When a startup founder goes on Shark Tank to seek an investment in their business, the primary motivation always relates to growth and expansion. If they were not seeking to grow, what other possible reason would a Shark have to invest? And so when the Sharks start grilling the founder about current sales, margins, and current leverage levels, they are trying to ascertain whether or not the business is ready to scale.
Investors want their investments to serve the primary purpose of fueling growth. If a startup is looking for capital to simply establish itself, rather than accelerate growth, most of the Sharks bow out because the company came “too early.”
Since creative entrepreneurs never get outside investment, we must fund our own startups. We must fund the early stages of establishing the business, we must fund our ongoing overhead, and we must fund our growth when things finally start to gain traction.
But when we hit that moment of growth, when we suddenly find ourselves with more opportunity than we have the capacity, do we ask ourselves the kinds of questions that the Sharks ask founders? Do we carefully assess the scalability of our business model before we jump in the fast lane?
Unfortunately, most creative entrepreneurs don’t, and we end up getting crushed by cash flow pressures or overwhelmed with the administrative overhead of managing a growing company.
What does it take to scale a creative practice? What kinds of questions should we be asking yourselves to determine if we are really ready to grow?
Is Your Creative Practice Ready to Scale?
So far in our “Shark Series,” we’ve addressed the topics of equity, margins, founder compensation, and leverage as they relate to creative startups. These are fundamental issues to evaluate even if you don’t intend to scale your practice. But if you do head down the growth path, these issues become absolutely crucial. During growth stages your profits will be further stretched, your overhead will increase, and you’ll increasingly leverage yourself—though as we noted last time, these time debts accrue to your future rather than your present (which makes them all the more deadly to your business).
If you start to grow, with slim profit margins and little savings, you’re heading for a predictable and all but certain collapse. Do your math first! And if, as you’ve been working toward growth, you have not been paying yourself well, and you have not accumulated savings, I can save you the trouble of doing math—you’re definitely not ready to scale!
But let’s assume that you have been operating with a reasonable profit margin, and you’ve saved up 3-6 months’ worth of operating expenses, and you want to take your creative practice to the next level. What are some of the specific problems you’re likely to experience as you scale?
Early Stage “Step Costs”
If you’re just starting on the growth path, moving from being a full-time freelancer to hiring your first employee, the biggest issue you’ll face is the disproportionately high “step costs” of hiring your first few employees. Let’s consider the dangers of early-stage step costs by thinking about it backwards. Let’s imagine that you already have ten employees and it’s time to hire the eleventh. A tenth employee will add about 10% more to your overhead. That’s not too hard to bear, especially if you’ve been operating with a 20-25% profit margin all along. Worst case, if you hire the wrong person, your profits take a 10% hit, but you’re still above water.
But what about that first hire? That’s close to a 100% increase in overhead. Perhaps more when you consider that your own productivity will be constrained as you onboard a new person, and learn how to work through the productivity of another. Going from two to three employees involves a 50% step cost, then three to four is 33.3%, etc. There’s great financial pressure in scaling a business, especially in its early stages.
Other Challenging Growth Stages
The early stages of growing a business are definitely the hardest. But there are other key growth moments creative entrepreneurs need to keep in mind as they scale. When a firm begins to grow from 10-12 staff members toward 20 the ways that they’ve been managing themselves will stop working. The ability to manage a company of ten is very different than how you manage larger teams. Larger teams require devoted management positions. You’ll need to rely more on systems, roles, and processes, than on direct person-to-person coaching. And these managerial layers add overhead. So the step costs don’t scale evenly when you hit that level. They jump up a bracket. And so you’ll need even greater margins on your work in order to cross that threshold.
A similar change occurs when you cross the 20-24 staff level. Managerial challenges take on additional layers, and the step cost chart moves up to yet another tier.
High Revenue, Low-Profit Practices
Because of growth step costs, many creative firms increase in size and revenue but maintain very low profit margins. That’s why, as I mentioned in “Revenues vs. Margins” some founders are dismayed to find out that after decades of pouring themselves out to build their business, their equity is hardly worth anything at all.
If you’re considering growing your practice, take some time to enter the imaginary Shark Tank for Creative Entrepreneurs, and scrutinize your business, and carefully access your plans for growth.