Grow the business you can afford
March 1, 2015 | By Hank Bulmash
Entrepreneurship comes with risks, but there are steps you can take to improve your chances of success.
Over the winter holidays, Toronto newspapers featured articles on a home renovation contractor who went out of business. Contractors go out of business all the time, but this story was a little different. The contractor had been operating for several years with happy customers. He received large deposits before beginning work, but he left about 10 homes in an uninhabitable state when he was locked out of his office by his landlord for unpaid rent. He had contracted to make large additions and had removed the rear walls, dug deep holes and removed roofs of homes all without completing the work. He left behind a disaster.
The man claimed the business had simply expanded beyond his control, but it is likely this was not just a case of bad management. There was evidence that he lived beyond his means with a home in a fashionable part of town with his kids enrolled in private schools.
There is an enormous amount of literature on building a business, and the books and articles repeat one truth: starting a successful business is hard. The statistics say that about 50 per cent of new businesses fail within the first five years of operation. There are reasons for every failure, and generally, more than one. Among those reasons are market changes, supply chains that fall apart, or a regulatory system that makes it too hard to run a profitable business. The other possibility is that the venture was doomed from the beginning, because it was undercapitalized or the entrepreneur just did not have the skillset for the job.
Only 20 per cent of marriages fail in the first five years, while 50 per cent of businesses do. That means that starting a successful business is about two and a half times harder than making a marriage work. There is a daunting statistic for you.
What about the businesses that succeed for five years or 10 or even 20, and then fail? That is a story we do not look at too often. Our contractor may have fallen victim to “payback” syndrome. After working hard for 10 years or so, many entrepreneurs and their spouses feel that they deserve some rewards. If they are not careful, those rewards can kill a business. In our contractor’s case, it looks like he simply took on expenses that he could never cover. Therefore, he extracted deposits from customers that were supposed to pay for supplies and labour but probably went into personal expenses.
It is certainly a sad story, but it raises another question. How long can we realistically expect a business to last? And why do so many successful businesses die early? First of all, it is important to be aware that businesses, like human beings, have a natural lifespan. In 1900, the biggest companies in North America were railroads. There are surviving rail companies, but most of the railroads that were viable at the beginning of the 20th Century are gone now. From the 1920s to the 1970s, it was the U.S. automakers. Making cars is still a big business, but it is not what it was, and the U.S. Big Three are no longer the giants they once were. Toyota dwarfs them all. In the 1990s, Microsoft looked like it would rule the world. Remember the paranoia that afflicted us then? No one is worried about Microsoft in the same way now. Today it is Apple, Amazon and Google, but their time will pass as well.
What is true of the big guys is also true of smaller companies. It is very hard to keep a business alive for longer than a generation. Too many things change. In particular, technology changes, but so do customer predilections and suppliers. Those are all external problems. But the internal issues of a business can be just as difficult to deal with.
Many companies develop profound internal concerns between year 10 and year 25. We discussed payback syndrome. Family spending can put a huge strain on a company’s viability. And the desire to spend more at home can lead an entrepreneur to take risks he might otherwise avoid – that is, risks related to premature growth.
Deciding to grow a business before it is ready can be fatal because a company must have excess capacity for growth, and that is expensive. Building for growth before the customers arrive can weaken the parsimonious mindset that helps entrepreneurs stay out of trouble. Of course, expanding capacity works brilliantly if the timing is good. But if you are unlucky enough to expand into a business decline, your company can run into real problems.
Transitioning is another struggle. When a partner retires and a pension must be paid or shares bought, the company may be subject to a financial burden it was never expected to carry. In a sense, transitioning is like buying a business. The old numbers may work just fine, but the purchaser (or the surviving partner) has to carry a debt load that the vendor never experienced. That means the past is not a good predictor of the future. A $30-million company with $3 million in debt is a different animal from the same business without debt. In many cases, the partner who leaves gets a much better bargain than the partner who stays. It is easy to feel that an old partner is a drag on operations, but frequently, some of the relationships and intellectual capital that are important to an enterprise terminate when a principal leaves. Their contribution to the business has become invisible and the cost of that loss may only be discovered after they leave.
Transitioning can be about existing management leaving, but it also often entails the involvement of new blood. That can be wonderful. It is also stressful, since it is likely a new manager will want to institute changes. Change may be necessary, but it is rarely easy. And because the change of generations often involves the business taking on new debt, vulnerabilities can increase.
It makes sense to consider the risks of transitions before you start. One way to do that is to treat the business after a major transition as a new creation with all the difficulties that a new business has along with being subject to that intimidating 50 per cent failure rate of new businesses. <>
