Owners Live in Two Different Worlds

Business owners live in two different worlds. If you are a Baby Boomer, the title of this column might bring memories of any one of the many covers of the song by the same name. (Everyone from Nat King Cole to Roger Williams, and from Jerry Vale to Englebert Humperdinck recorded it.)

My application of it in business refers to the chasm between those owners who plan to sell a business valued at less than $3 million, and those who have companies valued at more than that. In M&A parlance; “main street” and “mid-market” businesses.

business presentationSome background is in order. I spent the week at two conferences. At the Business Enterprise Institute’s Exit Planners’ Conference we talk mostly about the complexities and structures of mid-market transfers. From there, I attended The Alternative Board’s International Conference for advisors who run peer advisory groups and provide coaching, principally for the owners of main street companies.

At the latter, I had the privilege of being on a panel with Bo Burlingham of Inc. Magazine, the author of Small Giants and Finish Big, and John Warrillow, the Founder ofBurlingham Warrilow Dini the Value Builder System and author of  Built to Sell. It would be challenging to find three people in the country who have spent more combined time studying how small businesses sell, and what determines their value to a buyer.

Even with two audiences of savvy professionals who are focused on the flood of business owners transitioning from their businesses, in many sessions the presenters had to explain the difference between the two markets. As an owner, it’s critical that you understand what the market is for your company. Using data from the other side of the fence is only destined to frustrate you.

Mid-Market

These are companies with a value (not revenue!) of greater than $3,000,000. To garner the interests of financial buyers (private equity groups), they have to generate pre-tax earnings of at least a million dollars a year. To attract strategic buyers, they must have some real differentiation in their industry or market. Those who are truly scalable and have already grown to over 100 employees are the hottest commodity; but according to Doug Tatum, the author of No Man’s Land, they presently account for about 30,000 of the 6.5 million private employers (2-500 employees) in the marketplace.

The acquisition outlook for these companies is wonderful. The financial market is blazing hot, with 7,000 private equity players and publicly traded acquirers chasing those 30,000 businesses, or at least any among them who will still take a phone call. Valuations  are growing quickly, with multiples in the upper end of the market up over 20% in the last two years, and well over a trillion dollars of “dry powder” waiting to be spent on buying them.

Main Street

Clearly, the odds are pretty high that you are one of the 6,470,000 owners whose company does not fit the description above. Welcome to Main Street, where differentiation is difficult or impossible to quantify. (Sorry, but in all but the rarest cases,  “service” is not a competitive differentiation.) The business exists primarily for the purpose of providing financial security for the owner and the employees.  Likely acquirers include individuals seeking to purchase an income, small competitors, or if you are close to the million dollar pre-tax mark, perhaps a private equity group looking for a “tuck-in” or “bolt-on” to an existing similar acquisition.

The news for these owners could not be more starkly different than for the chosen few in the mid-market. According to Burlingham, somewhere between 1.3 and 2 million of these businesses will come up for sale in the coming decade. According to both IBBA (the business broker’s association) and the US Chamber of Commerce, only about 20% of them will successfully sell to a third party. With the much lower population of Generation X, who have little in the way of liquid savings and eschew 50 hour work weeks, the pre-tax multiples in Main Street values are contracting, and the shrinkage grows worse the farther down the food chain you are.

The message is clear. As John Warrillow said, if you are anywhere close to the magic numbers that attract mid-market buyers, the most important thing you can do is drive your company over the top. The difference can mean double, or even triple the proceeds you receive. Here’s an exercise. A company making $700,000 a year with a valuation of 3x earnings can sell for $2,100,000. If they grow to $1,100,000 in profits with a value of 5x earnings they’d get $5,500,000 at sale. That’s 57% growth in profits for 161% growth in price.

Any questions?

Even the measurement of earnings between the two types of business is different. We’ll discuss that next week.

 

 

Share
Posted in Economic Trends, Entrepreneurship, Exit Planning, Selling a business, Strategy and Planning, Top Blog Posts | Tagged , , , , , , , , , , , , , , , | 1 Comment

One Response to Owners Live in Two Different Worlds

  1. David Basri says:

    There is no question about the difficulty in the Main Street market. Another strategy besides fading into the night is to find someone to pass it on to. That likely means finding someone years in advance, nurturing them and at some point starting to share equity. Having said that, I fully recognize that many small businesses are not in a market where a successor is easy to find. While I own a small software company, it is not so easy to find someone willing to start work at 3 AM so there are fresh bagels ready by 6 AM. Thank goodness there are such folks.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

The Toughest Part of Performance Reviews

There’s been some noise in the business press of late regarding large corporations’ decisions to eliminate performance reviews. Like those who have installed unlimited PTO (Paid Time Off) and other “new” management methods, review-less organizations are deemed to be more enlightened. Employees, especially Millennials, who work for enlightened organizations are presumed to be happier, and therefore more voluntarily productive.

To quote David Crosby in the song Deja Vu, “We have all been here before.” In the 70’s we had “Management by Walking Around” (MBWA). The idea was that managers would spend more time observing and interacting with their subordinates. This ongoing communication would eliminate the need for periodic formal reviews.

I was living in New Brunswick, NJ as I finished my undergraduate degree. Johnson and Johnson headquarters is in New Brunswick, and J&J dominates the local news as the biggest fish in a small pond. Their enlightened adoption went so far as letting employees decide their own goals for measuring effectiveness.

(A momentary aside. In the 70’s, as the Baby Boomers flooded into the workplace, there was substantial managerial discussion about how they were different from preceding generations. They were more educated, more concerned about the planet and social issues, and less inclined to follow command-and-control management systems. Sound familiar?)

Johnson and Johnson won multiple national awards as a great place to work. Employee surveys ranked it highly for its culture and atmosphere. Unfortunately, J&J began regularly missing Wall Street’s quarterly expectations.

Eventually there was a change at the top. As I recall the newspaper interview with the new CEO, he described J&J as “A great place to work. Unfortunately, we had a bunch of really happy employees who weren’t actually accomplishing anything.”

Now Amazon is taking a media pounding for its “rank and yank” review systems. Wait a minute; isn’t this roughly the same as Jack Welch’s famous (and very popular) “Topgrading” at GE? The book, by Brad Smart, is now in its third edition. Is striving to hire and promote the best workers good business, or just nasty capitalism run amok? Is Amazon really a sweatshop, or merely constrained by its business model from practicing the type of enlightenment that companies with 90% incremental margins (like Netflix) can afford?

performance review formI teach an annual program for first-level supervisors. In eight years, I’ve never had a participant volunteer that he or she likes doing performance reviews. In most small businesses they are avoided, delayed, and rushed when they finally happen. They are as painful for the reviewer as for the reviewee.

The solution is simple, although its not easy. Like so many other business processes, the work has to come up front to make execution simple. The secret is in setting goals. Real goals, not cotton-candy. What employee can measure their progress against “Sally should focus on becoming more proficient at her job,” or “Bob is almost ready to be a supervisor. He needs to develop his ability to delegate?”

I know it’s old hat, but Specific, Measurable, Attainable, Resourced, and Time-Sensitive (SMART) works, and its use in performance evaluation is a powerful tool. On Bob’s expected progress to supervisor, here are the possible goal parameters.

  • Specific: Bob needs to develop the skills and experience to supervise others effectively (This would be the whole goal setting portion of most performance reviews.)
  • Measureable: This will be rated on Bob’s completion of training as outlined, and his proven ability to understand the quality and productivity metrics in his department by preparing all reports for a complete project.
  • Attainable: Bob agrees that the objectives and timeframes outlined in these goals are achievable, and the company commits to making the necessary adjustments to support these goals.
  • Resourced. Approval is hereby given for Bob to enroll in Supervision I and II as delivered by Online Training International, followed by assignment as assistant supervisor on a project of not less that $5 million.
  • Time sensitive: Bob will be responsible for arranging his schedule to permit his completion of Supervision I by the end of the first quarter, and Supervision II by the end of the second quarter. Assignment to a large (>$5MM) project will take place following the training, but no later than the first month of the fourth quarter.

Now Bob has a road map of what he needs to do, and how to do it if he wants to advance. A ten minute check at the end of each quarter can tell if he’s on track. When the next annual review comes, there is plenty of advance notice as to what the likely result will be.

Not every job is as easily broken down. In fact, most are much more difficult, but the payoff is substantial. After all, if you as a business owner can’t define what you expect from your employees, how can you hold them accountable for delivering it?

Share
Posted in Entrepreneurship, Incentives, Leadership, Managing Employees | Tagged , , , , , , , , , , , , , | 5 Comments

5 Responses to The Toughest Part of Performance Reviews

  1. Annual reviews are a horrible idea. Can imagine getting feedback 12 months later after a positive or negative event – how does it help? It only slightly recognizes what occurred. We are now moving to quarterly reviews and one day to monthly reviews. In the book The Game of Work, by Charles Coonradt, teaches an excellent method of measuring the success of the employee and how to harness that success to mutual benefit both employer and team members.

  2. Jon K. says:

    John,

    Thanks for the walk down memory lane, great reminders… As I recall, the things in life that are worth amything are often difficult and a lot of work, not fun and easy.

    jk

  3. Oswald Viva says:

    I fully agree with the negative feelings about performance reviews and that’s why I wrote my book “Performance Reviews; The Bad, The Ugly, … The Alternative” (Amazon).

    • John F. Dini says:

      I’ll still argue that the problem is with bad performance reviews. Everyone likes to know where they stand, and I’ve yet to see the management team that focuses on employee development without a regular system of communication.

  4. John Lind says:

    An employee is responsible to offer three areas to his/her employer; 1. Performance, 2. (Mutual Respect to organization, fellow employees and customers) , and the, 3. Ability to “Think” as to how they can assist and help achieve the organizations charge. That is it!

    A performance review, on a quarterly “update” basis, keeps the individual attuned and allows an avenue to resolve any issues that may be getting in the way of the best performance possible.

    It works.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

Never Fire a Salesperson

The majority of business owners prefer linking pay to employee performance. The sales role in most businesses is the easiest and most obvious place to begin. Yet owners struggle with compensating salespeople in a manner that is affordable while still driving sustained performance.

Building a sales commission plan requires a balance between security (some form of base compensation) and incentives for performance. In addition, there are three factors that are considerations in the structure; Service levels, price flexibility and the length of the company’s sales cycle.

  1. Service Levels: These are (or should be) described in the salesperson’s job description. How many tasks are required that aren’t, strictly speaking, sales? Duties may require in-servicing or training clients on new products, straightening customer inventory, troubleshooting shipping and production issues, or other ongoing responsibilities that  fall more under the category of customer service than new business development. Base pay should reflect the percentage of working time that is expected for these tasks. Ignore the cost to the salesperson of these requirements, and they are likely to be neglected.
  2. Price Flexibility: This is a pretty straightforward part of compensation structuring. If prices are fixed, and the salesperson has no control over them, then commissions can be tied to gross sales. If the salesperson can offer customers different percentages off a book price, estimates, volume discounts or has any other control over the selling price, commissions should be based on gross margins.
  3. Sales Cycle: Simply put, how long does it usually take to land a customer? I worked with a CPA firm that wanted to hire a salesperson on commission only. When asked about the typical time between introduction to a prospect, and a decision to move compliance business to the firm, they answered “Two or three years.” They had no idea how the salesperson was supposed to survive long enough to see the fruits of his or her efforts. Pure commission structures are more appropriate in one-stop sales situations.

Base compensation covers two scenarios. One is the non-sales work as described above. The other is to provide a level of security while the employee is learning the business or building a customer base. There are three types of base pay.

  • Draw is an advance on commissions not yet earned. If the salesperson is starting with no customer base, draw arrangements frequently fall into the trap of a disincentive. Negative balances that have to be made up before the employee can earn more are discouraging. If there is a draw arrangement, it should logically be accompanied by a starting active customer base or recurring revenue that at least comes close to covering it.
  • Guarantees are similar to draw, but with no downside or deficit balance for falling short of goal. They function like salary, except that they are directly tied to sales production from the first dollar.
  • Salary is appropriate for new people starting out, or for positions that have a high service requirement. If the salary is to be permanent, then it should be about half the eventual expected income.

salesmanSalaries don’t have to be permanent. I knew one very successful organization that started all new sales employees on straight salary. Commissions were tracked, but none were paid while the employee was getting a salary. It lasted for six months, after which the employee automatically converted to straight commission.

If commissions were running at a rate less than the salary after six months, the salesperson was welcome to continue working for less compensation. The company also offered an interesting feature. The salesperson could elect at any time prior to the six month cutoff to move to straight commission. Of course, there was no going back.

This type of plan illustrates the final critical factor in any sales incentive plan. The salesperson should know, from the first day of employment, the level at which he or she is expected to perform, and the time allowed to reach that goal. Except for service compensation, any guaranteed base ceases at that point. A chart of this concept, dubbed “The Francis Curve” after the friend who first drew it for me, is on page 66 of my book Hunting in a Farmer’s World.

In the straight-salary-to straight-commission model above, salespeople knew from the first day when their commissions were expected to exceed their guaranty. Of course, many pleaded for an extension, claiming to be “real close” to making it. They were  invited to invest in their own success by toughing it out until they succeeded.

In reality, most who were underperforming chose self-termination well in advance of the deadline. A properly structured compensation plan means that you never have to fire a salesperson. They either leave voluntarily, or lower their cost to match their performance.

Share
Posted in Entrepreneurship, Incentives, Managing Employees, Marketing and Sales, Sales, Strategy and Planning | Tagged , , , , , , , , , , , , , , | Leave a comment

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

Few Employees Can Go the Distance

It’s been an unusual week. I’ve had at least four coaching conversations about employees whose jobs have outgrown them. On the one hand, it’s good news. It means that the companies are growing. On the other hand, it’s always tough to deal with an employee who has hit their maximum in performance. (See “You Can Go this Far, but No Further“.)

Ming the mercilessThere’s a saying that I’ve heard attributed to Sanford Sigoloff, the corporate turnaround professional with the sobriquet “Ming the Merciless” for his scorched earth cost cutting. I can’t find it attributed to him or anyone else, so I’m claiming it as my own until someone gives me a source.

“Every time you double the size of a company, 75% of the people who got you there won’t be able to come with you to the next level.”

It sounds cold, which is probably why I associate it with Sigoloff/Ming. No matter how uncomfortable or politically incorrect it is, it is generally true.

Before we get into debate about what “doubling” means, let’s just say that it is different things in different industries. It could be the number of customers or orders you handle, the number of employees, or the gross revenue of a company. For this discussion, let’s use revenue in a mythical distribution/services business, where the dollar volume is a reasonable yardstick for the general complexity of the business.

A competent founder can usually manage an organization up to around $5,000,000 in gross revenue. (See “The Secret to Growing a $1 Million Company by 5x“.) At that point, the business has typically outstripped his or her ability to monitor all of its functions. If it is going to double, the founder has to develop people who can work unsupervised, who can supervise others in task-based activities, and who understand the company’s culture and vision for the future.

For many, this is a stalling point. If the “best” employees have been selected solely for their personal productivity, they may not have the skills to get the work accomplished through others. There is a leap in personal development for both the owner and the employee. The owner may have a challenge in learning to delegate. (In such cases, the owner is part of the 75% who can’t grow.)

The next doubling, from $10,000,000 to $20,000,000, requires that these people can do more than merely supervise. They have to be able to identify and teach others to work unsupervised, and communicate the culture and vision downstream. “Just watch me!” no longer works, since their span of management has grown beyond one-on-one training.

From $20,000,000 to $40,000,000 and beyond, the delegation and decision making is pushed even further away from the founder. Now his or her key people have to teach people how to teach people. Training the trainer is another category of skills, and one that relatively few people can do well.

If we use simple arithmetic progression, one of the four key workers at $5MM will be a great supervisor at $10MM. Perhaps two or three of the ten supervisors at $10MM will have grown into real managers at $20MM, and a small handful of managers will have developed into executives when the company reaches $40MM.

It sounds cruel, but anyone who has run a growing company knows that it’s true. As much as we value our best employees at each stage, most can’t maintain the “key employee” designation for the whole trip. They may still be in your organization, but only at the level where they reached their maximum performance capability. Trying to drag everyone the distance is really the crueler alternative.

Share
Posted in Entrepreneurship, Leadership, Managing Employees, Strategy and Planning | Tagged , , , , , , , , , , | 2 Comments

2 Responses to Few Employees Can Go the Distance

  1. Jim Marshall says:

    Other factors beside $ growth can impact “key employee” status. Among them are supervising a business when it starts multiple locations…which often occurs in businesses under 5 million….

  2. Mike Wright says:

    The owner should definitely consider this when hiring and selecting people for development, or they will have telling problems in achieving planned growth.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

Minimum Wage and the Middle Class

“Amongst the novel objects that attracted my attention during my stay in the United States, nothing struck me more forcibly than the general equality of conditions.”

Alexis De Tocqueville (Democracy in America, 1831)

Americans have always considered themselves “middle class.” Traditionally, that self-identification was embraced by people from just above the poverty line to those near the top 1% of incomes ($350,000 annually.)

The last two decades saw corporate CEO incomes rise from 40 times that of the average worker to 400. Young tech billionaires don’t maintain the low public profiles of earlier super-rich, but instead embark on grand projects (space flight, education, medical research) that were formerly limited to government sponsorship. A voracious media, in its quest for content, does it best to make certain that everyone is a voyeur of lifestyles they can never afford.

In the meantime, technology and global competition continue to erode the middle. When the job of someone making $35,000 a year is eliminated, they don’t just step up to a $50,000 job. In reality, most have to accept something less. The Department of Labor now counts 6,400,000 Americans who are working part time jobs, but say they want full time work. (Working as little as 1 hour a week means you do not count in the most widely published U-2 unemployment statistics.)

stairway to successAs the quadrennial election cycle heats up, a popular solution for income redistribution is to mandate a huge jump in minimum wage. Pay the lowest tier of workers more, the logic goes, and we will have a more stable democracy. Besides, the money will only come from business “profits,” and therefore be relatively painless for the payor.

According to the compensation survey company PayScale, the average small business owner with over ten years in business (a success, by most measures) makes just over $105,000 a year. That isn’t a shabby living, but it’s a long way from being rich; and it includes those profits.

Those small business owners create 65% of the new jobs in this country. Although Obamacare is a more direct tax on employers, minimum wage is similar in that it doesn’t apply if you don’t hire someone. One of the reasons for the huge growth in unwilling part-time employees (up 50% since 2008) is employer avoidance of the requirements for health insurance. It doesn’t take an economist to see the consequences of adding a high minimum wage to the cost of employment.

  • If high minimum wages are implemented piecemeal (by city or state)  then there will be some cross-migration. Businesses will select lower-wage areas, while employees will gravitate to places with higher wages.  The assumption of politicians that because a business has bricks and mortar it is stuck in their jurisdiction is erroneous.
  • If such a wage is enforced nationally, it’s hard to understand why offshoring to low-labor cost countries wouldn’t accelerate for those businesses that are able to do so. Those that can’t are concentrated in retail, hospitality and personal services — already among the lowest-margin areas of business ownership. So entrepreneurs who make the least money will shoulder the bigger burden.
  • Small businesses, typically laggards in adopting technology, will find the return on investment far more appealing. I can see fast food restaurants with touch pads for customers, and one long line for the computer illiterate.
  • Those currently making minimum wage will discover, much to their dismay, that between about $17,000 a year and $23,000 a year 85% of their income increase is offset by the loss of Earned Income Tax Credits; leaving them essentially even.
  • Starting a small business with employees will have much less financial appeal. Those with entrepreneurial instincts and ambition will recalculate the benefits. That may well lead to fewer bootstrap startups, which are typically a starting place for many minimum wage workers.

Finally, a high minimum wage doesn’t fix the problem. There are jobs, especially in the trades, where employers are happy to pay $15 an hour or more for people with appropriate skills. Paying a sandwich wrapper the same as an electrician’s helper won’t make sandwich wrapping a stepping stone to the middle class.

Here are some of my earlier posts on this topic:

A Tiered Minimum Wage for Small Business (2013)

The Black Donut Hole (2010)

If you like what you read, please pass it along. Comments are always welcomed!

Share
Posted in Economic Trends, Entrepreneurship, Managing Employees, Politics and Regulation, Strategy and Planning, Technology | Tagged , , , , , , , , , , , , , , , , , , , , | 1 Comment

One Response to Minimum Wage and the Middle Class

  1. Mike Wright says:

    The only real way to solve the problem of the shrinking middle class is through technological advances and higher levels of universal education. Governments at all levels have failed to provide the education required and continue to take more money away from the private sector. Money that could be used to develop new technologies and train their workers to move into higher paying jobs. They are taking actions to get the political support of those who cannot, or choose not to, understand that their simplistic approaches will fail. The envy of astronomically higher salaries of CEO’s are playing right into their political strategies that are definitely not “for the people”.

Leave a Reply

Your email address will not be published. Required fields are marked *

You may use these HTML tags and attributes: <a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>