Tag: People

Sei-Wook Kim ran his agency for 16 years and never had to lay anyone off. Then, in year 17, he had to lay off 15% of his work force. Layoffs are a fact of life when you run a boutique, especially if you do not have much recurring revenue. Sei-Wook will share lessons learned from his experience. These lessons will help you execute a layoff if, or when, the time comes.

TRANSCRIPT

Greg Alexander [00:00:15] Welcome to the Pro Serv Podcast, a podcast for leaders of thriving boutique professional services firms. For those that might not be familiar with us, Collective 54 is the first mastermind community focused exclusively on the unique needs of boutique professional services firms. My name is Greg Alexander. I founded Collective 54. I’m going to be a host today. On this episode, we’re going to discuss a timely issue, and that is the best way, if there is one, to execute a downsizing. Some of our community members over hired during the pandemic when things were really, really good. And the business, the macro environment is called bit and folks are now dealing with this difficult task of right sizing their business and it’s a tough thing to do. So we wanted to have a guest on with us today who has been through this, who might be willing to share some do’s and don’ts. And we’re lucky that we have Sei-Wook Kim with us, and he’s a member of Collective 54, and he’s going to share a bit of his story. So Sei-Wook it’s good to see you and thanks for being here today.

Sei-Wook Kim [00:01:33] Hi, Greg. Yeah, thanks for having me.

Greg Alexander [00:01:35] Would you mind giving a brief introduction of your company and of yourself?

Sei-Wook Kim [00:01:41] Sure. So you mentioned, I’m Sei-Wook, I’m Co-founder and COO at Barrel. We are a digital agency founded in New York City but now distributed around the world. I started the business in 2006 with my Co-founder, Peter Kang, and we’ve been focused on primarily designing, building, optimizing websites for our clients. Recently we’ve had a specialization e-commerce with Shopify as a platform in particular.

Greg Alexander [00:02:09] Okay, very good. So I really appreciate you being here because this topic can be a little emotional and sometimes folks aren’t willing to share what they learn. So again, on behalf of the membership. Appreciate you coming here. Maybe describe for us at 30,000 feet kind of what happened. And as I hear more about your story, I’ll maybe pick on a few things and ask some questions.

Sei-Wook Kim [00:02:33] Sure. So we’ve been in business since 2006, and we had never done a layoff in our history until 2022. So what happened? You know, through the history, you know, we mainly manage our slower periods of business through natural attrition, reducing contractor usage, or finding other opportunities to reduce costs. But in 2021, one thing that we realized was we were on a pretty strong growth trajectory, at least for us, growing about 30% year over year. And we entered Q3, Q4 with a significant pipeline of new work and we feel pretty positive about the pace of growth that we were going through that year. So with that, with those well behind us, we decided to invest in our growth and invest in quotes there. So we decided to start a new discipline and invest in that and basically hire a full team with a director and several team members ahead of actually winning the business. And we hired a lot of new roles in anticipation of work coming back in 2021. We hiring was a pretty challenging environment for us. There’s a long lead time to hiring new candidates, so when the opportunity came to hire people, we decided to pull the trigger and we ended up hiring a lot more people than we needed. So that’s how we entered into Q4 of 2021. Once we got there. 

Greg Alexander [00:04:16] Yeah, yeah, go ahead.

Sei-Wook Kim [00:04:18] Yeah, once we got there, what we realized was we kept losing projects that we thought were promising and we as we kept losing projects, we saw our revenue declining while our costs increasing. And we were trying to remain optimistic through this whole time, saying, you know, either one or two projects could turn things around very quickly. But the sad reality was that we ended up not winning those projects.

Greg Alexander [00:04:48] So, you know, this is a very real problem. I mean, matching revenue to expenses, which in pro serv is largely headcount is really hard, especially when you’re running a project-based firm and the revenue might be lumpy. And there’s always a debate, you know, do you wait until you have a signed contract to hire expansion headcount, which if you have long lead times to hire people, can be really challenging or do you hire, quote unquote, ahead of demand and bet on your sales forecasts of being accurate and then the business comes in and the way you go, it’s like, I don’t know, putting money on red and spinning the roulette wheel. So a little bit more about your firm. Are you like a lot of agencies where it’s project-based or do you have some kind of recurring revenue like how far out into the future can you see things?

Sei-Wook Kim [00:05:41] About 60% of our revenue now is recurring revenue and 40% project-based. So pretty significant amount of projects that make up our revenue. And yeah, so that can make pretty big swings from a month-to-month standpoint.

Greg Alexander [00:06:02] Now, back in ’21 when you were experiencing this, was it 60-40 split back then?

Sei-Wook Kim [00:06:09] I would say if I had to go back probably a little bit less, 50-50, maybe higher on the project then versus the retainers.

Greg Alexander [00:06:21] Okay. And, you know, having now gone through this, you know, what lessons have you learned and what did you ultimately do and what advice would you have for our membership?

Sei-Wook Kim [00:06:32] Yeah. So the biggest mistake that we made was we kept burning our costs. So we had monthly losses for 4 to 5 months before we made any action. And so we so by February of 2022 decided to make the decision to lay off about 15% of our team, because a very challenging decision, especially because we had just hired some of these team members months prior. So we went through that and a lot of things that we learned through that process, doing it for the first time. A few things that we changed in our business. First, just being more transparent about our financial situation with the entire team. I felt like a lot of our team felt a bit blindsided about the news because they just weren’t in the same conversations that we were having. So there are few team members that knew about our new business pipeline. Not everyone really understood the financials. So when the news came, a lot of people were surprised. And the second thing that we took away was that we need to make decisions quickly. I think every you know, when you’re losing money, every day counts. In hindsight, we should have made this decision in December, not February, maybe even sooner, when we saw the signs of the business not coming through. So I think the speed is something that we really took away of being swift with making cuts where needed. 

Greg Alexander [00:08:16] And when you made the cuts. And it’s always unfortunate when this happens, but, you know, from time to time, cycles matter and you have to do this. How did you communicate it not only to the people that were being let go, but also the people that were staying?

Sei-Wook Kim [00:08:33] So we did as much planning as possible where we would meet with the leadership team, the managers of these people, and in some cases team members that may have been directly impacted by these people leaving. Those were informal conversations. But once we did the formal layoff, we had a communications plan that we had laid out for the full team, setting out an email on the day of the layoff saying this is what happened. And we followed up immediately the next day with an all hands meeting so that we could field any questions, really give everyone else the confidence of moving forward and the plan that we had for our account team and the plan for the future. And then same thing for the clients. In some instances it’s 1 to 1 call. Let them know what’s happening, let them know who is taking over the account, looking forward. In other instances, it might be an email plus call, a follow up, but really trying to be as hands-on and present with the team and clients as possible. Yeah.

Greg Alexander [00:09:40] You mentioned two big learnings. One was being more transparent with the financials and the second was moving quicker. On the moving quicker one, it’s really hard because if you have this sales forecast and it says this work is coming and then you know, you, you hold out hope that the work is going to come in and you don’t want to pull the trigger and let some people go. And then the work does come in and you’ve got to go back and rehire them. So any like practical advice around, I don’t know, improving the sales forecast or something along those lines?

Sei-Wook Kim [00:10:12] In some ways, we’ve taken a very of the worst case scenario approach to looking at our sales forecast in a traditional sense. We have a waiting system for where deals are in the pipeline, but just playing through scenarios of what happens if you know, our estimates are correct and we end up losing more than we expected. We’ve, as a business, been a little bit more conservative after this experience about hiring into full-time roles. So thinking about what can we bring on in a contract capacity or a part-time capacity at least to give us the flexibility if we need to scale down, there’s less impact overall to the team. And just really running slim with expenses and other non-essential costs as possible, just so we have the flexibility to extend our runway as much as possible. 

Greg Alexander [00:11:11] And then on the first learning, which is being more transparent and open about sharing the financials, sometimes our members are a little afraid to do that because, you know, if you start showing a deterioration in the business, it might make the employees nervous and some of them might quit and some of your stars might quit because they think their job might go away. How do you balance, you know, the need to do that with the fear of rattling some cages?

Sei-Wook Kim [00:11:38] Yeah, it’s definitely a fine line and it’s a bit of storytelling as well as sharing the numbers. Oftentimes the numbers, you know, depending on who the person is, at what level and their familiarity, it may seem overwhelming to see a bunch of numbers thrown at them from revenue to projections of margins. And we aim to be just transparent with the numbers sharing them as they are. But layer on what we’re feeling about the business on top of it. So, you know, we have a lot of business in the pipeline that we feel confident. For these reasons, and these are the actions we’re taking to make sure that the business is stable. And if that’s not the case, be honest about it. Say, you know, we’re not too happy with how things are looking. We may have to do a layoff again, which, you know, that statement in itself goes inside a lot of kind of uncertainty and fear. But for the team members that we, you know, who are stars and we definitely want to keep, we’ll have the conversations to make sure that they feel comfortable about the situation.

Greg Alexander [00:12:54] Well, it’s remarkable that for the first 15, 16 years of your firm being around, you never had a layoff. And that’s an incredible track record. All of us eventually have to go through this. And hopefully this is the last time you have to go through it for some time. But we’re at our time window here. We try to keep these things short, but for members that are listening to this, a reminder that Sei-Wook will be on the Friday Q&A session, I’ve got about 25 more questions I’d like to ask him. I’m sure everybody else does as well. We will hold those for the Friday session, but Sei-Wook on behalf of the member community, I just wanted to thank you publicly for coming on the show and sharing your wisdom with us today.

Sei-Wook Kim [00:13:33] Thanks. Yeah. Appreciate you having me.

Greg Alexander [00:13:35] Okay. And for those that are listening. Couple of calls to action. So if you’re interested in joining our community and you’re a thriving boutique professional services firm, you want to meet interesting people like Sei-Wook, go to Collective 54.com and fill out the contact us form and a representative will get in contact with you. If you want to read more about this subject, pick up our book called The Boutique: How to Start, Scale, and Sell a Professional Services Firm. You can find that on Amazon. And if books aren’t your jam, you’re more interested in videos, podcasts and things like that, you can subscribe to Collected 54 Insights and there you’ll get three things. You get a blog on Monday, you get a video on Wednesday, you get a chart on Friday, and some really interesting content for days. But until next time, thanks for listening and we’ll speak to Sei-Wook on the Friday Q&A. Thanks again.

As boutiques scale the way decisions are made must change. Collective 54 Founder Greg Alexander shares why the decision-making leadership of the founder is diminished as boutiques scale.

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 that as boutique scale, the way decisions get made must change. A start up benefits from the speed of a single decision maker, however, during scale, the decision making ability of the central figure gets diminished. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s chief investment officer. Greg has helped many boutiques transition their power structures. Greg, great to see you. Welcome.

Greg Alexander [00:01:14] It’s nice to be here, Sean. Transitioning the governance system as a firm scale’s is a very important topic. So I’m glad we’re speaking about that today.

Sean Magennis [00:01:21] Yeah, I can’t agree more. Greg, can you set this up for the audience? Why should a founder of a scaling boutique really care about power structure.

Greg Alexander [00:01:30] Sure. So early stage growth firms require a dictator to be successful. These firms do not have time to build consensus. They must rapidly iterate and move very quickly. And the scope of the decisions that need to be made is small at this stage. The personal willpower of the founder dictator is a key reason these types of firms succeed. Strong leadership is crucial, and the skills needed in a dictator type of leader are easily defined and readily available am my making sense?

Sean Magennis [00:02:04] Yes, yes, you are correct. Please continue.

Greg Alexander [00:02:07] So when a firm starts to scale, it needs to implement a democracy. The boutique is larger and leadership must represent the team. More people need to have a say the dictator is removed from the front lines, his or her proximity to clients becomes more distant. As a result, his or her decision making ability becomes diminished. This person’s once prophetic instincts become dulled.

Sean Magennis [00:02:34] I completely understand that now. So owners of firms, when attempting to scale, need to make more and more complicated decisions. And the best people to make those decisions are those closest to the clients. A somewhat removed dictator is no longer the person uniquely qualified to steer the ship.

Greg Alexander [00:02:55] And you are correct.

Sean Magennis [00:02:56] So how does a boutique transition from the powerful dictator to a democracy?

Greg Alexander [00:03:01] Well, very carefully, as some foreigners do not want to go quietly, the strong willpower that made them successful in the first place now becomes a liability.

Sean Magennis [00:03:12] So, Greg, surely there must be some best practices to handle this transition smoothly?

Greg Alexander [00:03:17] Yeah, there are all firms go through this, at least the ones who scale beyond a nice lifestyle business.

Sean Magennis [00:03:22] So share some of these best practices with our listeners.

Greg Alexander [00:03:25] OK, so I’m going to try to simplify. So bear with me. All right. So the transition typically involves the election of a board. The board is comprised of the equity partners and at least one external independent board member. I play and have played this role. The board meets quarterly and it is mandated to make policy decisions. It is important to note that the board does not run the firm they have focused entirely on long term reporting to the board is a managing partner. The managing partner acts like a CEO does in a corporation. He or she is the boss and is accountable to the results. The managing partner has an executive leadership team that reports to him or her. Normally, the executive leadership team is comprised of the department heads. For example, the leader of the delivery staff is almost always on the ELT. This way the employees from each department are represented. These three bodies, the board, the managing partner and the Executive Leadership Team Act much like the checks and balances system in our government. For instance, the board is the legislative branch. The managing partner is the executive branch. In the executive leadership team is the judicial branch. The ultimate power sits with the owner or owners. The board answers to the owner. Think of the owner or owners, much like you would think about the shareholders of a public company. They own the company, but they do not run it. They elect a board to represent them and the board, selects a managing partner to run the firm. I’m dramatically oversimplifying, but does this basic structure make sense?

Sean Magennis [00:05:06] It certainly does in simplicity is preferred, makes it makes total sense. And I can clearly see how this power structure enables a firm to scale. And I do recognize how different this is than a small firm with all roads leading to a one shot caller.

Sean Magennis [00:05:26] And now a word from our sponsor, Collective 54, Collective 54 is a membership organization for owners of professional services firms. Members joined to work with their industry peers to grow scale and someday sell their firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.

Russ Perry [00:05:52] Hey there, my name is Russ Perry and I’m the founder and CEO of Design Pickle. Design Pickle offers, flat rate graphic design and custom illustrations to fit any team’s needs. We work with marketing teams, agencies and entrepreneurs across the world. Turn to us to help level up and scale your creative content. Find out more at designpickle.com.

Sean Magennis [00:06:12] 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 [00:06:30] OK, this takes us to the end of the episode, let’s try to help listeners apply this, Greg. 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 question that 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, your decision making is working for you. If you answer no too many times your decision making is more than likely getting in the way of your attempts to scale. Let’s begin with the questions.

Sean Magennis [00:07:14] Number one, have you transitioned from a growth stage boutique to a scale stage firm?

Greg Alexander [00:07:21] So the way that you would know that is when your aspirations change. So are you moving from aspiring to make more money. To building a firm that’s bigger than you, you know, moving beyond a lifestyle business. So that’s how you would answer that question.

Sean Magennis [00:07:37] That’s a good distinction. Number two, are you attempting to become a market leader? For example, one of the 4100 firms who have reached scale.

Greg Alexander [00:07:47] And if you are so now, if you’re going from scale to market leadership, then you absolutely need to embrace democracy over dictator.

Sean Magennis [00:07:55] Number three, do you have a dictator in place today?

Greg Alexander [00:07:58] If you do try to try to handle a a peaceful transition of power, a coup d’etat is not a good idea.

Sean Magennis [00:08:07] Number four, have the dictators once great instincts begun to deteriorate? Number five, have the number of decisions to be made gone up considerably? Number six, has the complexity of the decisions to be made increased substantially? Number seven, does it make sense to distribute authority closer to the client?

Greg Alexander [00:08:31] Right, so if you answered yes to five and six, the number of decisions in the complex decisions has increased, then it does make sense to distribute authority close to the client. However, if you’re running a very simple business with very few decisions to make in the ones, you do have to make a simple that. Maybe not.

Sean Magennis [00:08:48] Yep, got it. Number eight, do the employees want a greater say in policy making? Number nine, do the owners want to delegate decision making more?

[00:08:59] So this is what’s in it for the owners. You know, if if they have to make every decision every day, they’re probably working more than they want to make, more than they want to work. So by distributing decision making down to trusted lieutenants who can do it for them, they actually reduce their workload.

Sean Magennis [00:09:13] And work smarter, not harder.

Greg Alexander [00:09:14] It’s exactly right.

Sean Magennis [00:09:15] And number ten, do you have a person capable of serving as a managing partner?

Greg Alexander [00:09:20] So this is the biggest issue. Dictators, right. Those that are the founders that drive their firms to certain level of success, they oftentimes don’t want to relinquish power. So the way to do it, at least the way that that I did it and those that I’ve seen, pull this off, do it as they grow their own. Yes, risk is really high when you’re bringing somebody in from the outside. But if you’re if you’re grooming a successor over a number of years, this becomes easier.

Sean Magennis [00:09:45] I love it. The institutional knowledge. Yes, the culture knowledge is so key. So in summary, we do love our founders. They had the guts to start the firm and the skill to grow it. However, growing a boutique and scaling it are two very different things. Scaling does not mean doing more of what you are doing. It means doing what you would doing differently. This is the point whereby dictators plateau and a new governance system is needed.

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, thank you.

I’m Sean Magennis and thank you, our audience for listening.

Splitting the equity in a partnership is difficult. However, there is a proper way to do it that results in lots of wealth being created. Learn how to fix broken legacy partnership agreements as you grow, scale, and exit.

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’ll make the case that splitting up the equity in a partnership is difficult. However, there is a proper way to do it and it results in lots of wealth being created. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s Chief Investment Officer, Greg has helped many boutique owners fix broken legacy partnership agreements. Greg, good to see you and welcome.

Greg Alexander [00:01:09] It’s good to be here, Sean and you are correct, I was just helping an owner unravel a one sided agreement. Splitting up the pie is very tricky.

Sean Magennis [00:01:16] OK, let’s start there. Share the story with us.

Greg Alexander [00:01:19] OK, so a husband and wife team started a marketing agency and early on they promoted a key employee to partner and gave them 20 percent of the equity. This was in response to the employee receiving an attractive job offer from another agency. In the beginning, everyone was happy and it seemed to be working. As time went on, the husband and wife started resenting the new partner. The new partner was not delivering the expected revenue, yet he was getting distributions from their efforts.

Greg Alexander [00:01:52] Also, the husband and wife wanted to take the agency in a new direction, but the new partner did not. He resisted and the way the operating agreement was written as he was able to stop it. The situation deteriorated and got hostile, with lawyers and others coming in, a valuation firm was hired to figure out a buyout price. Of course, no one could agree on what his 20 percent was worth and how the buyout would be paid over time. It got ugly and it looks like 20 percent of the equity is now dead equity.

Sean Magennis [00:02:26] So, Greg, what’s going to happen in this situation?

Greg Alexander [00:02:28] Well, they are still fighting and a resolution has not been agreed to yet. However, I’m glad, you know, we let off with this story because there’s a big lesson to be learned here from this example.

Sean Magennis [00:02:39] Greg, what is that lesson?

Greg Alexander [00:02:41] So equity arrangements need to be flexible. So for our listeners, the evolutionary path is a startup that becomes a growth firm, that becomes a firm at scale and then eventually becomes a firm an exit. And equity splits need to change as they move along this life cycle, for example, it is almost impossible to split equity as a startup. There are no clients, there’s no revenue, no profits. It’s also almost impossible post startup in the growth stage. Yes, there are clients and revenue, but there’s no intellectual property or intellectual capital to be valued at that time. The firm is still not worth anything because nobody would buy it. 100 percent of zero is zero. This changes in the scale stage as the firm is now worth something and it changes again in the exit stage because after exit, some partners are leaving and some are staying on. That dictates the need for a new equity split.

Sean Magennis [00:03:38] Greg, this is so key. And before we move on to scale and exit, how should a boutique owner split equity at a startup or in the growth stage?

Greg Alexander [00:03:46] So when starting the firm, I recommend valuing the equity solely based on contributed capital. So, for example, let us say it takes a startup boutique a million dollars to launch. So if you put up 300K and I put up 700K then the equity split is 30 percent you and 70 percent me. A lot of boutique owners split up equity based on sweat equity instead of contributing capital. And this is a big mistake and it leads to hardship down the road. So why is that? Well, it’s impossible to accurately assign a value to sweat equity. So, for example, what percentage of equity should go to a great rainmaker versus an average rainmaker? The questions too difficult to answer instead. Sweat equity is accounted for in salaries, not in equity. For instance, if a partner was responsible for project management, they get paid a salary that reflects the going rate for a project manager. That is the value of the role and it is set objectively in the open market. Does that make sense?

Sean Magennis [00:04:45] Yes, it does. But what happens when a partner does not have any capital to put into a firm at launch, but over time ends up contributing a lot to the firm as it scales? OK, so now you’re talking and this happens all the time and therefore equity splits need to be dynamic, not static.

Sean Magennis [00:05:02] Yes.

Greg Alexander [00:05:02] So in this case, the partners use a tool called the Buy-Sell Agreement. This is a contract that stipulates how a partners share of a business can be bought and sold. It defines that equity splits can happen under certain conditions and it defines exactly how it will happen. For example, it is common that the buy sell agreement establishes how shares in the firm will be priced, who they can be sold to, how they would be paid for, etc.. So having a buy sell agreement in place provides the needed flexibility to dynamically adjust equity splits at as circumstances change.

Sean Magennis [00:05:37] Greg, is this common?

Greg Alexander [00:05:39] Well, yes and no. Buy-Sell agreements are well-worn territory and are an established best practice. A boutique owner could hire an attorney and get one in place very quickly and inexpensively. However, many boutique owners do not have one in place. And you might ask why? Well, this is because founders think they do not need them. They cannot imagine a scenario where the need for one would arise. This is foolish. If you scale your firm in one day, go to sell it. There is a better than average chance someone other than the founder has equity. Founders want to keep all the equity, but I remind them that 100 percent of zero is zero. Sharing the wealth with those who earn it is a very good idea. In my experience. When the founders shares the wealth, more wealth is created for everyone. Magical things happen when employees become owners.

Sean Magennis [00:06:26] That’s excellent advice, Greg, and great examples. Thank you. And now a word from our sponsor, Collective 54, Collective 54 is a membership organization for owners of professional services firms. Members joined to work with their industry peers to grow scale and someday sell firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.

Tad McIntosh [00:06:59] Hello, my name is Tad MCIntosh, I own HumCap, a human resources consulting and recruitment forum. We help small businesses with their growth, human resources and recruitment needs. We get asked very often about how we can help you have strategic value in human resources in your growing company. We also get ask what are the risks in H.R. as I grow my company? We solve these problems by building customized H.R. and recruiting solutions for each and every one of our clients. If we can help you with your needs, with our experience and recruiting professionals, please call me at 469-484-6023 or email me at [email protected]. Thank you and have a great day.

[00:07:51] 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. So, OK, this takes us to the end of the episode, let’s try to help listeners apply this. 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 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, your equity splits are working for you. If you answer no too many times, your equity split is likely getting in the way of your attempts to scale. Let’s begin.

Sean Magennis [00:08:52] Number one, is your firm owned by more than one person? Number two, do the owners contribute to wealth creation in different proportions? Number three, are the owners at different stages in life?

Greg Alexander [00:09:09] Yes, so we should talk about that. So if you start your firm and someone’s in their 50s and someone’s in their 20s, you know, over time that person in their 50s is going to want to exit before the person in their 20s. So that’s the reason. That’s just an obvious example of why dynamic splits as opposed to static splits.

Sean Magennis [00:09:28] That makes a lot of sense. Number four, do the owners have different financial needs?

Greg Alexander [00:09:33] Some might need more cash, so therefore they get a higher salary. Some might be more interested in long term wealth creation. So they take a lower salary to get a higher equity split.

Sean Magennis [00:09:42] Again, makes total sense. Number five, do the owners have different visions of the future? Hence your example. Number six, have the partner contributions fluctuated over the years?

Greg Alexander [00:09:55] And again, this is another good governance seal of approval here. If the equity split is dynamic, then somebody can’t rest on their laurels just because they got, let’s say, 20 percent of the firm, you know, at year three and year ten if they’re not contributing, then they should not hold on to the 20 percent in perpetuity forever.

Sean Magennis [00:10:14] Yep. Number seven, has resentment crept into the relationships?

Greg Alexander [00:10:19] Its all the time. Business partnerships are like marriages.

Sean Magennis [00:10:22] Yep. Number eight, are you living with a legacy ownership structure that is now outdated?

Greg Alexander [00:10:28] Yep.

Sean Magennis [00:10:29] Number nine, will rising stars require equity to be retained?

Greg Alexander [00:10:34] Yeah. And the foolish owner here says, well, fine, I’m not going to give him equity. Well, those rising stars will quit. They’ll go start their own firms and now you’ll have new competitors and you’ll have a talent drain. So, you know, don’t be penny wise and pound foolish.

Sean Magennis [00:10:52] Great advice, Greg. And then to wrap us up, number ten, has the ownership structure distorted policymaking?

Greg Alexander [00:10:59] Yeah, and that’s a separate issue. Governance is separate than ownership. So you could have different classes of shares with different voting rights, but that’s a whole nother topic for another day.

Sean Magennis [00:11:07] Yep. Thank you, Greg. In summary, during the start up and growth stage of a firm development, split up the equity based on contributed capital. However, as the firm scales put a buy sell agreement in place, this converts dysfunctional static equity arrangements into healthy, dynamic ones. This will result in more wealth for everyone involved. 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.

Designing the compensation system for Partners at boutique professional service firms requires special treatment. Partners are not like other employees and getting their pay system correct requires strategic thought.

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 that designing the compensation system for partners at the boutique professional services firm requires special treatment. Partners are not like other employees, and getting their pay system correct requires strategic thought. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s chief investment officer. On this show, I typically hold up Greg, as an example to follow. This show will be different in this instance, Greg made a few mistakes that actually cost him millions of dollars. Today, he will share his mistakes in the hopes of helping you avoid them. Greg, sorry to put you on the spot. And good to see you and welcome.

Greg Alexander [00:01:31] Hey, pal, give me a minute, will you? It looks like I’m getting ready to eat some humble pie and I want to grab some extra napkins because it’s going to be messy.

Sean Magennis [00:01:40] Don’t feel bad. No one is perfect. And that includes you. I appreciate your willingness, though, Greg, to share the mistakes along with the victories.

Greg Alexander [00:01:49] Of course I’m kidding. I’ve made more than my fair share of mistakes, and I’m happy to share if it helps others.

Sean Magennis [00:01:55] I know it will. So let’s get into it. Greg, tell me about this topic. Paying partners. Why is it important to our listeners?

Greg Alexander [00:02:03] So as a firm scale’s, it adds more partners, loyal employees earn the right to have a seat at the table. When this happens, these loyal employees get any job description. Individual contributions get replaced with firm building activities. For example, partners often own recruiting and they frequently are charged with employee training. Sometimes they’re asked to head up a new industry practice or in some cases maybe move overseas to expand internationally. Whatever it is, the days of just selling and delivering work are over. It is no longer about personal billings, but rather now it’s about the success of the firm exclusively. So the question is, how should a partner be compensated for these different activities?

Sean Magennis [00:02:43] Yes, this this makes sense. So our audience members are scaling their firms some dramatically. So and you’re right, this is leading to superstars earning the job title of partner. And with the new job comes new responsibilities, which requires a new compensation system where should a listener start.

Greg Alexander [00:03:04] Well, this shows about comp. This means salary and bonus in equity is ownership, not compensation. So I will leave the equity discussion for another show. Is that right?

Sean Magennis [00:03:15] OK, yes, this show is 10 to 15 minutes. So let’s shelve equity for another episode. Give you give me your take on salary and bonus.

Greg Alexander [00:03:25] OK, so I will discuss salary first as it is easy, my advice would simply to be calculate the going rate for the role and pay at the midpoint. For instance, a quick search on salary.com tells me a business development partner in my hometown of Dallas earns one hundred and twenty six thousand dollars at the midpoint, benchmark data is widely available. Pick your source. The reason you pay at the midpoint is simple. You are not a startup and yet you are not a market leader yet you are in between the two. Therefore pay in the middle obviously can you can tweak this up or down. But I like to keep things simple. My main point is to pay according to the market rate partners are labor. Labor is a commodity priced in the open market. There are buyers and sellers for this labor. The equilibrium point between buyer and seller is the price for the commodity. If the partner quit your firm, this is what she would fetch in the open market. If you recruited a new partner to the firm, this is what you would pay. Eliminate all the subjectivity from salary discussions. Let it be a data driven decision. Does this make sense?

Sean Magennis [00:04:35] Makes perfect sense. And the simplicity of this is actually wonderful. You mentioned bonuses are harder, so let’s jump to that.

Greg Alexander [00:04:44] Yeah, bonuses are much harder. So why is that? So it’s hard to find the balance between past contributions, current contributions and investments today that will lead to future contributions. So, for instance, you may have a partner that took on a strategic initiative that runs in the red this year, breaks even next year, and turns profitable two years from now. So how do you pay this partner? If you penalize him for the short term EBITA hit, he will never take on another strategic initiative if you reward him when the strategic initiative turns profitable, is that reward forever or is there an expiration date on it? This is a very tricky decision. There are three systems available and most firms choose one of these three. You want me to briefly describe this?

Sean Magennis [00:05:37] Yes, please, Greg, because I want to save some time for your war story.

Greg Alexander [00:05:42] OK, so the first system is based on seniority. The longer your tenure, the more you make. This has the benefit of being very easy to administer. But the younger partners hate paying the old farts forever. The second system is the performance based system. Each party gets assigned some goals and he or she gets paid if they are met. This sounds great as who does not love a meritocracy. The problem with this, however, is there is no incentive to build the firm. Pay that prioritizes short term performance can destroy a boutiques ability to scale at scaling takes longer than a year or two. The third system is called a reconciliation system. This involves a compensation committee made up of the owners and awards are handed out by vote. It comes with a formula usually tied to enterprise, wealth creation or partner distributions. It is subjective, but it does allow for a judgment to be applied. And since all partners are on the jury, the system does have integrity. Personally, I believe this is the best system for firms trying to scale. It does the best job of balancing the short term with the long term. Did I describe these three systems clearly?

Sean Magennis [00:07:00] Yes, you did. Thank you. So our listeners have three choices in front of them now, one seniority to performance based, three, reconciliation and listeners I recognize the devil is in the details. So if you have questions about this, reach out to our team at Collective 54 and they will help you. OK, Greg, would you please share your personal story?

Greg Alexander [00:07:28] Oh sure. I think I would call this Confessions from a Mad Man. So as I transitioned from a startup to a boutique, I did not change the partner compensation system. This cost me millions of dollars over time and it created tension among the partners. Our system was very unsophisticated. I paid partners a very generous salary that was well above the market rate. For example, the first group of partners earned 2x what they could fetch in the open market. To make matters worse, bonuses were paid as distribution’s. The distributions were paid based on the partners equity stake.

Greg Alexander [00:08:07] For example, if a partner owned 25 percent of the firm, they got 25 percent of the distributions. This was a huge mistake. Equity is different than pay. As we became very successful, partners were pulling millions of dollars out of the business. Yet this payment had very little to do with their contributions to the firm. The root cause of this mistake is easy to identify. I felt a loyalty to the early partners. They took a risk to join me in the early days and they took equity in lieu of cash. As time went on, I wanted to reward them for their early sacrifices.

Greg Alexander [00:08:43] However, I never contemplated when this debt was paid, I just kept paying that debt in perpetuity. They took advantage of me, the right thing to do would have been to refuse the excessive compensation for obscene but greed and envy of powerful forces for humans to resist. And I’m sure they felt they deserved what they were getting. All of us, including me, tend to overstate actually worth. The problem is that a new group of partners emerged and they were way underpaid.

Greg Alexander [00:09:17] The effect they were having on the business was large and growing, it eclipsed the contribution from the legacy partners. And as time went on, this compounded the gap between the old partners and the new partners became extreme. The dollar should have shifted from the legacy parties to the new partners, yet it did not. This was a failure in leadership. I mean, this poor leadership, fractured relationships. It created some bad blood. And I deeply regret this. Friends became enemies. Sadly, the shame of it all is this was all avoidable. I just did not know any better at the time. So please learn from my mistakes. Maybe my salvation can be realized in helping you steer clear of this grief.

Sean Magennis [00:10:02] Well, Greg, I’m I’m literally speechless and not for the reason you may think I’m speechless at how honest you are with our audience. It takes great humility to share something as personal in a medium like this. And I know this will be heard by thousands of people. So on behalf of our listeners, Greg, thank you. You know, I. I know you are living your mission statement every day, my friend.

Greg Alexander [00:10:27] Thanks, pal. Now, let me get up off this therapy couch and let’s cut to the checklist.

Sean Magennis [00:10:34] OK, you got it. And now a word from our sponsor, Collective 54, Collective 54 is a membership organization for owners of professional services firms. Members joined to work with their industry peers to grow scale and someday sell their firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.

Satish Manduva [00:11:05] Hello, my name is the basement. I work at Intellisoft Technlogies. We serve Fortune 500 clients in providing solution architecture, application development and consulting services. We are providing solutions in artificial intelligence, using our product data, market study and virtual learning with our product that brings these clients turn to us for help with any big data and AI solutions. We solve this problem by providing solutions for insurance, Teleco and financing the industry. Example fraud analytics for insurance, default analytics for finance and constant analysis for the health care. If you need help with any big data or AI solutions in finance, insurance or teleco, reach out to me at [email protected] www.Intellisofttech.com

Sean Magennis [00:12:03] 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. So this takes us to the end of the episode, let us try to help listeners apply this, 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 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, my instructions are a little different than normal. So please pay attention. Loyal listeners. If you answer yes to questions one and two, you do not need a new partner pay system if you answer no to questions one and two, you’ve got some work to do. If you answer yes to questions three, four and five, a seniority system might work for you. If you answer no to questions three, four and five, then a seniority based system is not for you. If you answer yes to questions, six, seven and eight, consider a performance based system. If you answered no to these questions, a performance based system is not a good fit for you. And lastly, if you answer yes to questions nine and ten, the reconciliation system might be best for you if you answer no to questions, nine and ten you can rule out the reconciliation system.

Greg Alexander [00:13:48] Very good.

Sean Magennis [00:13:50] Hopefully everyone gets this. Here goes number one, are you paying salaries based on external benchmarks? Number two, are you paying salaries at the midpoint of the benchmarks? Number three, are years of service, a fair way to pay partners? Number four, are senior partners past contributions contributing to today’s wealth creation?

Greg Alexander [00:14:21] Often overlooked.

Sean Magennis [00:14:22] Yes. Number five, will your younger partners stick around to wait for the senior partners to retire?

Greg Alexander [00:14:30] Oftentimes, no.

Sean Magennis [00:14:32] Number six, do you have clear objectives for each partner? Number seven, is it clear when the objectives are met? Number eight, is it possible to balance short term and long term wealth creation with these objectives? Number nine, will partners perform with integrity if placed on the bonus compensation committee?

Greg Alexander [00:15:01] Be very careful of politics there.

Sean Magennis [00:15:03] And number ten, can you develop a methodology that fairly attributes wealth creation to partner activities?

Greg Alexander [00:15:12] What’s important about number 10 is it’s about wealth creation and wealth creation attribution is hard.

Sean Magennis [00:15:18] Yep. So thank you, Greg. In summary, boutiques add partners over time. Paying partners correctly impacts the scalability of the boutique. Consider these three systems and learn from Greg’s mistakes. 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. Thanks for your candor today, Greg, and thank you to our audience for listening.

Founders of boutiques often mistakenly equate the number of employees with success. However, lots of employees signal a poorly run firm. Collective 54 founder Greg Alexander makes the case for lean staffing and illustrates the impact to profitability.

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 that fewer employees are better than many employees. Founders of boutiques often mistakenly equate number of employees with success when in fact lots of employees signals a poorly run firm. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s chief investment officer. Greg’s firm, SBI, at the time of exit averaged one million dollars in revenue per employee. This was driven by having fewer employees than most, this resulted in exceptional profitability and wealth creation for the owners. Greg, I’m looking forward to this. Good to see you and welcome.

Greg Alexander [00:01:33] It’s good to be with you. What a great topic we have today.

Sean Magennis [00:01:37] So, Greg, I often encounter boutique owners with bloated staffs and below average margins. Why is this happening?

Greg Alexander [00:01:46] Somewhere along the way, it became cool to say, quote, Hi, my name is so-and-so. The name of my company is X, Y, Z, and we are a 200 person firm in the blah blah, blah, blah space. Founders brag about lots of people to establish credibility, and maybe this works on the uneducated, but when I hear this, I think, oh no, this poor schmuck is working his tail off and not making any money.

Sean Magennis [00:02:14] So, Greg, what advice would you give a listener who is making this mistake?

Greg Alexander [00:02:18] Geez, where do I begin? I think the first thing I should do is explain that labor is the biggest expense in a professional services firm, often 80 percent of the total expense line. Therefore, anything you can do to reduce labor expenses, do it because this will equate to more profits. I mean, the best boutique in the world would have no employees and lots of clients and revenue.

Sean Magennis [00:02:43] Yeah, exactly. And let’s assume this poor schmuck, as you affectionately referred to earlier, was actually willing to listen. What steps would you have him or her take?

Greg Alexander [00:02:55] I would ask Mr. Schmuck three questions. Question number one, how many people do you need and why? The question number two, what type of people do you need and why? And question number three, which organizational structure would work for you and why?

Sean Magennis [00:03:13] And Greg, how would he know the answers to these questions?

Greg Alexander [00:03:17] Well, he would know the answers to these three questions if he understood three things. First, he would understand the skill level needed to perform the work skill level could be simply junior, mid-level or senior as an example. Second, he would understand the knowledge required to perform the work knowledge level could be simply industry knowledge or knowledge of the problem or knowledge of the solution. And third, he would know how long it would take to perform the work. This is measured in hours and rolled up into a level of effort budget.

Sean Magennis [00:03:57] Got it. And when he had the answers to these questions, what would he do with them?

Greg Alexander [00:04:02] Well, this would tell him how many people he needed and what type. And this is the most important part. He would have the data he needs to engineer a profitable organizational model.

Sean Magennis [00:04:15] How so Greg?

Greg Alexander [00:04:17] So after he knows what it really takes to perform the work, I mean, down at the task level, he will notice he is destroying profits. My friend, poor Mr. Schmuck will see almost every time he can do the work with less people, with more junior people and at less cost.

Sean Magennis [00:04:36] And how does he see that ?

Greg Alexander [00:04:39] Listen, we’re living in a different time today. The service delivery has forever been altered in three very distinctive ways. First, services can be automated with technology. For example, look at what is happening with robo advisors in the wealth management space. Portfolio managers are being replaced by algorithms by the thousands. Second work can be offshored. The big market leading firms offshore approximately 40 percent of their work, yet boutiques offshore about five percent. This is a missed profit opportunity. And third, the gig economy is here in the professional services space. And for real, you can now rent a Harvard MBA X McKinsey type from the to marketplace for less than one hundred bucks an hour. You can get excellent graphic design work from one of collected fifty four members, Russ Perry at Design Pickle for as little as five hundred dollars per month flat fee. These are just a few examples. If Mr. Schmuck picked his head up, he would see there a profit improvement opportunities all around him. Adding headcount is a lazy man’s way of scaling. The days of proving your success with large staffs have been replaced by today’s standard, which is profit. Standard of proof now is profit, not number of employees. There’s nothing cooler than fat profits. I encourage all of our listeners to intelligently design the org structure. Do not just throw heads at every problem.

Sean Magennis [00:06:20] That’s excellent advice, Greg, and great examples. Thank you. And now a word from our sponsor, Collective 54, Collective 54 is a membership organization for owners of professional services firms. Members joined to work with their industry peers to grow scale and someday sell their firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.

Don Goldstein [00:06:54] Hello, my name is Don Goldstein. I am president and part owner of 5Q. 5Q primarily serves commercial real estate companies across the United States. Our clients turn to us for help with maximizing technology, efficiency, security and compliance. We provide worry free I.T. with our full spectrum of technology solutions through four service lines I.T. and cyber leadership, I.T., managed services, cyber security, managed services and I.T. project management. If you need assistance in any or all of these areas, reach out to me at [email protected].

Sean Magennis [00:07:34] 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. OK, this takes us to the end of the episode, let us try to help listeners apply this. 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, your employee count is working for you. If you answer no, too many times, you are likely unsure of how many employees you need, which is getting in the way of your attempts to scale a profitable firm. Let’s begin.

Sean Magennis [00:08:41] Number one, can you decouple the rate of revenue growth from the rate of headcount growth?

Greg Alexander [00:08:47] Yeah, I mean, this is so important. You grow in revenue, 30 percent headcount of 30 percent. You’re running in place if you’re growing revenue, 30 percent in headcount growth to, let’s say, 10 percent, you’re expanding your margins.

Sean Magennis [00:08:58] Yes. Number two, are most of your problems, people related?

Greg Alexander [00:09:03] They say all your problems walking around on two feet. So fewer people, fewer problems.

Sean Magennis [00:09:08] Number three, is your payroll your biggest expense?

Greg Alexander [00:09:12] Obvious question.

Sean Magennis [00:09:13] Number four, can technology perform work that humans are doing today? Number five, are you offshoring less than 40 percent of your work?

Greg Alexander [00:09:25] Yeah, there’s still some fear there and our listeners need to get over this. I mean, this is well-worn territory at this point.

Sean Magennis [00:09:32] And the quality of offshoring is spectacular.

Greg Alexander [00:09:35] Sure.

Sean Magennis [00:09:36] Number six, can you flex up or flex down headcount to match demand in close to real time?

Greg Alexander [00:09:44] This is what’s great about these talent marketplaces like CATALIN.

Sean Magennis [00:09:49] Number seven, are you skilled at labor arbitrage? Number eight, is it clear that scale does not refer to the number of employees, but to the amount of cash flow? Number nine, is it hard to match revenue and expenses?

Greg Alexander [00:10:09] In a project based firm, it’s brutally difficult.

Sean Magennis [00:10:13] Number ten, do you have limited forward visibility in your business?

Greg Alexander [00:10:18] Yeah, and again, most of the listeners here run some version of a product project based firm. So forward visibility is a problem. That’s why these flexible labor models are so critical.

Sean Magennis [00:10:29] And really keeping all of those relationships warm.

Greg Alexander [00:10:31] Yes.

Sean Magennis [00:10:32] So, in summary, the best boutique would have no employees. Labor is your biggest cost. Organize to reduce employee related expenses. This will drive your profits up. 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 Professional Services Firm. I’m Sean Magennis. Thank you for listening.

As a firm scales its culture erodes. Bureaucracy creeps in as a firm gets larger. The owner shifts from an inspirational leader into a law enforcement officer which is not healthy. On this episode, we discuss how to build a great culture in professional services firms.

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 am Sean Magennis, CEO of Capital 54 and your host. On this episode, I will make the case that as a firm scales its culture, erodes. Bureaucracy, creeps in as a firm, gets larger, this converts the owner from an inspirational leader into a law enforcement officer over time, which is not healthy. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s chief investment officer. Greg, while owner and CEO of SBI, built one of the great cultures in professional services firms, he has much to share on the subject. Greg, good to see you. Welcome. Great subject.

Greg Alexander [00:01:21] Yeah. Sean, it’s good to be with you. I’m looking forward to today’s conversation.

Sean Magennis [00:01:25] Excellent. Greg, let’s start with an understanding as to why affirms culture erodes as it scales. Why does this happen?

Greg Alexander [00:01:34] You know, the reason is pretty simple. Founders of boutiques did not know how to scale a culture. And the root cause of this is there’s very little material available to founders on this subject. And most founders do not recognize the importance of scaling a culture until it’s too late.

Sean Magennis [00:01:50] And why is it important to scale a culture?

Greg Alexander [00:01:54] Culture defines how things get done, and defining how to do things matters, especially as the firm gets larger. There is more work to be done by more people. A hazing culture gets in the way of scaling because employees do not know how to behave. And when this happens, founders react by installing bureaucracy with lots of procedures and rules. This turns him or her into a law enforcement official. And once rules replace creative freedom, politics creep in and politics destroys firms. Employees shift their focus from serving the client to serving the boss and scale stalls out.

Sean Magennis [00:02:41] Boy, do I understand this one. Greg, you’ve taught our audience about the three life cycle stages of a professional services firm. Those are phase one growth, phase two scale and phase three exit. It appears that culture is a strength in phase one growth, but it becomes a weakness in phase two scale. Why is that?

Greg Alexander [00:03:10] That’s a great observation. You make a very important point here, Sean. The reason culture breaks down during phase two scale is because scaling is messy. The chaotic nature of scaling means that employees work while the system starts to break down due to all the growth. As previous methods are replaced with new procedures to accommodate the scale, employees struggle to adapt. And it is at this precise moment that they need to know how to behave. And this is when a strong culture can be very helpful. For example, let us imagine an exercise, a picture you and I meeting with a firm in Phase one growth. The firm is, let’s say, twenty five employees and has been in business for about five years. We ask each employee the following questions. Number one, what kind of behavior does the firm hire to? Number two, what types of behavior does the firm promote to? And number three, what types of behavior gets people fired? The answer is coming back from this group of 25 employees will be very similar and crystal clear. This will demonstrate employees know how to behave. Now, let us imagine, we are meeting with a firm in phase two scale. Let’s say this firm’s about 100 employees and has been in business for, let’s say, 15 years. We ask each employee the same three questions. What kind of behavior does the firm hire to what kind of behavior does the firm promote to? And what what types of behavior gets a person fired? The answers coming back from this group of 100 employees will be dissimilar and unclear. And this will show that employees do not know how to behave.

Sean Magennis [00:04:59] I can see that. And the hypothetical example makes common sense, but I’m not sure I understand the so what? Why should a listener care if employees do not know how to behave?

Greg Alexander [00:05:12] Good question. The reason our listeners should care is because during the scale phase, they cannot be everywhere and do everything themselves. They need to know their employees are representing the firm the way the founder wants it to be represented. Employee behavior shows up everywhere, shows up in sales calls, in job interviews and client meetings, etc.. If the culture does not scale, the firm will bring in the clients, hire the wrong employees for client satisfaction and so on and so on. And in the end, a eroding culture will result in missed budgets.

Sean Magennis [00:05:45] Yep, OK, I get it now. A strong culture is how a founder can succeed without having to be personally involved in everything. Greg, I recently listened to an interview. An interview you did on John Warrillow’s Built to Sell podcast. It became very popular as thousands of people have now listened to it. One of the reasons it was so well-received is you talked about the famous SBI culture. Would you share some of this with our audience today?

Greg Alexander [00:06:16] Sure, boy, there is a lot to share here, and I should not repeat what I shared with John as listeners of this show can go listen to that one. But let me share some of the story with you here. So my firm, SBI, was in the consulting space. One of the challenges in that industry is very high employee turnover. It is not uncommon for consulting firms to run it, let’s say 30 to 40 percent annual employee turnover. And we ran it less than 10 percent for years. One of the reasons for the high turnover in consulting is big consulting firms fire employees for not being compliant with the procedures in the rules. I mean, these firms have an operating manual for how to eat lunch. It’s insane. Personally, I hate rules. I recruited mavericks and hired rule breakers. My firm only had three rules. This meant an employee back then can only get fired for three reasons. And they were number one, if you steal from me, you’re gone. Number two, if you lie to me, you’re gone. And number three, if you mess with it with another employee’s ideal life, then you were fired. So, for example, if you goose an expense report, you were out. If you lied to me about a project or the outcome of a sales call, you were gone. And as it related to number three, we had every employee tell us what their ideal life was, meaning exactly how they wanted to live in the role the job with us played in that life. If you were someone who caused a teammate to be miserable, you got fired. This meant no midnight emails, no finger pointing, you know, none of that bad behavior. So my basic philosophy was you had lifetime employment with me, if he did not break the three rules, I hired adults and I treated them like adults. I did not question their work ethic and I did not let suspicion destroy trust. It was an innocent until proven guilty culture, not the other way around, as so many companies are. Everybody was clear as to what behavior got you fired. The net result of this was we scaled rapidly, we won big, we won fast, and we won more often than the typical firm. And this is what led to our remarkable exit. In my case, we scaled our culture by keeping it very basic. We prevented bureaucracy from creeping in and we relentlessly eliminated politics from affecting behavior. And I should note, this culture was not for everyone, but that was OK. I liked it that way. I wanted lots and lots of people to tell me I was nuts and that they would never work for me because those that opted into my tribe were my peeps, so to speak. I knew if I could recruit enough of my peeps, I could really do something special. And we did.

Sean Magennis [00:08:59] Greg, this is a great story. And my journey with you is is so bang on with this. I mean, it’s it really, truly is remarkable. I encourage your listeners to look to Greg as a role model in how to really scale a culture. Doing so is very important to be true to yourself and lead with your authenticity. And now a word from our sponsor, Collective 54, Collective 54 is a membership organization for owners of professional services firms. Members joined to work with their industry peers to grow scale and someday sell their firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.

Courtney Kehl [00:09:48] Hi, my name is Courtney Kehll. I own Expert Marketing Advisors. We serve B2B tech companies across the U.S. These clients turn to us for help with establishing best practices, growing and scaling up companies, as well as even launching or plugging in holes across there and marketing. If you need help with any of these areas or even interested in partnering, reach out to me at www.expertmarketingadvisors.com.

Sean Magennis [00:10:14] 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 [00:10:30] OK, 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, your culture is working for you. If you want to know too many times, culture is more than likely getting in the way of your attempts to scale. Let’s begin.

Sean Magennis [00:11:12] Number one is your culture important to the success of your boutique? Number two, does every employee understand the way things get done around here? Number three, does every employee understand what you are trying to accomplish? Number four, does every employee understand how they personally contribute to these goals? Number five, is it clear which behaviors are awarded? And number six, is it clear which behaviors are punished? Number seven, is it clear which function inside the boutique is the dominant function? Number eight, is the leader of that function, the leader of the boutique? Number nine, is the culture scaling naturally the way you want it to? And number ten, are you nurturing the culture as you scale?

Greg Alexander [00:12:21] You know, nine and ten are related and worth adding a little something to them. So cultures should scale naturally if the culture is healthy. Yep. Then people are going to take ownership of it and they’re going to scale it for you. If that’s not happening, then it’s upon it’s the responsibility of the founder to nurture it. You know, almost think about it like a plant. You know, you’ve got to fertilize it, you’ve got to water it. And there’s things you can do to nurture the culture to make sure it’s happening.

Sean Magennis [00:12:51] Critical. Great finishing comment, Greg. So in summary, culture allows a boutique to retain its identity as it scales. Culture is a welcome substitute for bureaucracy that can plague scaling boutiques. 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.

There is a dirty little secret about owners of boutique professional service firms. It is called the Hero Syndrome. If left unchecked, it will prevent you from scaling your firm. On this episode we discuss how to deal with this problem.

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 there is a dirty little secret about owners of boutique professional services firms. This dirty little secret is called the hero syndrome, and if left unchecked, it will prevent you from scaling your firm. I’ll try to prove this theory by interviewing Greg Alexander, Capital 54’s chief investment officer. Greg has some great suggestions on how to deal with this problem. Greg, great to see you, and welcome.

Greg Alexander [00:01:09] Sean, it’s good to be with you. Boy, what a topic we have today. I love that we tackle issues on this show that most shy away from.

Sean Magennis [00:01:18] Exactly, Greg. Excellent. Let’s start with the definition. What what is the hero syndrome?

Greg Alexander [00:01:25] The hero syndrome is when the owner of a professional services firm has his or her identity wrapped up in the firm. The clients and the employees need the owner, and this makes the owner feel like a hero, the hero style owner gets his or her personal validation from owning the firm, and it is appropriate to call it a syndrome as it leads to sickness and eventually death because the owner becomes a severe bottleneck.

Sean Magennis [00:01:57] And Greg, why do our listeners, owners of boutiques, suffer from this?

Greg Alexander [00:02:03] Man, why does the sun rise in the east and set in the west? The hero syndrome is part of human nature, I think. Founders of boutiques are human. This means they want to be part of a tribe, they want to be recognized. They want to feel needed to feel as if they matter. Owners of boutiques like all of us suffer from insecurities. And one way to deal with these insecurities is to build a firm completely dependent on the hero, the owner, our listeners. I mean, it is not a joy entering the battle as a hero and saving the day. I think human nature is why this happens repeatedly.

Sean Magennis [00:02:46] And you call it a dirty little secret. Why is the hero syndrome kept a secret?

Greg Alexander [00:02:54] In my opinion, there are two primary reasons why this is not openly discussed as often as required. First, it takes an above average level of self-awareness to recognize this problem, and in my experience, self-awareness is lacking. And a lot of founders, I think many of our listeners are suffering from the hero syndrome right now. Yet do not know it. Maybe this show can bring some awareness to this issue and the second reason this is kept a secret is no one wants to admit they’re holding their firm back because they like being the hero. I mean, it’s embarrassing. Imagine a staff meeting whereby the owner stands up and says to employees, I have an announcement to make. I’m an egomaniac and I love being the hero. Therefore, I’m unwilling to get out of my own way. And you are just going to have to deal with the consequences and the poor results.

Sean Magennis [00:03:49] Yeah, that would be super embarrassing. I can see why this is a dirty little secret. Let’s give the audience the benefit of the doubt and assume they are aware of the issue. What can they do about it?

Greg Alexander [00:04:04] The answer to this question is the best founders work themselves out of a job, they make themselves obsolete and build firms that can succeed without them. This is when hyperscale kicks in.

Sean Magennis [00:04:16] Aha. Found founders need to go from the hero to the invisible man.

Greg Alexander [00:04:22] That’s well said.

Sean Magennis [00:04:22] And how do you do this, Greg?

Greg Alexander [00:04:24] Boy, I could teach a week long course just on this subject. We only have a few minutes left on this show. So let me let me give you some quick suggestions. Let’s see. There is four things that come to mind. Number one, I would recommend stop being a control freak and try to replicate yourself in your employees. If an employee can do what you can do, 80 percent as well as you can do it. That’s a good thing. Do not feel threatened by this. Number two, it may be faster for you, the founder, to do something yourself, and you know that if you do it, whatever it is, you know, it will be done correctly. However, this is flawed thinking. Yes, it will take time to teach someone how to perform a task. And in the beginning, the employee will screw it up. But eventually you will replicate yourself and others to the point where you are no longer a bottleneck. Third, recognize there is a business case for eliminating you as the hero. Profits will go up when you do this. As the owner, you are the most expensive resource in the company. When you do something, the cost of completing the task is very high. The quickest way to destroy profits in a process of firm is to have senior people doing junior task work. And lastly, number four, the tactical program to launch is an employee certification program. An employee certification program proves to a founder that employee has reached a level of competency. If done correctly, an employee certification program can rapidly scale a boutique. Employee certification is a big topic, and we should reserve a future episode just to discuss it, to get it out here, every employee in the firm would be in a learning path certifying their knowledge. For example, the practical understanding of the subject matter, also certifying their skill, for example, their ability to do something. This approach systematically replicates an owner’s knowledge and skill into every employee in the firm over time and in perpetuity. And obviously, this removes the hero slash founder from being a bottleneck.

Sean Magennis [00:06:48] Excellent, Greg. So stop being a control freak, remove yourself as a bottleneck, and recognize the profit potential of doing so and roll out an employee certification program.

Sean Magennis [00:07:06] And now a word from our sponsor, Collective 54. Collective 54 is a membership organization for owners of professional services firms. Members joined to work with their industry peers to grow scale and someday sell their firms at the right time for the right price and on the right terms. Let us meet one of the collective 54 members.

Bryon Morrison [00:07:32] Hi, this is Bryon Morrison, CEO of Proxxy, your executive multiplier. And if you’re a Challenger executive running today’s small to medium-sized business, that’s going to be tomorrow’s next big thing. Proxxy is here to serve you. We provide a full-service chief-of-staff solution that gives you an experienced, well-trained professional to take over, automate those routine tasks while also providing strategic counsel and operationalizing your great ideas so you can keep driving your company forward. This is not a fractional executive that’s going to run out of time or cost you too much, and it’s not a virtual admin you’ll end up managing. Proxxy as a team and technology-based approach that gives you 24/7 coverage and gives you back at least eight hours each week. So if you want help from a pro that isn’t trying to climb a ladder or get more budget, get started with your own Proxxy chief-of-staff at www.remotechiefofstaff.com.

Sean Magennis [00:08:33] 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 Collective54.com. OK, 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, this strategy is working for you. If you answer no too many times, this strategy is more than likely getting in the way of your attempts to scale.

Sean Magennis [00:09:31] So let’s begin question number one. Do you feel like you must do everything yourself? Question number two, do you feel like you must be in every key meeting? Number three, do clients require you to be directly involved in their projects? Number four, do your employees come to you for help constantly? Number five, do you have to micromanage everyone? Number six, do you have to review everything before it goes out? Number seven, are you working too much? Number eight, is it faster to just do the work yourself? Number nine, do you feel like it will get done correctly only if you do it? And number ten, are you turning over employees?

Greg Alexander [00:10:38] So number ten’s interesting if you have a turnover problem, it’s because people arn’t growing inside your firm. Yep. Nobody wants to be a robot of the founder.

Sean Magennis [00:10:47] Exactly. So, in summary, boutique owners do suffer from the hero syndrome. This is because of human nature and founders seeking emotional validation from their role as hero/owner. This insecurity gets in the way of scaling the firm because owners become a bottleneck. The founders who scale their firms make themselves irrelevant building firms that can succeed without them. 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.

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 [email protected].

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.