doug Tatum

Doug Tatum is a partner of Tatum CFO Partners, L.L.P., a national firm of career chief financial officers providing innovative CFO solutions to companies of all sizes and industries. Tatum has developed and conducted seminars for the FICPA and several other state accounting societies and has co-authored a book and course for the Florida Institute of CPAs, "Technical Tools and the MAS Approach to Small Business Engagement." He currently serves on the board of directors for several national firms. Tatum addresses TEC groups on the subject of "No Man's Land: Where Growing Companies Fail."

© Copyright 2010, TEC, Inc. All Rights Reserved.

Your use of this website constitutes acceptance of the TEC Privacy Policy and Terms & Conditions.