How second-stage companies will drive the economic recovery
By Dan Shiffrin, Dan Shiffrin Communications

Over the last couple of years, the U.S. economy has taken a beating. But Michigan — whose economy has long depended on the struggling auto industry — has been hit particularly hard. Fortunately, there are some signs of brightness on the economic horizon.

According to Sandra Gohlke, a principal in Rehmann’s Troy office and leader of the firm’s Accounting, Consulting and Tax (ACT) department, the business owners she works with are “cautiously optimistic” about the future. “The companies that have survived,” Gohlke says, “have cut the fat from their income statements and done what it takes to stay in business. Now they’re in a position to become profitable as the economy recovers.”

As in the past, the economic recovery will be driven by second-stage companies — businesses that have survived the startup stage but have not yet reached maturity. These companies are poised for growth, but they also have some significant obstacles ahead of them. Like young people in their awkward teenage years, second-stage companies must deal with growing pains as they make the transition from an entrepreneurial culture to a more structured, controlled environment.

To thrive in the years ahead, second-stage companies must face several challenges, including raising capital, “professionalizing” their management teams, tightening internal controls and building an infrastructure that will support future growth. Business owners should not hesitate to seek help — from industry and business associations, state government, or trusted advisors — in meeting these challenges.

Recognizing the Signs

How do you know if your company is a second-stage company? As a general rule, second-stage companies are those with 10 to 99 employees and revenue between $1 million and $50 million. But the numbers tell only part of the story.

More than headcount and sales, the defining characteristics of second-stage companies have to do with where they are in their development. “We think of a second-stage company as one that has figured out its business model and is ready to take a product or service to a market that’s ready to buy it,” says Garrett Klein, a principal in Rehmann’s Troy office and leader of the firm’s Manufacturing Services group. “The challenge now is to replicate its processes more rapidly to keep up with growing demand, which may require new employees, additional financing, or expanded facilities.”

The typical second-stage company has reached a critical juncture. For Rob Fowler, president and CEO of the Small Business Association of Michigan (SBAM), the book “No Man’s Land,” by Doug Tatum, succinctly describes this phase in a company’s life: “Too big to be small, but too small to be big.”

There’s a gap, Fowler says, between where the company is now and where it needs to be to grow. “You’ve got a bookkeeper,” he says, “but you need a CFO. You’ve got an office manager, but you need a VP of human resources. Your CEO is also your chief marketing officer, but may not have the time or skills needed to develop a regional or national sales force.”

Coping With Growing Pains

Growth can put an enormous strain on a business. “It can strain a company’s management capabilities, manufacturing and business processes, reporting systems, and cash flow,” says Klein, “and the company must deal with bigger, more demanding customers and rapidly increasing levels of activity.”

To withstand these pressures, second-stage companies must be sure that they have the infrastructure, processes, financing and management talent in place now to accommodate future growth. “A good management team that really understands the business is critical,” Gohlke says. And with record levels of unemployment, she adds, “there’s a huge talent pool in Michigan to draw from.”

Klein cautions companies, however, not to add headcount simply because it’s easier to operate with more people. “We’re talking about having the right people in place,” he says. “Second-stage companies need to evaluate their existing talent and determine whether they have the best people on board in the roles that need to be filled.”

Fowler agrees. In fact, he says, “one of the reasons small businesses have led the way out of most recessions is their flexibility to right-size quickly.” The important thing, Fowler says, is to be thinking now about whether your business is the right size and figuring out where to go for people and capital before opportunities present themselves.

Closing the Gap

So how does a second-stage company close the gap between where it is now and where it needs to be to take advantage of growth opportunities? How does it reconcile the need for professional management, additional capital, and more sophisticated reporting systems with its current resources?

One answer: Don’t be afraid to ask for help. If your financial needs have grown beyond your bookkeeper’s skill set but you can’t afford a full-time CFO, consider “renting” or sharing a part-time CFO or controller. Tap business associations or outside consultants for help with market research, cash management, hiring and employee benefits, financial reporting, internal controls, IT security and strategic planning. Look into international organizations or networks that can help you take advantage of an increasingly global marketplace.

One of the biggest challenges for second-stage companies is overcoming the entrepreneurial mindset and recognizing that no business owner can take his or her business to the next level without help.

Planting the Seeds

SBAM recognizes the challenges faced by second-stage companies and has dedicated itself to helping these businesses grow. One of the organization’s goals is to change state government’s approach to economic development.

In talking about economic development, Fowler makes a distinction between “hunting” and “gardening.” For years, the traditional approach to economic development has been to focus on hunting — that is, attracting businesses or industries from other states. Hunting has a certain psychological appeal: “One company creating 1,000 jobs is news,” Fowler explains, “but one thousand companies creating one job each is not.”

Yet history shows that “economic gardening” — a strategy that focuses on growing existing businesses in a community, region, or state — is far more effective. According to the Edward Lowe Foundation, from 1993 to 2007, virtually all of the job growth in Michigan was attributable to the expansion of existing businesses. Relocation of businesses into or out of the state produced a net job loss. Most other states have experienced similar results.

The “godfather” of economic gardening is Chris Gibbons, the Director of Business/Industry Affairs in Littleton Colorado. Since Littleton embraced economic gardening in the late eighties, its job base has doubled, sales tax revenues have tripled and the job growth rate has climbed to 135 percent — all without recruiting a single company from outside the city. Following Littleton’s lead, several states have established or are considering economic gardening programs, including Florida, Washington, and Colorado.

Fowler doesn’t believe that Michigan should abandon efforts to attract businesses to the state. But he would like to see Michigan embrace economic gardening to help nurture the state’s 60,000 second-stage companies. For this to happen, however, the state needs a new set of “gardening tools.” Traditional economic development tools, like property tax abatement and tax increment financing, focus on attracting businesses but are of little value to existing ones.

SBAM is the process of testing several tools, including:

• Customized market research using sophisticated databases most small companies can’t afford on their own,
• Models for sharing part-time CFOs and other “C-Suite” talent,
• Models for vetting and brokering consultants, and
• Diagnostic tools that help companies assess their strengths and weaknesses and develop strategies for growth.

The association is also working with experts from a variety of disciplines and backgrounds to put together a “blueprint” for Michigan to become a leader in economic gardening.

A Bright Future

Although we’re not out of the woods yet, there’s reason to be optimistic about the future of Michigan’s economy. With thorough planning, strong management teams, and some outside assistance, Michigan’s second-stage companies are poised to lead the state’s economic recovery.