Episode 071: Navigating the Dynamics of a Growing Business

(00:00:00) Commentators: You’re listening to The Wrap, a Warren Averett podcast for business leaders designed to help you access vital business information and trends when you need it. So, you can listen, learn and then get on with your day. Now, let’s get down to business.

(00:00:17) Kim Hartsock: Hello, everybody, and welcome back to another episode of The Wrap. Today, we are doing episode 71. Just a reminder: we are in the middle of our series on the business life cycle. Today’s episode is going to focus on the growth stage, and I am excited to have with me—one of my partners from our Birmingham office—Will Aderholt. Welcome back, Will. You’ve been on the podcast… I know once, maybe more than once already.

(00:00:46) Will Aderholt: Yeah, I think it’s been a while, but glad to be back.

(00:00:48) Kim Hartsock: Yeah. We’re excited to have you. Today, we’re going to dive into some of the unique challenges and opportunities that come with businesses that are in the growth stage. Will, if you could just take a minute and introduce yourself to the listeners.

(00:01:01) Will Aderholt: Yeah. Like I said, happy to be here, Kim. I’ve been with the firm for about 16 years. My background was in tax, and I’ve just been very fortunate to come alongside and work with a lot of primarily family-owned and operated businesses, but also some portfolio companies of private equity that have really been in a growth phase. I’ve worked with a lot of M&A transactions in various capacities. And yeah, I just feel really blessed to have such great clients and to be here with you today.

(00:01:31) Kim Hartsock: Awesome. We’re glad to have you. So, we’re going to just jump right in. I think just to set the stage, maybe it’d be helpful to give an overview of what the growth phase of the business life cycle is. Like, what are the defining characteristics and even some challenges of companies that are in this stage?

(00:01:49) Will Aderholt: Yeah. Kim, the obvious answer is it’s a company that’s growing, but that can mean a lot of different things. Typically, that’s going to be top-line growth, but that could also not mean top-line growth. That could mean, maybe, we’re still pre-revenue but we’re past a start-up phase, but we’re really growing. But again, most of the time, this is going to be a business that’s growing its revenues.

That can look a lot of different ways: organic growth, they could be doing acquisitions, they could be greenfielding in new markets, investing in different technologies, strategic partnerships or joint ventures. There’s really no end to how a business can grow. So, it never really looks the same way. And then you mentioned challenges. And I know from being on here before, I’m a cash flow junkie. So, spoiler alert already: we’re going to talk a lot about cash flow because it’s very important in the growth phase. A lot of times, what comes with being in the growth phase is going through just maturation of the business from operations, management, sales functions and just stepping into really becoming a business along with managing all this growth—no matter what that looks like.

(00:03:06) Kim Hartsock: Our last episode that we did in this series was on the start-up phase. And I can imagine how much an owner’s role evolves in moving out of that start-up phase and into the growth phase. So, talk to us a little bit about that. How does the owner’s role change and what really is the owner’s role now in this stage?

(00:03:29) Will Aderholt: Yeah, it does. This is obviously one of the more nuanced and complex issues that I see that come along with a growing business because most of the time, the owner is probably going to be the founder, and they oftentimes didn’t start this business because they wanted to manage a business. Often, they started the business because they had a skill or trade or an idea that they wanted to bring to market or that they thought they could do better than what’s already in the market in their space. A lot of times, you reach this point when your business is growing, where the—and it’s cliché to say—but the owner really has to stop working in the business so much as working on the business. You just can’t literally do it all unless you’re really good at finding the right people and empowering them.

I’ve got a client that refers to it as hiring people that are smarter than me and then getting out of their way, which I think is really good advice and it served him really well. But it really doesn’t take any one particular form, but I’d say that’s really the most common thing I see is just that transition from doing what you love to do—which is why you started the business—into managing a business. That’s not really what a lot of entrepreneurs want to do.

(00:04:47) Kim Hartsock: Transition to doing what you have to do, not what you love to do.

(00:04:50) Will Aderholt: Yeah, exactly.

(00:04:51) Kim Hartsock: Along those lines, I’m sure most owners don’t start a business wanting to get into taxes, cash flow planning and reviewing financial statements. You and I do, but most owners don’t love that. So, what are the financial metrics that an owner really needs to know, understand and pay attention to that really show how the company is doing and show the company’s health during this phase?

(00:05:19) Will Aderholt: I think, typically, the first thing most people are going to want to look at, and again, it gets back to what we were saying about enjoying versus wanting to do things in the business. Obviously, they should be—and probably are—looking at profitability measures. What’s our growth rate? What’s our sales pipeline? What’s our backlog? What’s our gross profit, net profit? What’s our overhead doing? All those profit and loss type ratios that are really common.

Also, KPIs—there are key performance indicators that may be non-financial. Those are all very important, but you specifically asked about health, Kim, and I think if we’re talking about health, which you know, that I think is vitally important, especially with a growing business. The analysis and the metrics need to be more focused on the balance sheet, particularly around cash flow. Taking the net income a step further and looking at: okay, what really is our cash flow? What’s our working capital? What are our CapEx needs? And again, just putting more focus on the balance sheet—particularly on cash and working capital.

(00:06:27) Kim Hartsock: How should companies balance risk-taking when they’re focused on growth? Clearly, it took some level of risk to get to this point. But does the attitude towards risk change at this stage? How should they balance how much risk to take on versus being cautious so that they can continue to grow?

(00:06:50) Will Aderholt: This is really hard, particularly for a founder who really loves the business—especially if their background is in sales. Because they just want to go pedal to the metal, right? Which is how they got to this stage that we’re talking about. And my advice is you just have to look at it from a risk-adjusted return standpoint. What do I have to gain from this decision that I’m making? And then how much risk am I also taking on to get to that point?

A lot of times that’s really hard to measure. That sounds very “Pollyanna” of me to say here on a podcast with you, but oftentimes when I have these conversations with clients who are making decisions like that, I try to break it down into those two buckets: what’s our upside and what’s our downside? Then you throttle in where you want to be based on what the upside and the downside are. Just thinking about it holistically. Often, again, people want to go and they’re busy. We’re all busy, especially someone trying to run a growing business. Just really understanding when you’re making a decision that could trigger other outcomes that you might not see on the surface. Just having that discipline to step back and think about issues holistically and the different dominoes that may fall as a result of a particular decision.

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(00:08:40) Kim Hartsock: Now, I know when we were planning this episode, you mentioned that you had walked a client through a scenario like this, where they brought an opportunity to you. Maybe you can share that just in terms of how to balance that and the decision that was made by the client.

(00:08:56) Will Aderholt: Yeah, I think this is a great example, Kim, and I’ll try not to be too long-winded with it, but it’s a perfect example of what we’re talking about. Luckily, I was on the other side of this decision. So, I’ve got a client in the manufacturing industry who’s done several acquisitions, and I’ve been very lucky to walk alongside this client while they’ve been doing acquisitions. One particular acquisition, they were acquiring a competitor from a different geographical region.

At this point, just to set the table a little bit, my client still at that point is the sole domestic manufacturer of a particular product. One of his competitors on the opposite coast of where we are came to him and said, “Hey, look, I’ve invested in a very expensive piece of equipment from overseas that’s about to get delivered.” And there were a couple of different reasons why, but their competitor wanted my client to buy his business, and his leverage was, “Hey, I’ve gone out and bought this equipment. I’m about to start competing with you and your margins are going to go way down. So, I think you need to buy my business and it’s worth a lot.”

It was a profitable business. And so, they come to town, and we get in a meeting. I had gotten a little bit of financial information from them beforehand; I had a peek into it. Going into the meeting, I could see the beginning stages of some cash flow issues with this business, because it was growing on its own, and then they had also had to put down a deposit to get this machine built and get to this point. I failed to mention, but my client—while he’s in the manufacturing business, it’s a very capital-intensive manufacturing business. It’s long lead time, you have to buy a lot of raw materials, you have to stop the finished goods after you build it. It requires a lot of working capital to get through their cycle.

So, they come to town, we’re meeting and we’re just asking normal questions. I’m asking questions and writing down and trying to get to what this company’s cash flow conversion cycle would be. How much it’s going to cost to get the equipment here, get it rigged, installed, all that kind of stuff. On my notepad, I was making sort of a cash flow statement, so to speak, for what this new equipment was going to look like. To make a long story short, we figured out that this guy—I don’t remember what the exact numbers were—but let’s just say that it was going to take $10 million to get this equipment up and running and buy enough inventory to be able to fund the production through the receivable cycle to get cash in the business. Before this piece of equipment that—on paper would be very profitable—it was going to take him $10 million to get to the point of it being cash flow positive. And this guy just looked like a deer in headlights. He had no clue.

And like I said, he was already having some cash flow issues just because of the growth that he had already taken on organically with what they were already doing. The end result was we walked out of that meeting, and my client was able to have that piece of equipment diverted from going to the West Coast, back to his office in Alabama in that meeting. Like it was literally shipping out that day, the guy calls and we basically bought it at cost and then acquired this guy’s business for basically the value of the assets it had on the books. He realized in that meeting that he was going to go out of business if he didn’t do something. So, he went from walking into that meeting and thinking he had a very profitable business and that he had my client strategically pinned down into basically saying, “Hey, please take my business from me.”

So, it was pretty cool. That was fun.

(00:12:37) Kim Hartsock: That’s going back to you saying the importance of knowing cash flow and also surrounding yourself with good people, meaning your client knew his business, knew the operations, but you looked at it through a different lens. That ultimately is what he needed was somebody else’s skill set. So, that’s a great example. So, speaking of cash flow, most of the time when companies are in this growth phase, it can be really tempting to take the out because maybe you haven’t taken much out when you’ve gone through the start-up phase, and you’ve been really building the business. How do you balance the reinvestment of profits back into the business with essentially meeting your own personal needs and goals that you’re trying to juggle?

(00:13:23) Will Aderholt: Yes, again, to me, it always comes down to advisors and just having the right people on your team looking out for you in a holistic manner to make sure that you have a plan, right? The pieces of your financial picture don’t always match your plan, but you have to start with a plan. If your plan depends on your cash flow, personal cash flow needs, and your life stage—how close or far you are from retirement—then you have to take all that stuff into consideration.

Then, I think back to: okay, now what do I need personally? What are my goals personally? And then, okay, here’s my business and how can that support my personal needs and goals? There’s a trade-off too, right? In a high-growth business, most times that’s going to require a lot of reinvestments, right? That’s a trademark of a growing business. Until you reach maturity and cash cow status from your old business textbook, it just requires a lot of capital. So, maybe, if you need to take money out of the business, you have to plan ahead and be able to go get the liquidity that the business needs from somewhere else. Whether that’s taking on an investment—an equity investment from somebody—or making sure that you have enough availability for third-party debt and that sort of thing.

(00:14:50) Kim Hartsock: Yeah, that’s a good point of understanding if you know what you’re planning for, then you can review what your options are. A lot of times people will start with: what are my options? And you’re like, I don’t know. What you’re trying to accomplish out of this, right?

(00:15:04) Will Aderholt: I think that oftentimes with a founder-led operating a closely held business, they’ve always grown up—the businesses have grown up—with the owner thinking of the business and their personal financial pieces as one big bucket. And it is. You’re pretty much married to it. It is one and the same. As it goes, you go. But at some point in this—growing mature and getting to maturity stage—there comes a point where it’s really important and healthy to start thinking about those two things as being separate so that you can make sure you have a plan.

(00:15:43) Kim Hartsock: That’s a good point. So when should the owner begin to think about legacy planning and what the future is of the business? When do they start that?

(00:15:54) Will Aderholt: Yesterday is the answer to that question, Kim. It’s really important for a lot of reasons. And you put it into two different buckets. There’s a positive type of outlook: what’s my plan for the future versus a disaster recovery type of succession plan. Okay, what happens if something were to happen to me or one of my key managers? You have to have a plan for both. You really need to be thinking about that kind of thing from day one, just to ensure the success of the business. One way, whether that’s in the event that everything runs according to plan, and we’re very profitable, and we want to meet our goals in the future. Or someone gets hit by the proverbial bus. Really having a plan for both of those.

The other thing I thought of when you mentioned that was always taking the time to think about estate tax planning. This is fresh on my mind because I just left a meeting this morning about this, and like we said before, the owner’s net worth oftentimes in a closely held business is 95 percent the value of the business. And that’s illiquid, right? What you don’t want to get into is a position where the value of this business may put you in a taxable estate situation, but yet the business is not liquid because it’s growing and requires a lot of working capital. Just making sure you know where you are on that so that you can plan accordingly, whether that’s insurance or whatever else.

(00:17:22) Kim Hartsock: And revisiting that, because as we sit here today there’s the tax code that can change. And you never plan and are done. It’s an ongoing—annual or more frequent—thing that needs to be done to make sure that you’re really understanding the current picture and how it relates to you.

(00:17:44) Will Aderholt: And the business owner’s personal outlook can change very rapidly too. I’m working with another client whose business was doing very poorly and was very affected by COVID-19 and a lot of other unfortunate things; it was almost teetering on the edge of insolvency 24 months ago. They’re in the construction business and so they had a couple of really profitable jobs. So, in the course of 24 months, now we’re dealing with a $50+ million-dollar estate tax potential issue when the business was almost insolvent just not too long ago. So again, just a really good example of that’s a good problem to have that a lot of people don’t. It can change very rapidly. To your point, it’s important to revisit that on a regular basis.

(00:18:36) Kim Hartsock: We started with what defines being in the growth stage. How do you know when you’re starting to transition out of the growth stage?

(00:18:44) Will Aderholt: Yeah again, I hate to give you the obvious answer, but typically you’re going to see revenue growth level off. So not necessarily your growth slow or not necessarily the business shrinking, but your growth rate is leveling off. Most times when you see that, the business’ working capital needs are going to slow down. So, you’ll see cash flow start coming back into the business and things are a little more predictable. Cash flow is more steady. Revenue growth is more steady. Usually. That’s really it. That’s what you typically see there.

(00:19:19) Kim Hartsock: Here on The Wrap, we like to wrap it up in 60 seconds or less. I know there have been a lot of good points shared here, and I hope the listeners have found value in our discussion. What’s the one piece of advice you want to leave listeners with regarding companies currently in the growth stage?

(00:19:38) Will Aderholt: Kim, I always break the rules with this question because I can’t boil it down into one point. So, I’m going to break them again. It’s really two things. One is to make sure that you’re stepping back, as we said early on, and thinking about working on the business, not in the business. Otherwise, you can just get busy doing the same things, then look up and realize, “Oh gosh, I’ve outgrown my working capital.” So, that’s 1A.

I’ll give you 1B, if that doesn’t break the rules: it’s to have a team of advisors around you and to communicate with them often, ensuring they are in the loop about your plans so they can give you good advice. If you hire the right people, they’ve already helped others through this stage you’re going through. You can learn from their experiences, whether things went really well or not so well.

(00:20:31) Kim Hartsock: This has been great. Thanks so much, Will, for joining us, and thanks everyone for listening.

(00:20:37) Will Aderholt: Thanks, Kim. I really enjoyed being with you again.

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