I’m launching a periodic newsletter called The SMB MBA. It’s about the lessons I’ve learned along the way in 13 years of owning a company. If you got on this list by mistake, my apologies. If you like the content let me know and spread the word. Now on to my first post.
Alan
TL;DR: All businesses hit Black Holes where growth slows or reverses. These usually happen every time a business doubles. The solution to getting out of them is to become a better leader yourself and restructure your leadership team and processes.
Small businesses stay small for a reason and that reason is usually the owner(s). That’s a mangled quote from Brent Beshore who is one of the brightest thinkers out there on small business. Another business mentor of mine, Greg Crabtree, wrote about the most common reasons businesses get stuck at various stages of growth. He calls these plateaus the Black Holes of Business. Some people navigate the black holes that confront them with no issues but most just never do the learning they need or make the investment and effort to get past the plateaus1. Most small businesses just stay small.
I do a lot of business coaching through the Entrepreneurs Organization (EO) and I try to pay attention to the advice I give in running my own company. I’ve seen the black hole come several times: first at $1m, then when approaching $5m, and the again around $10m. It replicates its way on up the revenue scale whenever a company roughly doubles. So how does it show up?
The Black Hole at $1m
First, let’s look at $1m. Below that level, we are usually dealing with founder run and done businesses. The owner or owners are the driver of sales and the ones fulfilling the sales. They might have an admin person or a couple or a junior doer type but the founders are the business. Around $1m that begins to change. The owner(s) simply run out of time. Many businesses stop there. Only 10% of businesses ever generate $1m2.
So what’s happening? In most cases the business gets stuck at $1m because the owner(s) can’t generate business that other people can do or the owner can’t find the right type of person to do the work s/he is selling. In other words they have no leverage on their time.
The only escape from this trap is to get better at leverage or to charge more. Lawyers tend to be crappy at getting leverage. At most they’ll have 2-3 associates so their solution is to charge a lot more per hour. That’s fine as far as it goes but I don’t know any lawyers who are really coasting. They are always working. As one friend of mine who left a big firm put it: “A law firm is like a big pie eating contest where the reward for winning is more pie!” Do what you want with your life but that sounds to me like a terrible option.
Most business owners should aim to get more leverage. That means creating ways for other people to do things for you. So you’ve got to begin systematizing how you work. You’ve got to break out your process so that less experienced people can do parts of it. You have to automate and outsource non-core functions. And for god sakes go hire someone to do payroll!3
This process isn’t easy. It requires a lot of time, trial and error, and difficult decisions. You just don’t have enough experience. You have to hire well but you don't have much experience hiring. You have to pick a payroll provider, you have to make IT decisions, you have to…. It’s pretty overwhelming and the chances you will make good decisions 100% of the time are basically zero. There are three ways to deal with this issue:
Struggle.
Join a networking/educational organization like EO where you can get advice and recommendations4.
Buy a business that has already figured it out5.
I picked the “struggle” option for my $1m Black Hole. It took a couple of years of hiring and firing employees and service providers to figure enough out to launch my business past the first Black Hole and into orbit around the second. I don’t even want to talk about some of the lawyers, benefits brokers, and crazy employees I dealt with. Maybe that can be another post.
The Black Hole at $5m
The second Black Hole is in many ways the toughest. Very few companies get to this stage. Only 4-5% based on my interpretation of census data6. There’s a reason so few get there. Getting past $5m requires you to pretty much reformulate your entire business. The people you hired to start running parts of the company at $1m are not people that can run a $5m business.
At $5m you have to start employing specialized managers. For example, you probably need someone with at least some experience with Human Resources. That’s most likely not your skill as a business owner. At $1m you had an admin person cover it part time. Now the issues and risks are getting more complex and the admin person is dropping balls.
My guess is the admin person hasn’t become more experienced in HR since that isn’t his or her main job. You’re also probably not a great judge of HR experience and skill since it isn’t core to your business. Same goes for finance and maybe IT and marketing. I’ve found that owners tend to be good at sales and delivery of whatever product or service they provide but they pretty much suck at all the supporting functions. Most owners don’t want to deal with these supporting functions and are cheap so they jump at the easiest and least expensive option to “solve” those issues. The results of those decisions are not pretty. In the words of Jason Isbell: “Such damage was done.”
Many owners spend years hiring the wrong people, then firing them and searching around blind in the darkness while circling around that $3-5m revenue number. And this time all their salaries are higher than they were at $1m so the mistakes are bigger and take longer to recover from. I know I made all those mistakes and I even had the pleasure of losing money and piling debt on a line of credit while I tried to work things out.
My solution to the $5m Black Hole was to go learn. I joined EO. I hired Greg Crabtree’s firm and got profitable. I parted ways with some pretty fantastic people who weren’t right for the next phase. I got a better lawyer, accountant, and found a sales consultant focused on my industry. I hired that dedicated HR person and finance person with experience and created our first leadership team structure where leaders had distinct functions and responsibilities. We also implemented a version of Scaling Up and the Entrepreneurial Operating System (EOS) to track progress and encourage accountability.
Outside of people, I reviewed our cost structure and started cutting out expenses of dubious effectiveness and finally I learned about a word that had only brought shudders to me before: “process”.
At $5m you need to start writing down how you do things: how you win business and deliver it, how you onboard people, how you do payroll, etc. You also need that process to get data about how the business is doing month to month. If you don’t close your books every month, collect the data, and then make it available, you can’t measure how you are doing. If you don’t have a consistent marketing and sales process, you can’t project sales. It’s a lot of work but if you get enough of it right you find escape velocity and start cruising to $10m.
The Black Hole at $10m
Only 1.6% of business ever get over $10m. The air up here is a little thiner. At this point you are a roughly 50 person company unless you have lots of pass through revenue and subcontractors. You should have dedicated managers for almost every function: marketing, sales, delivery/fulfillment, finance, technology, and HR. Most companies will combine a few of these together (marketing and sales) or still outsource tech but most functions have or should be preparing to be separate functions.7
To get past this threshold I’ve found two things are crucial: the quality of the leaders running each function and their ability to build teams and processes around what they do. Lots of companies grow to $5 or even $10m on the back of its founders ability to sell. At this level, you need to start professionalizing the function. How do you get leads? How do you close those leads? Can anyone beyond the owner do that successfully? If the answer is no, you’re probably going to have trouble scaling.
Same goes for finance. Can you reliably predict revenue? Do you have a handle on your costs? Do you know what you are investing in and what the return is on that investment? Do you have a consistent way of interviewing, hiring, onboarding, managing the performance of, and off boarding employees? It starts getting scary here if you don’t. Crucially you also need your specialized managers to begin building teams. The finance person might need a controller. The HR person might need a recruiter and so on. Your managers have to go beyond managing themselves to building teams that run on explicit, written down, and auditable processes. Ughh, it’s starting to feel a bit less entrepreneurial.
It’s a challenge for most founders. At this stage, you should have people to manage almost everything in the business and your job becomes about coaching them and holding them accountable to processes and team management.
Companies get stuck here because the owner can’t adapt to his or her new coaching and accountability role. S/he wants to keep doing the function that makes them feel good. S/he won’t move on from that person who is loyal but can’t do the job at this level. S/he won’t pay for quality. “I’ll just get the junior person with no experience to take on HR,” the owner thinks. It’s all about tough decisions and risky investments. I’ll cover some of the key investments owners should think about at this stage as well in another post.
Beyond the owner, there is often an issue with a person who worked well at $5m but can’t get comfortable with building their own team and moving to more consistent ways of doing things. Unfortunately, those people need to go before you get over $10m.
The Black Hole Beyond $10m
This is a topic for another day but now you’ve got to think about departments and not teams. You’ve got to level up you talent by attracting big company people. There’ll be a lot of private equity people knocking on the door hoping you’ll let them in. Once again, the challenges are all different but I’ve rambled on long enough for today.
Just remember, owning a business is a huge challenge. It will reflect all of your idiosyncrasies and foibles. Unless you learn to deal with them, you’ll stay stuck. The Black Holes are how you learn. The market is telling you something is wrong and you need to be self aware enough and curious enough to figure out what that is and go fix it. As you can see it takes a lot to learn how to overcome these barriers so don’t do it alone. Network, meet other owners, find good service providers. A business isn’t built by one person alone.
That’s it for this week.
I believe VC backed businesses might be able to break through the black holes by throwing money at the issues. Eventually you’ll hire someone right. VC businesses hit different kinds of black holes and if they stay in them too long, that funding goes away.
Yes, yes, I know a lot of those businesses are some guy’s boat but it’s not a big number regardless.
You know who you are.
Option I would choose if I had to do it again.
Possibly the best option but very dependent on valuations and what is available. Good advice from EO is always there but good deals on acquisitions aren’t.
https://dmdatabases.com/databases/business-mailing-lists/how-many-businesses. I used roughly $200k in revenue per employee.
Of course there are exceptions to every rule so god bless you if you can run an operation this large without more professional management. Please send me your newsletter as I would like to subscribe.