Tag: Finance

Boutiques run on cash. They do not run on net income nor EBITDA. Some boutiques neglect the management of cash flow. Take a moment to understand how you can improve the flow in and out. In this podcast episode, we look at where you can find cash flow when scaling a business.

TRANSCRIPT

Sean Magennis [00:00:15]: Welcome to the Boutique with Capital 54, a podcast for owners of professional services firms. This show aims  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 boutiques run on cash-flow. They do not run on net income or EBITA. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s chief investment officer. Greg is an expert at helping firm owners boost cash flow. Greg, good to see you. Welcome.

Greg Alexander [00:01:03]: Hey. Good to be with you. Do you remember the movie Jerry Maguire and the famous line, show me the money? Let’s start with that. So on the count of three, let me hear your best “Show me the money.” Are you ready?. One, two, three.

Sean Magennis [00:01:19]: Show me the money.

Greg Alexander [00:01:24]: Awesome, you’re a great sport. I think we’re ready to begin.

Sean Magennis [00:01:27]: Yes, we are, funny enough. I just watched that again recently. It’s a great movie.

Why is Cash Flow So Important When Scaling a Business?

Sean Magennis [00:01:32]: Okay. So why is cash flow more important than net income and EBITDA for a firm trying to scale.

Greg Alexander [00:01:41]: Sure. And when I say casual, I mean simply cash coming in and going out of a professional services firm. And it is different than net income. Net income is a profit a firm makes for a period and is often calculated for tax purposes. Whereas cash flow comes from daily activities, and cash flow is also different from  EBITDA because EBITDA does not consider capital expenditures, which are most definitely cash outflows.

Greg Alexander [00:02:06]: As to why it is more important to boutiques trying to scale, its firms run on cash. They are scaling a business, which means they are pouring the cash back into the business. They would rather invest it than give it to the government or a potential acquirer.

Sean Magennis [00:02:22]: Completely understood. And it’s often said entrepreneurs often seriously mismanage cash flow. Do you agree with the statement? And if so, is it relevant to our listeners?

Greg Alexander [00:02:34]: Yes and yes. In my capacity as Chief Investment Officer at Capital 54, I see our listeners, a.k.a. owners of boutique service firms, trying to raise capital when they don’t need it. They think they need X amount of capital to scale when in fact, they’re often generating enough cash from operations to fund scaling.

Sean Magennis [00:02:57]: And Greg, why does this happen?

Greg Alexander [00:02:59]: This happens because sometimes owners do not know how to boost cash flow because they are not measuring it properly.

Sean Magennis [00:03:06]: Please explain that to our listeners.

How to Scale a Service Business: Ways to Boost Cash Flow

Greg Alexander [00:03:08]: The best way to find ways to boost cash flow is to measure it correctly, and  the best way to measure it is at the project level. Measuring cash flow in the aggregate hides waste. Here’s a recent example. My team recently performed due diligence on a public relations firm seeking to raise growth capital, and they used the following formula. I wish I was on a whiteboard but bear with me here audio audience. 

So cash flow per project equals cash flow divided by fees times fees divided by staff times, and staff divided by project. This revealed a healthy six hundred and fifty thousand dollars per project in this instance. This told me the firm was generating plenty of cash to fund it’s  aggressive expansion plan. Yet they were on a Zoom with me looking to raise money, claiming they did not have enough cash. I’m not sure where the cash was leaking, but it was leaking like an old faucet.

Sean Magennis [00:04:14]: And Greg, the point is to measure cash flow at the project level, not at the firm level.

Greg Alexander [00:04:19]: Yes, exactly.

Sean Magennis [00:04:23]: And now a word from our sponsor. Collective 54 is a membership organization for owners of professional services firms. Members join our mastermind group to work with their industry peers to grow, scale, and someday sell live firms at the right time, for the right price, and on the right terms. Let us meet one of the Collective 54 members.

Nish Parikh [00:04:49]: Hello. My name is Nish Parikh. I owned Rangam Consultants, where empathy drives innovation every single day. We serve Fortune Global 500 companies for their I.T. and all business professional leads. We serve customers in the United States, Canada, Ireland, UK, and India. 

These customers turn to us for help with their disability and autism hiring programs. Every one of us is connected to someone on the autism spectrum or with a disability. The challenge is finding autism-friendly  jobs and matching them to the right candidate where they can be successful. We solve this problem by building a connected community in the workplace through technology. 

We build a formal, structured, and scalable program that seamlessly integrates with our clients’ existing hiring practices. If you need help with your disability and autism hiring program, reach out to me at [email protected] or visit sourceabled.com.

Sean Magennis [00:05:53]: 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 the Collective 54 community page. .

Sean Magennis [00:06:10]: 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 professional services 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 ten questions. In this instance, if you answer yes to eight or more of these questions, your cash flow is not your obstacle to scaling a business. If you answered no a lot, you are not generating enough cash to scale.

Sean Magennis [00:06:48]: So let’s begin. Question number one, will you run out of working capital if you double the size of your firm?

Greg Alexander [00:06:56]: So this happens all the time. You go sign up a bunch of work. You got net 30 terms, which means they pay net 60, and you’re literally growing yourself out of business.

Sean Magennis [00:07:07]: Yep. Got it. Number two, will you need short-term debt if you double your firm?

Greg Alexander [00:07:12]: So, in that instance, now you’re borrowing money just to make payroll.

Sean Magennis [00:07:18]: Number three, will you develop a collections problem if you double your firm.

Greg Alexander [00:07:24]: Here we go.

Sean Magennis [00:07:24]: You said it, right?

Greg Alexander [00:07:24]: Right. So all of a sudden, now you’re, instead of selling projects, you are  chasing bills.

Sean Magennis [00:07:28]: Yep. Number four, will your cash payments exceed your cash income if you double your firm?

Greg Alexander [00:07:36]: Payroll is going to kill you there. Right.

Sean Magennis [00:07:38]: Right. Number five, will you have a hard time getting enough cash on the balance sheet to double your firm?

Greg Alexander [00:07:45]: Right. So the way to handle that, if you’re going to have this cash flow problem, meaning you get paid after you do the work instead of before the work, is you get to build up cash reserves on your balance sheet to carry you through those times.

Sean Magennis [00:07:58]: Number six, when growth has spiked in the past, did your cash flow ever turn negative?

Greg Alexander [00:08:05]: Yep.

Sean Magennis [00:08:06]: Number seven, will payroll growth exceed accounts receivable growth when you double your boutique? 

Greg Alexander [00:08:13]: Yep.

Sean Magennis [00:08:14]: Number eight, will cash flow problems be hidden due to lack of forward visibility?

Greg Alexander [00:08:20]: That happens all the time.

Sean Magennis [00:08:22]: Number nine, will it be hard to generate yield on your cash deposits? Specifically in today’s day and age.

Greg Alexander [00:08:30]: Yes, exactly.

Sean Magennis [00:08:31]: And number ten, will you be at risk of paying your future obligations if you double your firm?

Greg Alexander [00:08:37]: Right. So, I mean, literally, if you think about it, if you’re one of these high growth businesses, which is our listeners, you can grow yourself into a lot of cash flow problems. So you got to be aware of that by asking yourself these ten questions. And there’s so many easy fixes here.

Sean Magennis [00:08:54]: Yes.

Greg Alexander [00:08:54]: And that’s probably content for another episode. But the easiest one just to give you the silver bullet is to get paid in advance. If you get paid in advance, you don’t have these issues.

Sean Magennis [00:09:04]: Love it. So, in summary, boutiques run on cash. They do not run on net income or EBITDA. Do not run out of cash as you try to scale.

Sean Magennis [00:09:16]: 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.” Greg, thanks for being here. I’m Sean Magennis, and thank you, our listeners.

Scaling a boutique takes money. This type of money is called scale capital. There are three primary sources of scale capital. Each has a set of advantages and disadvantages. Which is best for you is highly situational.

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TRANSCRIPT

Sean Magennis [00:00:15] 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 to scale your firm requires capital, and that not all capital is the same. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s founder and chief investment officer. Greg has been on both sides of this. While the owner-operator of consulting firm SBI, he raised capital and as chief investment officer of Capital 54, he invest capital into boutiques like yours. This makes him uniquely qualified to help boutique owners think through the need for capital during your scale stage. Greg, great to see you, and welcome.

Greg Alexander [00:01:25] Hey, pal. Good to be with you. I’m looking forward to our discussion today. By the end of the show, we will be reminded that it takes money to make money.

Sean Magennis [00:01:34] It sure does Greg, why don’t we start right there? Why do firms need capital when trying to scale?

Greg Alexander [00:01:41] So scaling usually means entering new markets, launching new service lines, adding more headcount and many other strategic initiatives. And these things take money.

Sean Magennis [00:01:52] Yes, I agree. And at the top of the show, I suggested that not all capital is the same. What sources of capital are available to boutique owners during the scale stage?

Greg Alexander [00:02:05] These days, capital is abundant and there are many kinds. You only have 10 minutes or so, therefore I would focus on a do it yourself approach, which has three types of capital. First, there is free cash flow from operations. This comes from increasing revenue and driving down costs using the spread to scale. I mean, why give it to the government in taxes. Number two is debt. It comes from banks and private lenders. There is a way to do this without mortgaging your soul. And third, we have equity partners. This is when an investor puts in cash in exchange for a piece of the action. Watch out for predators. But the right equity partner can add a lot in addition to capital.

Sean Magennis [00:02:52] This is simple enough. But what are the pros and cons of each of those?

Greg Alexander [00:02:58] Well, free cash flow from operations is the best. The reason this is the best is because it’s cheap and in unlimited supply for well-run boutiques scaling with free cash flow. Preserve the preserves the owners equity. It does not add a debt service burden to the peno in the best of the best boutiques. Know how to allocate intelligently, which acts as a flywheel throwing off more and more of this free cash flow. There are some disadvantages to relying on free cash flow to scale.

Greg Alexander [00:03:34] For instance, instead of putting the free cash back into the business to fund scale, many owners pull it out of the business and pay themselves. This retards growth and adds years to the firm’s timeline toward an eventual exit. This is a difficult temptation to resist. Debt is the next best alternative to free cash flow. In my view, it is not cheap, but it is reasonable as lenders charge modest rates and loans to boutiques and it is also readily available in the two to three times, even arrange the negatives to debt are obvious. But let me quickly point them out. It does add an expense to the PNL as a loan payments need to be made. This will reduce the owner’s income. However, it does preserve the owner’s equity. So this can balance out over time. Unfortunately, young firms cannot secure it unless they personally guaranteed a loan. In some cases, this still does not work because the owner’s personal assets are not enough to act as collateral. Lastly, there is taking on an equity partner. This is cheap in the short term, but expensive in the long term. There is no loan payment to be made, meaning more cash is available. However, the owners stake in the firm is diluted as the equity partner is taking a piece of the business. And when an owner of a boutique sells, the equity partner gets his piece of the pie.

Greg Alexander [00:05:08] And one more thing. It is difficult for a processor firm to attract an equity investor. Many equity investors simply do not invest in people driven businesses. So it is in short supply. But that was a lot. Let me stop talking here.

Sean Magennis [00:05:24] Greg, this is excellent. How about sharing a little from your personal journey to to make sense of this?

Greg Alexander [00:05:31] Sure. So my firm, SBI, used free cash flow from operations as its source of scale capital. In retrospect, this was a mistake. It took 11 years to start scale and sell my firm. If I had taken on some debt, I think I could have cut this time in half. We were able to deploy capital effectively. Each investment resulted in more clients and each initiative resulted in lower costs. More capital would have resulted in even more clients and even lower costs. During my run, the cost of debt was much lower than the return we were generating. I will say, however, I am grateful I did not take on an equity partner. We were able to sell for nine figures. If I had taken on an equity partner, my share of the price would have been much less and I would have had sellers regret.

Sean Magennis [00:06:26] That’s a great personal example Greg. Thank you for bringing this to life. Well, I can’t think of a more important strategic decision for our listeners to get right. This one comes with very high stakes.

Sean Magennis [00:06:43] 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 sell live firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.

Matt Rosen [00:07:09] Hello. My name is Matt Rosen and I’m the founder and CEO of Allata. Allata serves large enterprise clients in the financial services, healthcare, retail distribution and professional services spaces. Our clients are centered around our offices in Dallas, Phoenix, Provo and Boise. Clients like the Frieman companies and brinks some security turn to us for help with strategic initiatives in the business and digital transformation space, typically creating new revenue streams, building seamless customer experiences and streamlining operations. We help with these initiatives by building digital strategies and roadmaps, assisting with enterprise architecture and design, working with data as an asset and customer, developing solutions which help our clients reach their strategic objectives. If you ever need help with digital strategy data and customer development initiatives, please reach out to me at www.allata.com Or [email protected]. Thank you.

Sean Magennis [00:07:57] 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 [00:08:13] 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 the listener to apply the lessons to his or her firm, our preferred tool as 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, all three of these capital sources are available to you. If you want to know to questions one to three, do not pursue funding scale with free cash flow. If you answer no to questions, four through nine do not rely on debt to fund scale. If you answer no question, 10 do not take on an equity partner. Get it, Greg?

Greg Alexander [00:09:06] I got it.

Sean Magennis [00:09:07] So let’s begin. Number one, are you generating enough free cash flow to fund scale? Number two, do you know where to deploy this extra free cash flow? Number three, are you willing to go without today for scale, tomorrow? Number four, have you been in business for at least five years? Number five, are you generating stable EBITDA every year? Number six, Would two to three times EBITDA be enough to fund scaling your firm? Number seven, can your PNL handled a debt service burden of a loan? Number eight, are you willing to personally guarantee a loan? Number nine, do you have enough personal assets to secure the loan, if you’re open to a guarantee? And number ten, are you willing to dilute your ownership take for the right equity partner?

Sean Magennis [00:10:26] In summary, it takes money to make money. Scaling a boutique takes money. There are different funding sources, each with their own pros and cons, all work well. Which is best for you is highly situational. Take your time to consider this very important strategic decision.

Sean Magennis [00:10:51] 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.