Entrepreneurship vs. Wall Street – Can you cut your way to growth? And a few thoughts on weasels.

I read with interest the article “This One Mistake Can Eat Your Business Alive” on Inc. earlier that’s worth a read particularly for small business owners that are beginning or in the midst of Finding the Exit® or someday will (everyone eventually does, no?).  If that’s you it’s worth your while to read that article before you may read my comments … a real world example of cost cutting and P&L targets eating a business alive.

I’ve toiled in both the private and publicly held arenas over the years and there’s a fundamental difference in the mind sets between successful Entrepreneurs and Wall Street.  Entrepreneurs, in my experience tend to view a successful financial year on a “did I/we earn more this year than last” and “cash flow” basis.  That’s straightforward and sound. Wall St and those companies with a like mind set focus more upon: Revenue growth, Margin vs. Industry/last year, EBIT/EBITDA and EPS.  Each sound as well although undue focus upon margin can run cross purposes to revenue growth and your bottom line e.g. the successful entrepreneur will grab that big piece of profitable business, even at half their typical margin, that improves their bottom line – every time (near term that’s the right answer too – forget about margin – even if it only covers a bit more than variable costs that can not be adjusted by more, sooner).  Conversely, if undue emphasis is placed on margin that piece of business that improves everything except margin might be turned away.

Similarly, the successful entrepreneurs I know have a keen sense on the difference between non/less contributory expense and critical mass vs. “if that’s your revenue forecast you need to cut SG&A expense by x%”.

Think it doesn’t happen?  A real world example …

Background – We were a division of a very large, public, creative service industry operation. A few years prior I was brought on-board to spearhead turning several years of losses around.  We did and principally here’s how:

  • Staffing – was upside down and almost completely re-tooled, headcount was reduced by nearly 60%.  Importantly, associated compensation (salary/freelance/consulting) expense was reduced only 5-6%. Five $30K employees cannot do the job that calls for the experience of one capable $150K manager.
  • Pricing & Positioning – we moved from loosely managed, poorly estimated “time + materials” to better managed “fixed fee” and improved gross margin just under 70% in the process and write-offs were markedly reduced.
  • Non-contributory expense – we eliminated nearly 20% of non-personnel, non-contributory overhead expense, principally by consolidating offices, losing very few customers in the process.
  • Promises – don’t make any you can’t keep.
  • Key metrics vs. Industry – Revenue per headcount, margin, day’s sales outstanding, cash flow, customer turnover were improved to industry norms or better.  The sole area we fell somewhat below industry norm was revenue growth.

Then we were acquired.

Shortly thereafter my new CFO began to review and didn’t care so much that several years of 7 figure red ink had expeditiously been eliminated, that we were profitable for several years, that revenues were consistently improving (albeit somewhat below industry) as well as the bottom line or that we were at or above every other key industry metric.  That the sole losing division just a few years prior was now a contributor, with sound leadership and a winning, trusted (and fun) culture had displaced years of losing.  We’d done the job.

The edict to cut expense – to improve the bottom line followed shortly thereafter.  Discussions of “critical mass” and every other KPI fell on deaf ears.

I lost the “critical mass” debate and the cuts were done, in fact I was charged with implementing.  I accepted a new position in another unrelated company a few months later.  The division we successfully turned profitable fell back into the red and was dissolved 2 years later.  Surprised?  I wasn’t – sad, but not surprised.

Think some, dare I say, bean counters masquerading as CFOs, may have but “cut” in their quiver?

You can’t cut your way to growth!

But I digress, for any business owner seeking an exit, a few thoughts to consider before you close:

  • Margin – Query your suitor on the above margin example particularly if you will be on an earn out.  Would they accept the profitable, lower margin business or would your hands be tied?
  • Overhead – Scrutinize every possible aspect of any “corporate overhead” charge that may be “assigned”, again particularly if you will be on an earn out that’s based on anything below the revenue line.  These “charges” can come in many forms including:  mandated marketing, integration charges, new benefits, accounting/audit/legal charges and the like.  Leave no stone unturned or you will be surprised.
  • Boss – You now have one, perhaps more than one and you probably haven’t had one in “forever”.  I’ve been on both the acquiring and acquired side and observed first hand the “adjustment”.  This is no mean hurdle.  The best advice I can offer on this is speak to everyone you possibly can who has sold their business or been through it and query them until the cows come home, especially if you spot one of the aforementioned weasels in the mix.  The insight you will gain on “surprises”, things to look out for and emotional preparation will prove invaluable.  And include a capable exit planner, that’s been through it and can advise on all your options, in the mix too!


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