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Berkonomics

Plan for your ‘every three million dollar crisis.’

Here is a phenomenon I discovered over time when dealing with many small start-ups in their early revenue period.  A very predictable series of rotating crises seemed to befall most every one of these young companies.  These became so predictable that I could accurately label them as occurring about every $3 million in gross profit (or revenue for service companies).  By defining this in terms of gross profit, we can therefore include distributors with 15% gross margins as easily as software companies boasting nearly 100% gross margin.

There is a rotating series of predictable crises that most often reveal themselves like this:

At the $3 million revenue mark, the company often has grown from founders to about 20 employees, or $150 thousand in revenue (gross profit) per employee.  Of course, venture-funded startups with long product creation times do not fit this mold as easily, often funded for long periods of losses with many more employees at hand in development positions.  But at or around the 20 employee mark, the founders usually find that two things occur.  The original management span of control is exceeded and management must be delegated to one or more middle managers to maintain efficiency in the workplace.  Second, some of the original employees, occasionally one or two friends of the founders, are discovered to be falling behind as more professional employees show them up to be less competitive in their jobs.  So management reorganizes the structure of the organization to fit the new needs of the growing enterprise.

[Email readers continue here…]  At about the $6 million mark, revenues have ramped to the extent where the original product standards of quality are challenged, as is the speed and efficiency of customer service. Changes need to be made quickly to preserve the reputation of the company, adding a quality control function if not present, adding more QC steps in the process, addressing the number of customer service people on the line, creating longer hours to serve a larger customer base.  Failure to respond to this predictable crisis quickly labels a company as a provider of poor quality, which seems to travel unbelievably fast among the industry, helped by competitors anxious to point out the problems.  And once fixed, the perception of a fixed problem lags the reality by many months, making this a particularly tough crisis, common as it is.

At around the $9 million mark, the company suffers a most predictable cash crisis, one where the costs of growth in working capital and infrastructure creates the need for new sources of funds from investors, banks or asset-based lenders.  If the company is not profitable, these channels for capital are not as easily tapped, extending the crisis and challenging the health of the enterprise.

Surprise.  At around the $12 million mark, the company finds itself full circle, and in need of reorganization again along with a bit of house cleaning, pruning the poorer performers from the ranks.  That’s about at the 80 employee count, a time a little beyond when the company should have transitioned to a professional human resources manager to help solve this and future employee crises.

Do these sound familiar?  They should, even if the dollar amounts are out of alignment with your experience, since some companies are funded well enough to skip the first financial crisis and some so efficient as to skip the first organizational crisis.

With this insight, you should be equipped to spot early signs of each crisis and plan around them in time to avoid the full impact of each in turn.

  • When in the beginning the founders are working hard to try to get the products out in the market, there is little time nor incentivie to think ahead with the problems and crisis that a growing company is bound to experience as Dave so nicely summariezed. I think the key is less bound to the every $3 million mark, and more to detecting the problems as early as possible, and ringing a bell when that first danger sign appears.

    An entrepreneur can easily feel like a frog at the bottom of a well. Such insigt serves as a constant reminder and in doing so broaden the sky that we see.

  • Michael O'Daniel

    With all due respect, I would recommend a little different approach. People are SO critical to the success of an enterprise of any size that I believe you must institute “professional human resources management” from the very beginning, even if you use a consultant or part-time contractor(s) to do it.

    Founder-run organizations in particular are very susceptible to ignoring this critical area, which is not surprising since the founder(s) themselves probably do not have professional management skills, and in the early stages everyone is hunkered down trying to do the work, avoid cash crises, etc.

    You can’t afford poor performers even when you are at 20 employees or fewer, and maybe the product hasn’t even rolled out the door yet. And then when you ramp up your customer-facing activities with a small workforce, one bad hiring/firing decision can cripple the entire company.

    If you set up an ongoing process of employee review and evaluation, as well as a regular feedback loop with your employees, from the very beginning, you can mitigate some of these bumps at the $3-6-9 million milestones. If you treat your employees as collaborators and assets / profit centers instead of headcount / cost centers, it makes a huge difference in growing a successful business.

    When and if you do add middle managers, one of the key things you want to look at is their ability to enroll the workforce in constantly raising the level of performance and contributing to the growth of the organization. That’s how you keep superior employees and set standards that motivate the not-so-superior people to improve their game.

  • Dave brings such clarity to an undisputed truism on what I’ve seen happen at 2 other companies and am witnessing as we currently grow from $6m to $9m.
    Thank you for the reminder!

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