Written by Greg Crabtree
There is a natural no-man’s land for privately owned businesses that are between $1 million and $5 million in revenue. If your business is one of those that is stuck in the “black hole of business,” rest assured that there are reasons for the challenge and hope for your successful escape!
The Reason the Black Hole Exists
If you started your business from scratch, you not only managed all functions of the business, you were likely the only employee and executed all of the functions of your business, too. As you learned to work “on” your business instead of “in” your business, you climbed your way up to the magical $1 million in revenue and hit the first major transition point. It is here that you most likely had to give up either sales (business development) or operations.
Most entrepreneurs are naturally gifted towards sales or operations, but rarely both. The ones gifted in operational knowledge get stuck at $1 million because they have sold to all of the people they know or can easily contact, but they are more likely to be profitable at this point.
The ones gifted in sales have blown through the $1 million dollar mark headed towards $5 million but their hair is on fire, they are about out of funding resources, and are most likely losing money with the belief that the next dollar in sales will make them profitable.
Both entrepreneurial types need to begin by learning a simple lesson. The operations-gifted entrepreneur needs to find a way to create sales. The sales-gifted entrepreneur needs to get operations under control and exercise financial discipline - not every sale is a good sale.
The true challenge for both is that the $1 million sales mark is the first major time in the business cycle when they must hire infrastructure talent in advance of being able to easily afford it.
This challenge is made worse by having to truly delegate to this new key hire. They may come with experience, but there is that nagging thought that if they were so experienced, “why were they available?” If they show skill but have limited experience, you are turning over your precious business to someone who may risk your reputation and limited capital.
Welcome to the reason why entrepreneurs deserve the profits of their success!
The 5 Steps to Break Free of the Black Hole
Step 1: Drive to 15% pretax profit by the time you get to $1 million in revenue.
It always sounds great to glorify the success stories of the entrepreneurs that threw caution to the wind, grew like crazy and then figured out how to fund it. Unfortunately, you don’t hear the stories of how many more businesses fail by growing fast and unprofitably. Unless an investor or buyer can figure out how to get your fast-growing business profitable, you are of no interest to them, beyond picking up the pieces of your impending bankruptcy.
Step 2: Include the owner market-based wages in your calculation of profit.
If you get to 15% pretax net income, it is only real if you are paying yourself a market-based wage and are able to meet your living expenses off of your net pay. This means there are no distributions being taken out of the business except for covering the taxes on your business profits (assuming you are an S corporation or an LLC).
Step 3: Take no distributions of after-tax profits until you have met your growth goal.
The easiest way to measure this is to build your company cash balance to at least 2 months of operating expenses and have nothing drawn on your line of credit. This is what I refer to as your “core capital target.”
Step 4: Build your team using the “Salary Cap” concept.
Once you have got your business to 15% pretax profit, you can now make the next key hire and allow your profit to drop to no less than 10% pretax profit. You would then hold salaries constant until you are able to drive back to 15% pretax profit.
Once back to 15% pretax profit, you add the next one or two key hires and repeat the process. You may not be able to fund your growth totally from your own cash, but your line of credit balance should generally remain less than 50% of accounts receivable during this process.
Step 5: The “Cash Reward:” when growth levels off
Once you have a period of 3 to 6 months of level sales and you have maintained 10% to 15% profit during this growth cycle, you will experience the great cash reward as you do not have to reinvest your profits. It is critical to not become a “professional consumer” at this point and develop obligations (new house with big mortgage) or bad spending habits (exotic cars, vacation homes or recurring expensive vacations).
Those items are not necessarily bad, but it is easy to fall into spending the early fruits of your labor rather than building a strong foundation to weather the inevitable down cycle of the business market. I am all for enjoying the fruits of success, but too often the enjoyment gets in the way of good judgment.
When you can get the “silently successful” entrepreneurs to tell their story, you will find more of them followed a similar path to this than the flashy stories of high risk and high return. Both methods can work, but there are many more business casualties using high growth without profitability. Using this method, you will be much better equipped to have the kind of “backup fuel” needed to achieve escape velocity out of the “black hole of business” and into a new horizon of possibilities!
About the Author: Greg Crabtree has worked in the financial industry for more than 30 years. He founded Crabtree, Rowe & Berger, PC, a CPA firm dedicated to helping entrepreneurs build the economic engine of their business. Crabtree leads the business consulting team, helping clients align their financial goals with their profit model and their core business values. He is the author of Simple Numbers, Straight Talk, Big Profits! For more information, please visit: http://www.seeingbeyondnumbers.com/.