Boutique firms often grow but do not scale. Growth means more projects delivered with the same type of staff. If nothing changes, then the growth rate is proportional to the number of partner/owners required.
TRANSCRIPT
Various Speakers [00:00:01] You can avoid these landmines. It’s a buy versus build conversation. What’s the root cause of that mistake? Very moved by your story. Dive all in on the next chapter in life.
Sean Magennis [00:00:16] Welcome to the Boutique with Capital 54, a podcast for owners of professional services firms. My goal with this show is to help you grow scale and sell your firm at the right time for the right price and on the right terms. I’m Sean Magennis, CEO of Capital 54 and your host on this episode. I will make the case that sometimes boutiques grow but do not scale. I’ll try to prove this counter-intuitive theory by interviewing Greg Alexander, Capital 54’s founder and chief investment officer. Greg is an expert at helping boutique owners avoid the growth trap. Greg, great to see you as always, and welcome.
Greg Alexander [00:01:03] Hey, pal. Good to be with you. Let’s kick some “you know what” today. Too many boutique owners are growing but are not making more money in the process and I’m tired of this crap. These entrepreneurs should be properly rewarded. So let’s put an end to this nonsense.
Sean Magennis [00:01:14] Absolutely. I can see. Greg, you’re ready to go, you’re passionate about this topic. I love it. So where do you want to dive in?
Greg Alexander [00:01:21] Sorry, I can get carried away because I truly give a shit about our tribe.
Sean Magennis [00:01:25] Absolutely. I know you do as I do and how about we start with why this is happening?
Greg Alexander [00:01:31] Okay. So understand why this is happening is easy. If revenue growth and headcount growth are proportional, the owner does not increase his or her income with growth. It’s not until headcount growth is decoupled from revenue growth, does an owner grow his income.
Sean Magennis [00:01:45] You know, this makes sense as the top expense by a wide margin for a professional services firm, as you and I and our listeners know, is labor. So more headcount means more expense and less income. But as a firm takes on more work, don’t they need more heads to complete it?
Greg Alexander [00:02:03] Yes, but what type of heads and at what cost? So lazy boutique owners just do more of the same. However, the owners capable of scale do not. They re-engineer how they deliver the service so that it takes a few heads to deliver or less expensive heads to deliver. This is known as creating leverage.
Sean Magennis [00:02:26] So what is leverage in this context? And is there in fact a way to measure it?
Greg Alexander [00:02:32] There is a definition in a metric that measures it well called the leverage ratio. So allow me to explain the definition of leverage. Is the number of employees to owners. An example of how to calculate their leverage ratio as a firm with 30 employees and three owners has a leverage ratio of 10 to one. The higher the leverage ratio, the more money the owner makes. Why is this? A profit pool divided up by three people is better than a profit pool divided up by 10 people. This makes sense, Greg, but it begs the question, how does an owner increase the leverage ratio? This is the million dollar question. So it comes down to the type of work the boutique performs as this drives the type of employees they need to hire and how many of them they need. For instance, if the work requires a high skill level, the leverage ratio will be small. It is very difficult to proceduralize this type of work, which means junior staff cannot handle it. This type of firm is likely to have lots of senior people who all want to be partners with ownership stakes. In contrast, if the work is routine, junior staff can perform it. In this instance, leverage will be very high as the org will be filled with an army of junior staff and few partners.
Greg Alexander [00:03:57] This brings us to the root cause of the big issue. Owners often have expensive senior staff performing junior grade work. This destroys profitability and the owner’s income.
Sean Magennis [00:04:11] This is an aha moment for many. So what is the fix for this Greg?
Greg Alexander [00:04:17] So the fix is to proceduralize as much of the work as possible and then to have the discipline to only go after that type of work. Revenue outside of this scope gets turned away. This allows owners to push out expensive senior staff and their owners compensation requirements and replace them with junior staff capable of doing the work at a fraction of the cost. This is what pushes up the leverage ratio. And this is what allows an owner to make more money and more money as the firm grows.
Sean Magennis [00:04:55] So, Greg, this idea of leverage. It’s not new. It’s been around for a long time. This means the solution to this problem is readily available. Why is it owners keep making this mistake?
Greg Alexander [00:05:08] Human nature. Us Americans in particular pride ourselves on working hard. We equate long hours with strong character, and this mentality needs to be replaced with a work smarter, not harder mentality. If our listeners adopt the concept of leverage, they will work less and make more.
Sean Magennis [00:05:32] But that is a spectacular goal. So achieve our financial goals and have a life as well.
Sean Magennis [00:05:42] And now a word from our sponsor. Collective 54, Collective 54 is a membership organization for owners of professional services firms. Members join to work with their industry peers to grow scale and someday cell phones at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.
Mike Snyder [00:06:08] Hey there. My name is Mike Snyder. I own RSM Marketing Services in Kansas City and Wichita. We serve marketing frustrated, growth oriented principles for middle market firms across all categories nationally. These clients turn to us when they feel the need to pivot, do something remarkably different to get their company moving in strategic marketing with great online execution. We solve this problem by providing an outsourced marketing department where clients receive a fractional marketing director and all the marketing services they need for a flat monthly subscription. If you want to please the robot’s impact humans and delight your CFO, reach out to me at rsmconnect.com or email mnyder@rsmconnect.com.
Sean Magennis [00:06:58] If you are trying to grow scale or sell your firm and feel you would benefit from being a part of a community of peers, visit Collective54.com.
Sean Magennis [00:07:16] Excellent. So this takes us to the end of this episode. And as is customary, we end each show with a tool. We do so because this allows a listener to apply the lessons to his or her firm. Our preferred tool is a checklist. And our style of checklist is a yes-no questionnaire. We aim to keep it simple by asking only 10 questions. In this instance, if you answer yes to eight or more of these questions on leverage or lack thereof is not preventing you from scale.
Sean Magennis [00:07:48] If you answer no, too often, poor leverage might be the reason growth is not equating to personal income. Let’s begin. Question number one, is your leverage of employee to owner at least 10 to one? Number two, is the proper mix of junior, middle and senior staff clear to you? Number three, do you understand the skills mix of a project before you sign it? Number four, do you understand which revenue is good and which is bad? Number five, do you have a zero tolerance policy for one off projects? Number six, do the owners work on the business instead of in the business? Number seven, do your service offerings come with procedure manuals for the staff? Number eight, do you assign work to teams strategically versus reactionary? Number nine, does your hiring plan forecast demand for a specific leverage ratio? And number ten, do your financial goals match up with the leverage ratio assumptions in your business plan?
Sean Magennis [00:09:23] In summary, scaling means working less and making more. It does not mean just growing. If you want to earn what you are worth, decouple revenue growth and headcount growth, the definition of success is not the number of employees you have, but rather it is how much net income you produce.
Sean Magennis [00:09:48] If you enjoyed the show and want to learn more, pick up a copy of Greg Alexander’s book titled The Boutique How to Start Scale and Sell a Professional Services Firm. I’m Sean Magennis. Thank you for listening.