Intelligent Insights
Diligent Legal Advocacy

Small Business is either a Lifestyle or a Scalable Enterprise – Which one are you?

by | Sep 22, 2023 | Business Law

Greater Cleveland today is a thriving metropolis for family and closely held businesses employing many friends and neighbors as well as and providing career options for our offspring. That was not always the case.  I began my career at Ernst & Ernst in the 70s when Cleveland had many Fortune 500 companies headquartered on the shores of Lake Erie, such as SOHIO and TRW. Downtown was crowded at lunchtime  as the sidewalks were full of the office workers employed by large companies and the professionals that supported them, such as Ernst & Ernst. Today, most of those big companies and their large payrolls have moved to warmer climates or been acquired and relocated out of town.

The Land supports many successful small, often family-owned, businesses that are primarily structured as “Lifestyle” or “Scalable.” This blog explores the differences between the two, the benefits of each, and some drawbacks.  We also address how we can serve our clients in something other than the classic rendering of legal advice. We often function as advisors who use our experience and exposure to many diverse businesses to assist our clients in theirs. I firmly believe that no one has a monopoly on good ideas, techniques, and strategies.

Lifestyle generally means that the business sustains the owners’ level of income to facilitate, whether by design or by default, the owner and their family’s lifestyle. The scalable business, by definition, can grow beyond the owner’s personal capacity and, ideally, is not dependent upon the owner. Rather it is conducted through others, often at the direction of the owner but importantly, not dependent upon the owner per se, especially in day-to-day operations.

The owner of the lifestyle venture is generally immersed in everything that keeps the business successful. They make daily/sometimes hourly decisions from the most detailed matters to big-picture strategic objectives. Virtually all customers and employees work with the owner and rely upon their expertise, experience, and business acumen (the works) to conduct the key/crucial activities of the business to satisfy the customers (keep them coming back) and to keep the staff employed. The lifestyle owner enjoys absolute control over most of the business decision making, especially the management of employees and interaction with vendors/suppliers.

As the chief honcho, the owner knows that they can do whatever needs to be done better than anyone around them and usually finds delegation to be time consuming and disappointing. Absolute control often comes with much gratification as they and their family experience the rewards of their total commitment. It also comes with little or no time for other things as they need to remain locked on the treadmill of their need to participate in everything for the enterprise to continue to prosper; therein lies the ultimate conflict; too much time working, not time enough to enjoy the lifestyle being created.

The economics of the lifestyle business, given its dependence upon the owner, has a ceiling because the owner must do “everything” to make it work. Increasing efficacy, quality, and volume with the result being more profits usually hits the ceiling of 24 hours in a day, not enough time and the owner not being able to stretch their own available time to accomplish all that needs to be done.

The Scalable business’ differentiator is process. The process is sometimes the brainchild of the owner, maybe tested by the owner, implemented by the owner, and evaluated by the owner and their trusted advisors. I find, however, that in many instances, talented people who have a thriving business either recognize early or learn the hard way that management is not their strong suit. Just because the owner’s idea has become a viable business, the owner learns that to grow requires the competent performance of employees and advisors.

The Scalable enterprise utilizes procedures, job descriptions, delegation, and supervision by the owner instead of “doing” by the owner. We counsel our clients to find their highest and best use in the business. We test this by asking if they are still doing something related to the day-to-day business activities that someone else on their payroll could do if given the authority. We stress that there are many critical strategies and activities that no one else can do since they are not the owner/president. However, many of these special opportunities and responsibilities do not get attended to because the owner does not have the time because they are still doing what can and should be delegated. Each owner, with the assistance of key employees, family, and advisors, should challenge their routine activities to focus their attention on the strategic decisions and opportunities. The scalable owner determines their highest and best use and makes sure they have time to do what only they can.

The Scalable model allows the owner to delegate tasks to staff and other resources, including technology, that facilitates the ability to generate revenue and profits beyond what the owner can do individually. The operations are managed by the owner, not performed. The owner evaluates, makes changes, if necessary, hires new personnel, and sometimes replaces staff, determined to be necessary to achieve a competitive edge and maximize performance.

The firm’s merger and acquisition practice encompasses the sale of both Lifestyle and Scalable companies, and there are plenty of both in NE Ohio. The Lifestyle business is often sold to key employees or family members who have become known to the customers and employees. Hopefully, the family member or key employee, can perform at a level comparable to the founder/owner to replicate the lifestyle enjoyed by the seller. The difficulty is the lifestyle business must generate enough profit to continue the lifestyle of the seller/senior and provide a similar lifestyle to the buyer and their family. This results in the need to increase the business revenue and corresponding profit to satisfy the requirements of buyer and seller.

Family enterprises are often successful at this transfer of ownership, with each party (seller and buyer) willing to take a little less to maintain the enterprise as family-owned and operated. We often assist the next generation through succession planning and related consulting to become a scalable venture that allows much faster growth than the typical lifestyle activity to allow both seller and buyer to enjoy the fruits of the lifestyle they envision.

Key employees, who are known quantities to the customers, to the employees, and the vendors are often the best option as buyers for the owner of a lifestyle business. This familiarity should be cultivated by the owner (which they often find difficult to do as most are control freaks…) to ensure that the customer base remains intact, and the staff is able to continue to service those customers. Cultivating means relinquishing iron-clad control/access to key customers so that the customer comes to know, like, and trust the new owners because they are familiar with each other. Owners are often paranoid that if they introduce their people to their customers, the key employee will start their own lifestyle activity. We generally try to allay that fear through the use of “anti-piracy” contracts, which restrict the ability of the key employees to “steal the client” without compensation. These arrangements also limit the ability of the departing key employee to hire other employees. The framework of such arrangements is that if the key employee leaves and the customer wants to use them, we do not restrict that customer from taking their business to the former employee. We find that if the client does assert that under a non-compete, the customer cannot use the key employee, the customer will usually be angry and find a third party to do their work. The consequence of the non-compete is that the owner and the key employee both lose. The anti-piracy arrangement usually provides a condition that if the customer moves their business to the key employee, the revenue generated for a number of years is paid by the former employee to the owner, which is essentially the purchase of a portion of the business.

The scalable business is much easier to sell because the owner can prove that all the elements necessary to operate the enterprise profitably are in place and, more importantly, are no longer dependent upon the owner, his/her relationships, expertise, and 60-hour work weeks. The key employees, customer loyalty, and staffing of the operations are all in place and, therefore can be continued without the owner’s day-to-day involvement.

Retention of the key employees is an area of focus in a scalable business, so incentive arrangements are developed to “keep them in the fold” for the owners’ benefit. These may take the form of stay put agreements, which generally give the key employees a percentage of the sale proceeds upon a change of control event (sale of assets, equity, or a merger with the controlling owners changing). Phantom stock plans and employment agreements are often utilized to retain the individuals to whom the owner has successfully delegated key responsibilities. The owner’s knowledge and experience are certainly helpful to the buyer and are reflected in consulting agreements from the buyer to the seller/owner, but the day-to-day functions are in place, and the profitability of the company is demonstrated by historic performance of the business even with the seller/owner spending their winters in warmer climates and much of their time doing things other than operating the business day to day.

I urge you to reflect, are you a lifestyle business or a scalable enterprise? Do you want to retain what you currently enjoy as complete freedom and control in the lifestyle business, or do you want more freedom to enjoy life in addition to enjoying the running of your business?

Watch the video

Practice Areas