I’m more proud of a business owner who gets a million dollars of revenue and brings home a half-million

dollars in profit than someone who’s earning $5 million dollars in revenue but is in debt up to the
eyeballs. He can’t even pay himself a salary, and he’s about to go broke. BREAKING EVEN ISN’T GOOD
ENOUGH Every business owner who’s either starting a business or running a business probably
instinctively knows what the breakeven point means. The standard definition is when the business has
income that equals its expenses. At my firm, we discovered that the breakeven concept is a flawed way
of thinking. By the time you’re at the breakeven point, your business is already dead. After we looked at
breakeven analyses, we concluded that when your pretax profit is at or below 5 percent of revenue,
your business is on life support. At that point, you’ve got to do something drastic. When it comes to
pretax profit, here’s what I’ve found to be true for the vast majority of businesses: 5 percent or less of
pretax profit means your business is on life support. 10 percent of pretax profit means you have a good
business. 15 percent or more of pretax pr do Q pretax ofit means you have a great business. If you’re
above 15 percent, you better take it while you can because the market will eventually change. The best
businesses tend to operate between 10 percent and 15 percent. After businesses get beyond $5 million,
there are a few outliers. For example, grocery stores have a very low margin and high turnover of goods.
Distribution businesses may earn $40 million a year in revenue but only have a 5 percent bottom line.
They have very low margins and usually don’t have to pay for what they sell until they collect it from
their customers, so they have back-to-back financing. When you first start a business, you’re just happy
to get your salary, and then you’re happy to reach the breakeven point. Later you’re happy to have a
little bit of profit. I frequently see entrepreneurs who become ecstatic over that first bit of profit. Then a
nasty little realization pops into their heads: I owe taxes on that. But that’s not a bad thing. Remember
from chapter 1 that your number one key performance indicator is how big a check you write to the IRS.
THE EIGHT FUNCTIONAL AREAS There’s a natural differential that takes place between startup and
hitting the $1 million-in-revenue mark. This is probably contrary to what many others think, but I believe
that once you get to a million dollars of revenue, you’d better be profitable and paying yourself a
market-based wage. Keep in mind that a market-based wage is based on what your role is. If you were
an executive making a $150,000 a year but now you’re a store manager for Fred’s Lawn Care, your
market-based wage isn’t $150,000 anymore. What happens at a million dollars is that you can no longer
take care of all the functional positions. You need enough revenue to cover the costs of paying market
wages for people to perform in all of your business’s functional positions. If you can’t cover these costs
with your million dollars in revenue, you are not making a profit, and you will quickly go out of business.
One of the things I do when I sit down with owners of million-dollar businesses is ask them to put the
responsible person’s name beside these eight functional areas: 1. CEO: In most cases, the CEO is the
owner, but you may want to hire one if you are not the best fit. 2. Sales: Sales management is the key
function, more so than who actual y does the sel ing. 3. Marketing: I make a distinct differentiation
between sales and marketing; they are two different functional areas. The same person may be doing
both jobs, but they’re not the same job. 4. Operations: This is the person who makes sure that the trains
run on time and that whatever product or service you’re sel ing gets delivered. 5. IT and technology
development: You need somebody to take care of information technology capabilities. These days,
everybody needs some IT in their cupboard. You might outsource it, but somebody needs to own that
function. 6. g m Qvalue="6Finance: Somebody has to pay the bil s, balance the checkbook, and do basic
financial reporting. You can outsource part of it, but someone in the company has to be responsible for
it. 7. Customer service: Who’s the customer service advocate? There is an overlap between sales and
operations in meeting your customer expectations. Someone needs to bridge these two areas to make
sure the customer is getting what you say you are sel ing. 8. HR functions: There are paperwork
functions in human resources that need to be handled, but as you get larger, someone has to make sure
the company mission and values connects with the employees. This has to be tied into the development
of your culture and your appraisal processes. Time and time again, in a single-shareholder business, the
owner takes care of all these functional areas except for one or two undesirable things, which are
outsourced to a contractor or delegated to an employee. When there are two shareholders, there is
more of a balance between them in terms of jobs and wearing hats. But the bottom line is that when
you hit a million dollars in revenue, you have to think about these things. The exception is if you’re a
web-based business startup and you plan to get a gazillion customers and charge them $9 per month. It
isn’t easy to keep up with all of that and still make a profit. These kinds of businesses burn through huge
amounts of capital before they have a positive cash flow. THE BLACK HOLE Between $1 million and $5
million in revenue is what I refer to as the black hole. This is the time in your business growth when
you’re forced to add staffing and infrastructure before you can really afford to. Even if you try to add it
as late as possible and maybe even pay for only part-time help, at the end of the day you’re going to
drive profitability down and risk destroying your business. Can You Make It Through the Badlands? In
some ways, leading a business through the black hole that lies between $1 million and $5 million in
revenue is like leading a wagon train. Let’s say I’m in Kansas City, and I buy what I think are enough
provisions to get through to California. When I hit the Badlands, I think to myself, “I sure hope I have
enough provisions to get through that.” If you don’t have enough provisions, one of two things is going
to happen, and they are both bad. The first is that you are going to die on the trail. The second is you’re
going to have to turn around and go back and get more provisions, learn some lessons, and try it again.
As you grow from $1 million to $5 million in revenue, you are going to hit some badlands, and you are
going to need some resources. The most important resource you will need is extra manpower. It doesn’t
matter what business you’re in. You have to take care of those eight functional areas no matter what
size your business is. At this point, entrepreneurs often get frustrated about their businesses because of
their lack of success in hiring staff to perform high-level functions. It usually goes something like this:
Entrep Entrreneur: I’m looking to sell my business. (The unspoken reason is because they are in the
black hole.) Greg: Okay, great, but what do you think you’re going to do next? Entrepreneur: I’m going
to find a business where I don’t really have to deal with customers or employees. And it will be a
business where I really don’t have to work a lot, but it makes me a lot of money. Greg: Great. If you find
that, then you let us all know about it. It would be nice if we could all find a business that makes a lot of
profit and comes without employee and customer headaches. But that’s not realistic. To get through
these challenges, you need to prepare your wagon train and have the right provisions. That means you
have to hire people with the right skill sets to make the journey with you, and you have to pay them a
market based wage. If you don’t, you’re not going to get through the Badlands in one piece. When
you’re at a million dollars and you start adding the people you need, you feel really happy about it.
You’re building a growing business, and you think that anybody you hire will work for you forever. Then
you realize at some point, gee, maybe that person isn’t the best fit. You have to understand that people
are going to change and that one of the keys to success is continually upgrading your staff. Most
Challenging Level of Profitability: $2 Million to $3.5 Million One of the things I’ve noticed is that the
most challenging level of profitability is between $2 million and $3.5 million. I’ve also discussed this with
one of my clients who does social science research. A social scientist on his staff uncovered the reason.
The need to add management infrastructure seems to naturally occur when you have about twenty
employees typically, when you’re between $2 million and $3.5 million in revenue. Before then, you can
get away with not having management structures and moving people from a production role to a
management role. But when you have about twenty employees, you have to create a different
management structure. This situation typically occurs when you’re between $2 million and $3.5 million
in revenue. It’s really expensive to hire the wrong people and then replace them. The more times you
have to repeat that hiring cycle, the more expensive and more damaging it becomes. The real cost
varies, depending on the situation. The usual scenario is that you add labor cost, and the added labor
does not increase revenue. Thus, the cost of the additional labor causes an equal drop in net income.
Your existing staff see this impact (whether you share numbers or not) and become afraid that they may
be let go as the company struggles. Your most capable employees sense this and leave for better
opportunities, leaving you with the least productive people. Your lost profit from your hiring mistake
leaves you with no excess capital or borrowing capacity to hire a replacement. So you retrench and you
assume the role you tried to hire for. You push to stabilize the company so you can make another hiring
attempt as soon as you can. Hire with Care as You Grow Here’s what I always tell people: hire slowly, fire
quickly. I’m a big fan of the topgrading concept of hiring when it comes to interviewing and selecting
candidates. I strongly encourage my clients to read Topgrading: How Leading Companies Win by Hiring,
Coaching, and Keeping the Best People by Bradford D. Smart (Portfolio, 2005) to understand the
process. I also highly encourage the use of personality profiles as part of the screening process so you
understand what makes that person tick. I have tried many different profiles, but I prefer the Caliper
Profile from Caliper Human Strategies ([Link]). A lot of growing businesses want to hire
someone who has “been there, done that” credentials, but my clients have the least success with this
approach. In fact, only about one out of ten has been successful. There are times you must hire
experience, for instance, if you need to hire someone to lead your IT department. But usually you need
to ask yourself why the “been there, done that” person is available. You’ll always get a story to explain
it, but do your homework to find the real reason because it’s likely you’re not getting the full story.
Recently, I was very fortunate to take advantage of a two-day plant tour and program at Dell, the
computer manufacturer. I spent a full day with Dell executives, and they said quite a few of their
executives were first hired as consultants. This gave the company a chance to get to know them. If Dell
decided they wanted to work long-term with a consultant, they hired the person as a full-time
executive. This strikes me as a very wise approach for executive-level talent. It gives you time to make
sure the consultants don’t have just two ideas they continually repeat; better yet, you don’t end up
paying over and over again for the same two ideas. Another successful approach is hiring young talent
and investing in their education. In fact, at my firm we like to hire people straight out of college. They
don’t know a lot about anything when they come out of college, but they also do not have any baggage
to unlearn. I like having the responsibility to fill their heads full of things I want them to know. A lot of
my clients have had their greatest success with young talent who bought into the vision and the dream
for the company. These young people are like sponges, and they want to absorb knowledge and
information. You may find the greatest person in the world, but maybe that person isn’t right for the
role you’re hiring for. Too often employers want to attach a bad outcome to a specific person. But
actually the employer is probably to blame, because he hired the wrong person for the job. I’ve found
that most of the people who have gone through my business, as well as many others, go on to find
great, happy, and successful careers at other places. They just weren’t the right fit for my business. The
goal is to make sure you don’t use a trial-and-error approach to hiring. When you hire someone, you
want it to be an informed decision. Even though we know we have to hire the right people, we still say
we want to add those labor costs at the last possible moment. Although you don’t want to add the cost
of new employees until you have to, you also have to take your time to find the right people and hire
them before your business outgrows your ability to manage all the functional areas by an Q areas
byourself. Your Capital Safety Net Another important resource you’ll need for your journey through the
Badlands is capital reserves. You can’t get from $1 million to $5 million on borrowed money. How much
of a capital reserve do you need to get your company through the Badlands? In other words, what is
your capital safety net? It’s pretty easy to figure out. Calculate how much cash you need to hire the
people you need, then estimate how long it will be before your business can pay the new hires and still
remain profitable. I’m going to challenge you to be specific and model the costs on a monthly basis. You
must make assumptions about when the revenue should show up and bring you back to your target
profit. It is not as simple as using just the new hire cost, because other costs will rise with the added
labor. Forecasting is critical, and I’ll cover simple techniques and tools in chapter 10, “Skip the Budget,
Learn to Forecast.” It is not sufficient to just forecast net income; you also need to forecast cash flows
and capital requirements. This will help you know if you have enough resources to get through the
Badlands without raising capital or borrowing money. What if you don’t have the capital and you still
want to make the journey? In this situation, you might decide to go out and raise capital. Think about
getting money from investors, friends, family, venture capitalists, or whomever else you can think of.
There’s always money in the market. Most venture capitalists will tell you that there isn’t a lack of
money but there’s a lack of good business ideas and good deals. But there’s always money for good
deals. I’ve worked with a number of companies that have raised big money to get through the Badlands.
Sometimes they spent the money immediately, either because they needed to or the investor pushed
them to spend the money to justify the investment. What happens when people raise the extra money
but then end up blowing it? They either go for a second round of financing and give up more of the
company, or they find a way to rub two dollar bills together to make a profit. That’s how many
businesses actually work. I’ve had other clients who took the investment money and never tapped into
it. They put it on their balance sheet and kept on going. This money was their true capital safety net,
which is a great strategy. These clients were committed to being profitable every step of the way from
the ver