Expanding and Handling Problems

Once your business has started, you will face the challenge of making it grow. In this session, you will learn about some basic rules to follow before expanding.

Before even thinking about growing your business, you must first have a stable platform from which to take off. You must work out the bugs in your initial operation, including making it profitable.

Your readiness to expand will improve if you can gain experience in all aspects of your start-up unit. Whether you have started an internet business or opened a restaurant, become personally involved in all the functions of your business. Then you can detect weaknesses that can be remedied early on, where changes can be made rapidly and at less exposure to loss.

Another reason to become personally involved in every aspect of your business is that later on after expansion plans are implemented, you will be depending on others to whom you must delegate responsibilities. Because you will have had personal experience in running things yourself, no one will be able to mislead you.

Remember that after you expand, you will no longer be the person at the cash register. You must have systems in place to prevent employee theft and shrinkage (shoplifting). Your competitors have probably already figured out the loss-prevention systems that work best for your particular business. So, check out and implement systems already being used in your industry. (If you're going to open a convenience store, go to work for 7-Eleven beforehand to learn its systems that work!)

Try to avoid giving your personal guarantee on leases or creditor obligations. As much as possible, separate your business liabilities from your personal assets. While banks will most likely require your personal guarantee on business loans, exposure of your personal assets can be mitigated by drawing the line against this practice whenever possible.

For example, a potential landlord for your second store may ask you to personally guarantee the lease. Your exposure in a five-year lease of $3,000 per month would be $180,000. This amount could far exceed the initial capitalization of your business. Yet, because of the desire and enthusiasm to add more stores, it will be tempting to incur such potentially overwhelming liabilities.

Instead, by practicing discipline in limiting your liability, you might insist on negotiating a one-year lease with options for additional periods of time. Your liability, in this case, would be reduced to $36,000.

There are some understandable reasons why many entrepreneurs overlook the importance of having a successful pilot operation in place before expanding.

Entrepreneurs by definition are self-confident: The problem is that too often we are overconfident either in ourselves or our product or service. This overconfidence can propel us into expansion programs without carefully working out the wrinkles, including getting to the point of having a proven and profitable pilot plant (model) from which to expand.

One reason for overconfidence is that many wealthy entrepreneurs have enjoyed success in an unrelated field: A wealthy tycoon who had a successful career, for example, might start a new business in a field that he or she doesn't know or understand and might meet with failure because he or she assumed his/her expertise would transfer.

Another enemy is haste: Entrepreneurs who start multi-unit businesses will experience some deficiencies in their first unit. Many will lose money at the beginning. This is the time to work out the bugs and produce a positive income statement. If you can't, this may be time to abandon the idea. But, if you are starting a restaurant chain and in haste open six of them with problems, your losses could become overwhelming.

There will be controls needed in your expanded business that have not been present in your start-up mode. It will take careful preparation to break the do-it-yourself mode. For example, your business will need accounting and cash flow controls that measure the performance of individual units within your overall operation. These reports will be required on a frequent basis. In many businesses, weekly income statements are used to prevent small problems from growing into bigger ones that may become unmanageable. Your accountant can help you set up unit financial reporting.

The Importance of an Advisory Board
Expanding your business means you will be taking on more risk. Yet your dilemma will be that once you have made it and are ready for growth, you will become exposed to new dimensions of risk. And the only way to avoid risk is not to make mistakes. This is where a board of advisors becomes an important participant in your growth program. Entice the best brains you know, both in your business and outside it, to become your board of advisors. Your advisory board, a body of collective wisdom, will become your cost-free insurance policy against making mistakes.

Delegation of Responsibility and Authority
Your expanding business will require delegation of responsibility and authority. New skills in recruitment, evaluation and training will be needed. The greatest leap of expansion for most businesses is growing from the first unit to the second one. Once you have made the big step from one to two, you are now a chain! From then on, it can become a continually improving cookie-cutter operation.

Sometimes it is difficult for the beginning entrepreneur to delegate authority. There are many ways to do so without relinquishing certain functions that you will want to keep for yourself. For example, you should be the only person signing checks and deciding on capital allocations, yet you might want to delegate the training of employees to your managers.

But without giving up these functions, you can still motivate key employees in two ways: recognition and reward. Recognition means much more than bestowing an impressive title. The most important recognition is to let it be clear that your key people are in positions of authority as well as responsibility. While delegating authority will mean that your managers will be making some mistakes, their mistakes will be limited to their spheres of responsibility. Also, frequent financial reporting will minimize the adverse financial impact of their mistakes.

Delegation of authority can be accomplished by:

• Financial motivation of key employees
• Creation of profit centers

Monetary Incentive Plans
Good managers are motivated by monetary incentive plans that are tied to their individual success: The incentive compensation of your management team should be, therefore, compartmentalized for each manager, so that a manager's bonus is based solely on what he or she has accomplished and not diluted by how other parts of the business are doing. For example, if you develop a chain of stores, each store manager's incentive compensation should be based only on the profit of his or her store.

If you are uncertain as to how to set up such a profit sharing plan, you might get ideas from your most successful competitors, who have already gone through the trial-and-error process of refining such systems.

Let's first set a definition of recognition: It is creating a business structure where your key employees are given authority and responsibility, which is tied to profit and accountability. This becomes a "profit center" that the key employee manages. Each profit center has separate profit and loss accountability, which is determined frequently. (Many fast food stores operate on weekly profit and loss statements!) The idea is to create an atmosphere where your key people feel they have entrepreneurial decision-making authority and are paid incentive compensation based on their own center profits. But, they are not given authority in two non-delegated roles, which remain your sole responsibility:

1. Capital expenditures
2. Signing checks

This suggests that your key people will be given enough latitude in operating their profit centers that they might make some mistakes.

By the two restrictions stated above, plus frequent financial reporting, you can recruit well-motivated managers and at the same time limit your exposure to big losses.

Obviously, the incentive plan must be tailored to each business situation and be based on the profit and loss report of the individual's separate responsibility.

By rewarding managers through profit participation, you create the engine that will drive your managers to success. And, the greater their success (and reward), the more your overall business will benefit.

Here are three types of plans (there are many) that have been used to structure a manager's incentive:

Leveraged Profit Sharing Plan
Managers receive all, or a large part of, unit earnings over a fixed target. This has been used successfully by fast food chains that are company owned and operated (rather than franchised units). Here is an example of a simplified weekly income statement of a donut shop that is operated by a company employee-manager. This plan is "leveraged" because every penny saved becomes a penny going into the manager's bonus check.

Unleveraged Profit Sharing Plan
In this case, your manager receives a percentage of earnings of his or her profit center. Here is an example:

Commission Plan
In this plan, the manager receives a percentage of sales for the accounting period. Assuming, as above, that sales for the period are $5,000 and the commission is 5%, the compensation would be $250. In many instances, commission incentive is not appropriate because it does not include provisions for expenses. Your manager could get rich while you go broke. But commission incentive can work well when the manager does not control pricing. Salespersons in a retail-clothing store would be a good example of a commission structure.

Let's review some of the basic rules that apply to the creation of profit centers:

• Create a separate profit center for each expansion unit. This means separate profit and loss statements that are compartmentalized for each manager.
• Make the accounting periods very short. When there are not big fluctuations in inventories or other costs, even weekly profit and loss statements work well. But, if possible, don't wait for six or twelve months to reward managers. Rewards are best when received early!
• Keep your profit-sharing incentive plan simple and clear. It will avoid misunderstandings and misinterpretations. Use simple words and simple accounting.
• Have all your profit sharing agreements in writing. It will avoid innocent differences of interpretation. A ball painted half black and half white is going to look differently depending on where you are viewing the ball!
• Check out how your best competitor motivates their managers. Your competitors may have already come up with a system that is most appropriate for your particular business.

• Save money.
• Stay in a field you love.
• Know your business before you start (work for someone else in it).
• Copycat the winners in your business.
• Specialize, even to a single product.
• Find a product or service that is needed or desired and not subject to price regulation.
• Set a cap on your liability.
• Learn computer skills.
• Learn communication skills.
• Have a lawyer, accountant, and insurance agent before you start.
• Prepare a business plan.
• Prepare the site criteria model for your particular business.
• Do "for and against" lists for major decisions.
• Buy when everyone is selling (and vice versa).
• Deal with those you like, trust and admire.
• Learn accounting.
• Create your own internal control plan.
• Keep going to school in subjects important to you.
• Give back to the community.

Pitfalls to Avoid:

• Never sign a lease without your lawyer's review.
• Don't rush: there is no such thing as the last good deal.
• Avoid a "commodity" business (one without pricing power).
• Don't burn bridges of job security to start a business if you can help it.
• Don't become a business zombie: take time off.
• Don't compete with category killers (such as Walmart) unless you have a special niche.

Long-Range Financial Planning
Before expanding your business, you should consult with your lawyer, accountant and insurance agent to develop benefits for your future employees as well as for yourself. The goal is to provide benefits sufficient to recruit and maintain outstanding managers. Provisions can be considered for retirement plans, health insurance and vacation and holiday benefits. These costs should then be included in your budget.

It is also important to make plans for times when you're not actively running your business. When you die, become incapacitated, or simply go on a much-needed vacation, will those you have left in charge know how to maintain the momentum of your business? It is a good idea to have a guide prepared for your employees which contains critical information (what to do, who to call, where to find it). This will help assure the consistency of your business in your absence.

Now let's identify some of the common mistakes made when businesses begin to grow. These mistakes can be deadly, so benefit from the others who have gone before you!

• Uncontrolled Cash Flow: People fail because they run out of money. When you run out of cash, you crash. So, prepare your cash flow projections for expansion very conservatively. Review the Accounting and Cash Flow session. In projections, be sure to:
  
  1. Forecast income (sales) very low
  2. Forecast expenses very high
  3. Provide for unanticipated contingencies
• A drop in Sales or Insufficient Sales: If this happens, your income and cash flow will be impacted. Immediately take the necessary remedial steps by ruthlessly cutting costs.
• Higher Costs: Can you increase the volume of sales? Can you offset with higher prices?
• New Competition: The reality of the entrepreneur's life! Can you learn from them? Can you neutralize their opening impact?
• Business Recessions: You will need to promptly cut costs to maintain earnings and cash flow.
• Incompetent Managers or Employees: Act swiftly to rid yourself of them.
• Dishonesty and Theft: Study the ways your most successful competitor controls all forms of dishonesty that your business is exposed to, including shrinkage (shoplifting) and employee dishonesty. Each business will be different.
• A Combination of Any or All of the Above

What are your recommendations for people when they encounter serious business problems?

• Identify and acknowledge your problems with brutal honesty.
• Immediately reduce your losses by unemotionally cutting your costs to maintain a positive cash flow and profitability. This is the first and most important action to take.
• Don't switch horses. Stay with the business you know unless its future is fatally defective.
• Take the initiative to explain to your creditors what your problems are and why slow or smaller payments will be necessary. Never write post-dated checks or send late payments without an explanation.
• Don't cut value or quality of your products or services. Make them even better.
• Improve every aspect you can of your performance and image.
• Look for opportunity in adversity. Sometimes there will be bargain opportunities during business slumps.
• Remember that businesses have cycles. So, hang in there and ride out the adverse periods.

• Review case histories of the most successful businesses in your field.
• Review the case histories of failed businesses to determine their mistakes. Was it inadequate testing, planning, and experience?
• Identify a typical business problem in your intended business and plan a solution.
• Identify a combination of problems in your business and plan a solution.

THE TOP 10 DO'S

1. Motivate your managers with monetary incentives tied to their individual success.
2. Copycat the successful marketing and policies of your large, successful competitors.
3. Identify, acknowledge and attack your problems with brutal honesty.
4. Look for opportunities, including bargains, in hard times.
5. Stick with what you do best during downturns in business cycles.
6. Compartmentalize your expanding business into profit centers.
7. Copycat the internal controls used by your successful competitors.
8. Prepare monthly financial statements of your individual profit centers.
9. Act swiftly to rid yourself of incompetent or dishonest employees.
10. Take the initiative to keep creditors informed of your problems and needs.

THE TOP 10 DON'TS

1. Think about your second store before the first one is reliably profitable.
2. Sign long-term leases. (Instead ask for short-term plus options.)
3. Open the second store before delegation controls are in place.
4. Let self-confidence overcome prudent and calculated decision-making.
5. Give your personal guarantee wherever asked.
6. Let commissioned salespersons set prices.
7. Fail to promptly cut cost to maintain positive cash flow.
8. Pursue a "commodity" business (one without pricing power).
9. Cut the value or quality of your product or service.
10. Delegate signing checks (any amount) or making capital expenditures.

Here are some key terms and definitions used in this session or related to this session: