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Marketing, Sales

Business Growth Pitfalls to Avoid

blog_12_GrowthPitfalls

Every small business wants to grow – but sometimes it’s possible to grow your business “too fast.” Companies that experience high rates of growth often encounter unique new challenges that the small business owners might not have been prepared for. Although these are often “good problems to have” (it’s better to have an insanely fast-growing company than a bankrupt company), there are special risks that go with owning a fast-growing business, especially if the growth is outpacing the owners’ ability to keep up.

We talked with Matt Turner, a management consultant with Boston Turner Group who has worked with many fast-growing companies, about some of the biggest risks, challenges, and potential pitfalls of high-speed business growth.

Below is our interview with Matt, where he offered his insights on how fast-growing companies can achieve what he calls “Enterprise Velocity” – while still staying in touch with what made them great in the first place.

Small business owners who want to get working capital for their companies often have to decide between small business loans of equity financing, where they essentially give up a percentage of ownership of the company to venture capital investors. But is it possible to “give away” too much equity in the company to investors? Is it ever a mistake to give away too much ownership of the company? How do company founders/business owners strike the right balance when deciding how much equity to offer to investors? Is there a standard percentage that is typical?

There isn’t really a standard percentage because the percentage is affected by two varying factors every time: where is the company valued and how much do the founders need for their goals? Those two variables are widely different in every single Series A round of venture capital funding. It really comes down to what the founders want to do and how actively they want to be involved.

For example, there are a few common scenarios for how startups raise working capital via equity financing.

Let’s say Company A has visionary founders and a killer app. The company’s valuation comes in very high. The founders benefit from this because they can meet their goals for how much money they will receive from investors in the Series A raise without giving away as much equity in the company. The investors probably like this too, at least at first, because it keeps the founders tied in with some golden handcuffs in the form of a higher equity stake – investors are happy to invest in this high-potential company because they believe in the vision of the founders.

Another example is Company B, which is a more mature company with slower but predictable growth, and the founders want to raise money from investors so they can take some chips off the table to start a new nonprofit organization. Company B is not an exciting company but they are steady, so the valuation is lower and the founders give up more equity. The positives here are that the investors are happy and if the investors also have a great management team, they are all in because of their higher stake. They can keep stock option prices low to attract top talent while the founders disappear for a while. The founders of Company B didn’t make as much money from selling equity in their company as the founders of Company A did, but they’re satisfied with the deal because they’ve already had some good profitable years with the company and are happy to reduce their level of involvement in running the company.

Most people would be excited about being a part of Company A, but it depends on your goals and the purpose of the fund raise. Now, here’s a problem people don’t think about with Company A. The higher valuation makes the stakes higher for everyone. It’s going to be harder to hit the growth goals that the investors need. Company A is probably going to need a series B round of venture capital raising to go buy some other companies or expand, but you’ve set the bar very high and no one wants the valuation to go down in your series B round. Also, investors aren’t willing to set the option price low enough to attract real entrepreneurial thinkers.

Another example: Company C wants to expand into new markets and is raising money. They want a high valuation because they don’t want to give up a high percentage of equity, but their lead investor can’t justify that high valuation because there’s no track record in that new market. A decent solution could be to lower both the valuation and the amount raised. The founders use the money to prove their concept, come back at the higher valuation for more money, and everyone is happy.

Another challenge of rapid growth is that some companies get so preoccupied with chasing new growth and new markets, that they “take their eye off the ball” and lose track of key existing business. Do you know of any examples of how this could happen? Do companies sometimes chase growth in new markets at the expense of their core business?

A lot of companies don’t pay attention to their ability to scale their business BEFORE they invest in growth, new products, and new markets. With every new vertical or product you launch, you are committing to new feature developments, product specialists, industry gurus, and everything else that you need to invest in to make that new launch a success. You are pursuing the extension of your brand in ways that could push your team to the limits. A team of five support people focused on a single industry might be able to triple the number of clients they can serve together. But you might need to hire five more support staff just to launch into the new industry because of the different skill sets you need.

When companies are growing fast, they sometimes run into a tricky-but-important economic principle called “diseconomies of scale.” To make it easy to understand, imagine a company with two employees and one customer. It’s very easy to support that single customer, because the two employees talk to each other and to the customer. You have only three possible connection points to worry about, employee to employee and employee to customer. But now you want to add another customer. If you can’t scale, you hire two more employees. Now you’ve doubled your revenue (or have you…?) but your connections have grown from three to 12. As companies grow, the number of connection points grows, and it becomes more complex to support customers and manage the daily business operations.

Another challenge for fast-growing companies is brand dilution and self-competition. Plenty of software companies have a successful market with large customers, and then they ask “how do I grow this into the SMB market?” So they launch a scaled down version of their software, with fewer features and a lower price point. But often they discover that their large enterprise customers didn’t like all of those features anyway, so now instead of selling higher priced software to big companies, everyone likes the smaller version. The software company ends up competing with themselves and lowering their overall profit, at least for a while, until the volume of the smaller product picks up.

This is a bit old, but the story of the Commodore 64 is instructive. At one point they were selling 2 million units a year and then they decided to release a new innovative product that wasn’t compatible. No one wanted it and the company shut down in 1994.

Another challenge for high-growth companies is being able to create and maintain a coherent culture as the company grows. Do companies often “lose touch with their roots” as they grow? How can company founders prevent this from happening? Or is it inevitable?

This doesn’t need to happen. As the small business owner, you must set your ideals in place before growth. You need to know why you’re in business, what is the connection to your customers and employees, and what is the change you’re here to make in the universe well before you establish a revenue plan.

Unfortunately, most companies, especially ones with new investors, are 100% tactically focused on meeting their monthly and quarterly goals, and it prevents them from being able to go back and establish their ideals and values. The company lacks touchstones, so the further they get away from the founder’s vision the more they forget who they are and what makes them unique. Having coherent ideals and company culture gives your team an overall sense of what they’re working toward – it helps you to coordinate your company’s efforts and stay on the right track.

When I’m working with high-growth companies, we have a focused discussion to help clarify the company’s ideals in five related areas: mission, values, major audacious goals (what I call “The Impossible Dream”), five-year goals, and the brand contract. These become the touchstones for behavior so that as you grow fast, all your employees have a basis for their decision making in rapidly expanding spheres.

Another challenge for small businesses is the fear of losing key employees during the growth process – what if some of your best people get hired by competitors? How can companies avoid losing key people during high growth phases, other than offering good salaries and equity in the form of generous stock options?

In general, I believe that losing key employees happens less frequently than business owners fear it will. Obviously, as small business owners and managers of your employees, you have to be decent human beings and not burn people out (again, this is an issue with scaling up the company – try not to overload your existing employees with too many demands as the company gets bigger). But in the end, ideally, there shouldn’t be any “indispensable employees.” If one employee can hold your company hostage, you have bigger issues. As you grow, you have to build a scalable, repeatable system that makes it easier to on-board and develop new employees.

So there are things leaders can do to make the place more fun, more beneficial, and less arduous. But at the end of the day, if you got the ideas right in terms of building a coherent culture as discussed above, you’ve built a culture of people who care about your mission. If your mission is to just go out and make a bunch of money, then you’re going to attract coin-operated mercenaries. And that’s fine in some industries. But if your mission is to change the world in your own unique way, you’ll attract believers who will see you through the tough times.

As companies grow, they change – and sometimes it gets to the point where it’s not “the same company anymore,” and company owners lose passion for the business or decide that they want to move on to do other things. As part of overall “exit strategy” planning, how does a company founder know when the time is right to move on? What happens if you find that your business has grown to the point where you’d rather cash out your money and do something else?

It’s a common problem. Most companies reach a ceiling at around $10 million or so in revenue where the company founders reach a crossroads and have to decide whether to stay or get out. Often this happens because the founder wore ten different hats to get them there: visionary, head of sales, head of marketing, financier, customer relations, etc. But to scale larger, the company founders have to start delegating and handing off responsibilities, and the people you delegate to are not going to be as good as you were, and they have a learning curve, and they won’t do things the way you would’ve done them.

Barring an outright exit of the founders, there are some things that company owners can do. First, some founders might decide to go back to the roots that made them happy in the first place. Maybe you loved designing new software, and the whole CEO thing keeps you awake at night. Name yourself CTO and hire a CEO. Do what you love doing because that is best for your customers and employees. The same holds true for hiring new COOs, CMOs, CFOs, etc. – look for ways to delegate the part of the business that isn’t as much fun for you.

Second, there are ways to “exit without exiting,” per se. Some founders with predictable businesses might decide to grow via debt financing instead of selling equity. Some might recruit family members. Some might offer to sell the business to employees and stay on as chairman of the board. There are many ways to stay involved with your business as it grows, and profit from that growth, even if you no longer take as active of a role in day-to-day operations as you used to.

Have you witnessed any of these challenges and risks as your own company has grown? How do you manage the challenges of growth? Tweet us at @KabbageInc and let us know!