Lessons from growing too fast without enough working capital

Many retiring owners take their foot off the gas as they get closer to calling it a day. For the next generation of owner-operators, they see a large opportunity to come in and pour gas on the fire. Depending on the business, that could mean hiring an outbound sales team, investing heavily in performance marketing, or seeking out larger contracts.

But, it’s important to remember that not all growth is good growth.

The past few weeks, I’ve chatted with a number of former owner-operators who grew themselves into choppy waters. One even went bankrupt.

Here’s an anonymized story of what bad growth looks like.

Rob owned and operated a commercial construction company. He had used an SBA 7(a) loan to fund his acquisition. When he transitioned into the owner’s seat, they were making around $500K of profit each year. At the time, they bid on small local projects, typically got paid on time, and no single project would make or break the business.

But, Rob knew they were capable of more. He had the sales guy start tracking and bidding on bigger projects in the state.

It turns out, Rob was right. Within a year, they won a number of bids that were much larger than anything the firm had done in the past.

Once the documents were signed, Rob went to work on executing against the bids. He spent millions purchasing the materials for the projects. He then paid his guys and the subcontractors to start executing on the projects. The developer began to pay him in milestones on a NET-60 basis.

Then trouble struck.

The developer started delaying payments beyond their terms. The same thing happened at another project.

Although his customers were delaying their payments, Rob still had to make good on his employees’ paychecks. He still needed to pay rent on the shop. He still needed to make loan payments on the trucks.

But, before long, he didn’t have enough money to go around. The larger projects had wiped out his working capital and he defaulted on his SBA loan.

Rob's not alone.

The other stories were quite similar. One was an IT business opening up another data center but miscalculating how long until the center would become profitable. Another was a manufacturing company that started ramping into another product line before a large customer changed course.

The root cause of bad growth is often some mix of:

• Not understanding how your cash conversion cycle works

• Assuming bigger customers will act just like the smaller customers did

• Increasing customer concentration as a result of a new large contract

• Trying to grow too fast out of the gate

The goal is healthy, sustainable growth.

For those planning to become owners of SMBs, here are some tips on how to think about growth:

1. Understand how growth impacts your cashflow

   - A lot of growth requires upfront capital investment that may take years to recoup. Additionally, you may not have control over recouping it (e.g., a large developer needs to honor your payment terms).

2. Focus on avoiding go-to-zero risk

   – When planning to transition into the owner’s seat, the first order of business is stability. In our experience, it’s best to spend the entire first year on wrangling the business into order before you try to grow it.

3. Grow slower than you want

   - Every time your business doubles, things break. By growing at a healthy but sustained rate, you’ll have time to continue to work on the business as well as see how growth impacts your cashflow.

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