no man's land (growing companies) 05222012

No Man’s LandWhat to Do When Your Company Is Too Big to Be Small but Too Small to

Be Big

Doug Tatum

New York, NY: Portfolio (Penguin Group), 2007.

04/11/2023 [email protected] 2

Doug Tatum. No Man’s Land (NY: Portfolio, 2007)

Failures

Successful Small

Businesses Gazelles

Business Breakouts And

Merger CandidatesInflection

Point

No Man’s Land

Reve

nue

Employees1 20 100

No Man’s Land Inflection Point



The Four Ms

• Understand the transition that will happen in the Market.

• Address the changes that will be required in Management.

• Test the economic Model to assure continued profitability as the business scales upward.

• Understand the practical requirements for attracting the needed Money.



Conceptualizing Rapid Growth

• You parachute onto an island, set up camp, and create a very comfortable place.

• Then you send out scouts. Many never return, but a few come back saying “This is the path.”

• So then what you have to do is make a heroic decision to strike camp and burn it and say we will go now and never ever look back.



Rapid Growth

• Corollary #1: Rapid growth has a clear beginning.• Corollary #2: Growth confronts companies with

common problems.• Corollary #3: There Is no shortcut through rapid

growth.• Corollary #4: On the other hand, no man’s land

happens only once.• Corollary #5: Rapid growth has a clear endgame.



Market Misalignment Signs

• Has sales growth stalled? Losing your competitive advantage?

• Tension between promises made (sales) and delivery (operations)?

• Quality problems? Customer complaints? Always dealing with problems vs. high touch customer relations?

• Are you becoming bored and frustrated and looking for new products (as an escape)?

• Unable to distinguish between “good” customers who will lead you to growth and “bad” ones who won’t?



Market Navigational Rule

• The business as a whole must become good at doing what the entrepreneur did well with customers in order to re-create market alignment.– I do provide unique value, and this is what I built

my firm on.– My clients and what I do for them have changed

more than I ever thought they would.– I can no longer keep the business physically

aligned on the basis of my own efforts.



Reality Check

• Can you articulate your firm’s core value proposition, and can this proposition be broken down into a list of discrete processes?– Institutionalize the core value proposition.– Develop processes that replicate the

entrepreneur’s talents and systematize those processes.

– Develop a way to measure the results of the systematization and use the feedback to fine-tune or change the processes.



Pause Point Questions

1. Which customers would you bet on for the future, and which customers should be fired?

2. Name the one company that would be most interested in buying your company? Why?

3. What must you do to ensure that your business can continue to deliver its value proposition in a simple exchange? (What does your business have to do internally to keep it simple to do business with, without losing perceived value?)



Management Misalignment

• Is your inner circle frozen in its tracks? Do longtime, loyal employees seem in over their heads?

• Do all decisions rely on you? Are decisions not being made on a timely basis? Are you stretched too thin?

• Are you making bigger decisions based on instinct rather than actual knowledge? Is your business asking questions you can’t answer? Do other people in your firm sense a weak link?

• Is it difficult to find and retain new talent?



Hiring Senior Management

• Hire people who can do what you don’t do well.– CFOs are logical people to hire.– Don’t necessarily replace yourself with a CEO.

• Balance between continuity and change.– Keep the soul while acquiring new capabilities.– Protect the “soft side” of the business.– Agree on what to preserve in the culture and what to change.

• Cultivate a mutual decision-making environment – Include the best of what the old-timers and the newcomers

find important. Merge the old with the new.



Hiring Senior Management

• Make the tough management decisions.• Hire people who can make decisions.

– Do not hire in the middle before bringing in senior management.

– Only a senior-level hire will have the ability to make the experience-based decisions the firm will need.

• Complete the management transition.– Go after the best of the best.– Create the proper environment.– Be a help in the transition to experience-based decision

making. Follow through, don’t dump.



Outgrowing your Model

• A business model is an analysis of how a business makes money.– Capital deployed, the revenue produced, and the changes

in the elements of revenue, cost, and capital under different scenarios.

• Balance Sheet – still photo, once a month. – Assets = Liabilities + Owner’s Equity

• Income Statement – video month to month.– The income statement is a balance sheet changing over

time, including cash flow statements.



Outgrowing your Model

• Balance sheets and income statements, important as they be, are backward-looking.

• A business model, by contrast, is forward-looking.– A preview of the stills and the video.



…cheap labor”

Start-up Model

(won’t work forever)

“high perform-

ance…



High Performance, Cheap Labor

• Entrepreneur is the chief source of the firm’s value proposition.

• High quality goods and services delivered inexpensively.

• Relies on below-market labor of a committed core group.

• Unsustainable with growth.



Capital Cost of an Employee

Borrowed Equivalent

Salary Monthly

Salary Annually

$100,000 $1,559 $18,703

$150,000 $2,338 $28,055

$200,000 $3,117 $37,407

$250,000 $3,897 $46,759

$300,000 $4,676 $56,110

$350,000 $5,455 $65,462

7 year, 8 percent term note

Paying a salary of $56,000 requires the same amount of resources as borrowing and repaying $300,000.



Model Navigational Rule

• The value proposition of the business must be scalable (profitable at a higher volume) to navigate No Man’s Land.





REVENUES

variable cost

fixed

cos

t

No Man’sLandco

st

time line

Meeting the Growth Challenge



Model Question

• What kind of operational report can you create that will allow me to predict, with an accuracy of within +/- 10 percent, the company’s net income, prior to creation of the end-of-month financial statements?

• You can’t run your firm by looking backward every month to see what already happened.

• Creation of a viable operational report represents the only way for you to regain financial control and retain confidence in your business model.



Money

• Firms need to invest capital in front of revenue to create high-octane, high-volume infrastructure.

• Undercapitalization is usually not the cause, but rather a fatal symptom of business failure.

• $2 to $3 million is too much for early stage investors and incubators, but not enough to interest the venture capitalists.

• Capital shortfalls are the nemeses of No Man’s Land firms.



Misconceptions about Cash Flow

• Rapid-growth firms generally underestimate the capital required to emerge from No Man’s Land.

• Growth itself generates the need for capital, which seems counterintuitive. Growth creates a critical need for cash.

• A growing business requires capital in advance of revenue.

• And even when a business is and remains profitable, growth requires infusions of capital, for the very reason that growth eats up cash flow.



Misconceptions about Cash Flow

• The faster the firm’s orders accelerate, the more profit it makes, the lower the cash flows.

• More money going out quicker than the money coming in.



Profitable and Negative Cash Flow

-4

-3

-2

-1

0

1

2

3

4

1.22

2.32.9

3.3 3.8

-0.9

-1.8 -2-2.5

-3.5-4



The Capital Gap

• The number one priority of emerging growth companies is sufficient and efficient access to capital.

• To banks, due diligence and servicing capital needs of under $1 million are cost prohibitive.

• There is seed capital around, and private equity to fund established firms that have made it through No Man’s Land and have needs of $5 - $10 million.

• But there is a range of capital need ($250K-$5M) that the capital markets simply aren’t servicing.



Capital Funding GapCap Funding Levels Business Category Capital Sources Investor risk

$5 Million

• Commercial Bankers• Private Equity Groups• Venture Capitalists• Loans

$250,000

• Very limited access to capital (angels/factors)• High cost of account and collateral management• Business Borrowing exceeds personal assets

0

• Investment Made by Friends and Family• Personal Loans (banks, home equity, credit cards, SBICs, SBA loans

Emerging Growth Companies

Lower Risk

Higher Risk

Businessesin No Man’s LandLIMITED CASH FLOW - - Too big to be small,too small to be big

Small Businesses and Start-ups



Docusource (Example)“We offered a 20 percent annual interest rate, and at this point had only raised about 40 percent of what we need, with half of that total coming from the owners.”

“If we had additional capital, we would have built our sales organization and become aggressive with the other SouthernCalifornia companies; we would be placing sales branches in thosemarketplaces.”

“The acquiring company probably doesn’t need all our infrastructure – which means that the economy would be better off with us as an independent company than if we were acquired and duplicate personnel had to be laid off.”



What to Do?To maximize its chances of raising money, a company needs to reduce its real and perceived risk, by taking real steps related to the previous three Ms. Once a firm is realigned with its market, once management issues are dealt with, and once the firm develops a model for scaling profitably, the real and perceived risk goes way down.

Develop an honest, forthright, clear relationship with the people who lend you money. You will miss problems in the initial analysis, and many changes will occur. Do not hide problems. Remember that you will always need more capital than you think. They know that, too.



Cycles“It’s as if every company has to handle a ‘bet the company’transition every three to four years after the initial No Man’s Land transition to stay aligned with the lightning-fast changes going on in a given firm’s marketplace.”

What is difficult for the investor is determining whether it isinvesting at the very beginning of the transition, and thus gaining the advantage of catching the company just after it has successfully realigned for growth, or at the end of a cycle, thus getting stuck with helping the company during its next transition.

“It’s no longer just a financial engineering exercise. We really have to help these companies grow – management is now the key.”



The Issue of Risk

1. Are there any risks in the business that can be eliminated with money?

2. Knowing all that you know about this business,would you buy it?

3. What kind of money do you really need to growthe business?

4. Are you ready for outside equity and the transparency with investors necessary to make it work?



The Fifth M

• To survive No Man’s Land, leaders must manage a firm’s culture (i.e. its decision-making process) to assure that an appearance of forward motion exists at all times, even when survival seems uncertain.

• Momentum is institutional self-esteem.• Momentum galvanizes an organization, even when

mistakes are made and readjustment becomesnecessary mid-course.



Momentum “Mess Up and Clean Up”

• If a firm doesn’t make new promises, it is stuck with stagnant customers.

• If a firm makes too many promises, excessive burdens are placed on the staff.

• What firms need is not “messing up” and “cleaning up” but a productive balance between the two.

• Remember though, that some promises lead to whole rooms full of new customers, and others lead to an empty room with only a couple of new customers in it.



Move It or Lose It

“In the mid-1990s, I spoke with a guy who worked for a nationalcompany that was acquiring regional firms like ours. I remember him saying, ‘You either have to get in the game like us, or you’re going to shrink to a mom-and-pop again.’ That’s the choice. We have to move somewhere to survive. We can’t stand still.”

Getting through No Man’s Land is a “bet the company” commitment. You can’t both move to scale and not move to scale. A growing firm can survive for some time in a stagnant state, but not indefinitely. Something has to be done, and no number of half-measures, however well intentioned, will suffice.



Beyond Growth

“With something like this, your personal philosophy of life has to drive it. I was alone when I got into this thing, and I was alone when I got out. There are tons of reasons to make decisions, but not all of them are financial in nature.” Entrepreneur



No Man’s Land

(End of Part One)