Atomic has the goal of being the first 100-year-old software consultancy. In a business environment where software consultancies are succumbing to the ebb and flow of industry demand, this is an ambitious goal. As innovation in the custom software industry has become a competitive advantage for big business, many software consultancies have been acquired for moderate sums of money. It seems like the journey to 100 years may be both harrowing and fool-hardy.

So why would we as an organization stretch toward this goal? There must be something of worth within Atomic to go to the effort of being around for that long.

The answer lies in the fact that we see our organization being accountable to more than our bottom line. We are more than a money-making machine.

A Triple Bottom Line?

Many companies refer to this style of accountability as a “triple bottom line”. Instead of just letting a profit & loss statement (traditional bottom line) be the measure of performance, they choose to evaluate on more than economic factors. They take into account their social and environmental performance in addition to their financials.

Some indicators of social performance could be charitable contributions, employee welfare and engaging in fair trade practices. Indicators of environment tend to be measurements of resource consumption, land use and waste management.

Atomic’s Quadruple Bottom Line

At Atomic, we have a quadruple bottom line. We’re overachievers to the end! We refer to these areas of accountability as our “four buckets of good”. The buckets are: People, Profit, Product, and Place.

• People – Our most valuable resource are Atoms, the people who work at Atomic. We invest heavily in their professional development every year.
• Product – Atomic’s brand promise to our clients is an awesome product (the work we do for them) and an awesome experience (their involvement with our teams should be wildly positive).
• Profit – We care deeply about our financial performance. Without solid financial performance, we would be dead in the water very quickly. Much of what we do in all the other buckets flows from this bucket.
• Place – As a business, we want to make a positive impact in the places we live and work. We want the urban areas we choose to place our offices in to be noticeably improved as a result of hosting us.

We want the good we do as a business to fill up these figurative buckets. They are, in effect, our most important stakeholders. To bring this full-circle—the good we do by filling these buckets represents the moral underpinning of our goal to be the first 100-year-old software consultancy. We believe this engine of good in the universe deserves to be around for at least 100 years.

Enter Agency Theory

As a for-profit business, Atomic stands in stark contrast to alternatives in corporate America. In the present day, why do for-profit businesses exist? The reason is kinda in the name, right? They are “for profit”. This is, in fact, an interesting idea popularized in the 1970s called “agency theory”. This idea became so popular that it guides operational decisions at a majority of publicly traded companies today.

Agency theory is the idea that the only success factor in business is the bottom line. How do you know if you were successful in a given quarter? Look at the bottom line of your profit & loss statement. Is there a positive number down there? Then you did good.

In this scenario, there is only one stakeholder in business–the shareholder. Executives work as agents of the shareholders, thus the name “agency theory”. Executive decisions are judged by whether or not the results fall in line with shareholders perceived best interests.

Increasingly, corporate shareholder boards have used stock options to more closely align executive priorities with shareholder priorities. Shareholders’ top priority in this arrangement is to maximize shareholder return quarter over quarter.

The Dangers of Agency Theory

Although agency theory seems to make sense for a for-profit organization, it has some unhealthy underpinnings.

1. Disengagement from the community

First of all, it assumes that a corporation operates in a vacuum. There is an intimate entanglement between any business and its community. The business provides wealth, goods, and services to the community. In turn, the community provides consumers, employees, facilities, and possibly raw materials. To say that this relationship doesn’t necessitate some responsibility between the two parties is to ignore a fundamental part of what it is to be in business.

Shouldn’t a corporation seek the best health of the community in which it exists to ensure the long-term health of the organization? If a business cuts off all inputs in an effort to eliminate responsibility with the surrounding world, it will wither and die. If it indiscriminately pollutes the surrounding world, eventually there won’t be anything to keep it in business.

2. Focus on expectation markets

Agency theory has also oriented business success factors away from “real” markets to “expectation” markets. Publicly-traded companies performance is monitored by the stock market on a quarterly basis through a quarterly earnings call. The content of this call gives investors and investment reporters an indication of how the company has performed relative to investor expectations. If the company is judged to have performed well by maximizing shareholder return, more investors will buy stock in the organization. If the company fails to maximize shareholder return according to expectation, the company is underperforming and runs the risk of investor sell-off, which devalues the organization.

This re-orientation of attention from the “real” market to an “expectation” market is, by far, the most damaging effect of agency theory. In Roger Martin’s book “Fixing the Game”, the author likens this phenomena to a breakdown in the separation between active competitors in the NFL and the gambling market. Imagine if the coach of your favorite NFL team wasn’t focused on preparing the team to win games, but instead focused on getting the team to perform according to the expectations of a majority of bettors. Would you have faith in the efforts of your team? They would no longer be focused on the “real” market of playing to win the game. They would be focused on the “expectation” market gamblers created. In corporate America, attention has pivoted from competing in the real market of consumers and is focused on competing in the expectation market of stocks.

3. Short-term thinking

Additionally, the prevalence of agency theory has led to a shortened time window in which business practice is evaluated. Quarterly earning calls drive share prices in the stock market. If a business is forced to operate in a three-month time window, it is highly unlikely it will innovate. Innovation’s payoff isn’t short term. The iPhone, probably the single biggest technological innovation in the last 25 years, took a decade to conceive and build. How many products were conceived internally at Apple and thrown away in those ten years? Research and development isn’t cheap, isn’t efficient, and it isn’t profitable. The return on the investment you make in innovation isn’t certain.

Be Different

There is a widening divide in business between those following the whims of the expectation market and those who have their pulse on the real market. At Atomic, our passion is to serve the real market in a way that makes a lasting impact. Although we deeply care about the financial well-being of our organization, it isn’t our only priority. We hope that this practice will improve our chances of being around for 100 years.

The post Why should Atomic exist for 100 years? appeared first on Great Not Big.

      

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Every company knows how important a great customer experience is for success. And yet, there are still plenty of nightmare stories where customers are treated poorly—by airlines, cable providers, and even small companies. You probably have a poor customer experience story of your own. I’m still upset—years later—by a car rental disaster from my brother’s wedding.

In an attempt to stand out from these bad experiences, some companies work very hard to “delight” us—to surprise or wow us in a unique way. But studies show that this doesn’t move the needle. In a super-busy and unpredictable world, all we want is to work with people who can make our lives easy.

Delight is Easy; Good Service is Hard

When I worked at a large regional health plan provider, I handled a major project that was designed to improve the customer experience by simplifying their paper bills. We faced many obstacles (complex billing relationships, multiple facilities and doctors, prescription coverage, government regulations, etc.) and had to settle for something far less useful and easy-to-understand than we had hoped.

Shortly after this project, the company started promoting “delight” stories from customers who’d had a great experience with us. Improving the customer experience required making strategic choices that the company wasn’t ready to tackle. But focusing on “delight” was obtainable.

It is easy for people to hold on to the idea of customer delight. We simply have to do something impressive in a relationship. This usually happens during the “sale.” Take a client to a fancy dinner or give them an unexpected gift. When we win the business, we hope the rest will take care of itself.

I’m reminded of a trip my wife and I took to Playa Del Carmen. At check-in, we were immediately served champagne and chocolate-covered strawberries. We still had the normal check-in paperwork to do, of course, but now we had to do it using clipboards on our laps, while holding champagne glasses and eating sticky food. It was a nice experience, but it really didn’t differentiate them from any other resort we’ve visited.

Delight isn’t sustainable, nor is it scalable. Once one hotel started folding towels in cute ways to impress customers, all of the other hotels started doing it. When everyone does something, it’s no longer special. And even if a hotel is delighting customers with cute towels, all of that goodwill will disappear in a flash if they can’t handle something like helping a customer resolve a billing dispute easily.

Effortlessness > Delight

In their book The Effortless Experience: Conquering the New Battleground for Customer Loyalty, Nick Toman, Matthew Dixon, and Rick Delisi looked closely at what drives customer loyalty. Their research showed:

• There is no difference in the loyalty of customers whose expectations have been met vs. those whose expectations have been exceeded.
• Just because your customers are satisfied doesn’t mean they will keep buying from you.
• Bad customer experiences reduce loyalty more than positive experiences increase loyalty.
• The key to keeping your customers loyal is to reduce their work effort.

This research suggests that creating a great customer experience is really about making the work your customer does with you as easy as possible. This is especially true when an issue happens—and issues always happen. Find a way to ease your customers’ workload across your business, and you should keep your customers.

To be clear, there is nothing wrong in doing something to delight a customer. Just make sure that whatever you do to delight has a visible level of effort. 

I believe this is the magic that Danny Meyer, CEO of Union Square Cafe and author of Setting the Table, describes with Enlightened Hospitality (which John Fisher wrote about here last week). In his book, Meyer shared a story about spilling olive oil on a woman wearing a brand new Calvin Klein dress. Not only did the restaurant send a gift basket as an apology; they also replaced the dress. As Meyer said, “A great restaurant doesn’t distinguish itself by how few mistakes it makes, but by how well they handle those mistakes.”

Creating Great Experiences with Atomic

At Atomic Object, we’ve distilled these findings into three cornerstones for creating a great long-term customer experience to drive loyalty.

1. Meet their expectations.

Instead of worrying about delighting our customers, our focus is on making sure we set and meet the right expectation for the project. This starts in our first contact in sales. From our first triage call through our pre-project consultation, we are doing four things:

• Educating our customers how software products are made
• Making sure the customer accepts that learnings/discoveries during the project may change their product direction
• Determining if we are the right partner to solve their problem, and if not, helping them make a connection to someone who can help
• Ensuring there is strong alignment with both companies’ values

When we agree to move forward on a project, our team works consistently to manage and meet expectations. Atomic’s team, processes, and tools are optimized to empower clients to make the right decisions for their products. The Delivery Leads work with clients to manage scope and efforts within a budget. Our scrum process allows us to adapt the work as new insights are gained through the development effort. And most importantly, we are constantly teaching our clients how great software products are made.

Perhaps the best example of meeting expectations is the high level of quality in our craft. Wrapping the software with tests, keeping an eye on continuation integration, and working in a team model allows us to deliver a high-quality product–a product that is stable and lets the customer sleep well at night.

2. Make it simple for them.

In everything we do, we work to make it easy for our customers. This means we invest a high level of effort on their behalf even before they are a client. Some examples of how we put this into practice include:

• Taking on the burden of scheduling meetings, building agendas, and being clear on simple things like parking
• Performing research ahead of new client calls so we are in the best position to help
• Responding promptly to requests for help even before projects begin
• Bringing clarity on the work we will perform and the kind of work we won’t do
• Constantly explaining what we are doing and why we are doing it

The craft of creating a software product is not a simple endeavor. It’s full of risks, and there are real budget limitations. Non-technical business owners can feel the information asymmetry when working with agencies like Atomic. To make this easier for clients, Atomic publishes content on software product creation in its blog. We also take the time to carefully explain all of our recommendations so they will feel comfortable making decisions.

3. Handle mistakes with grace.

To be clear, Atomic Object is not perfect. We do make mistakes from time to time. As Mr. Meyers says, “Human beings are probably the animal on earth best designed for mistake making.” His service business expects mistakes to happen.

He describes a philosophy for handling mistakes in his restaurant business called the five As. The first step is to be Aware you made it. If you are not aware, you are nowhere. Second, Acknowledge the mistake. Third, Apologize for it. Fourth, Act on the mistake to correct it. And, finally, Apply additional generosity.

In a service company which builds digital products from people’s minds, mistakes are a part of the learning process. When we are aware we’ve made a mistake, we follow our values by owning it, giving a shit, and thinking long-term. As Mr. Meyers suggests, we apologize and take action to make it right. We also use the mistake as an opportunity to learn and get better.

The Loyalty Results

Atomic Object works hard to create customer loyalty. In some sense, the company has been doing this from the beginning because what we did made sense to us. After reading The Effortless Experience, we learned the specific principles that get the best results. With this knowledge, we’ve focused more of our efforts in this direction.

Mr. Meyers shared that in his restaurant business, it’s easier than ever for his competition to copy the delight elements that have driven their success. He used to travel Europe to find rare recipes to bring back for his customers. Now, with the internet, these recipes are available to everyone. He can no longer rely on that as a way to delight his customers. More than ever, he needs the specific principles described here to maintain their success.

Fulfill your customer promise. Make it easy for them to work with you. Provide a service or product that solves a real problem for them.

Do these things, and you will find loyal customers and a fulfilling business purpose.

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Once you’ve decided to sell shares, the most practical question — and to everyone involved the most important — is that of valuation: What’s the company worth?

I spent a year researching this question, collecting valuation models, seeking an authoritative, definitive answer. I stopped seeking when I realized the answer wasn’t a number or an algorithm, but a mutual agreement. For my purpose, shares were worth what I was willing to sell them for, and what other employees were willing to buy them for.

This post is the third in a series on Atomic Object’s ownership and the non-ESOP approach we took to gradually shift from a founder-owned to a broadly employee-owned company.

1. Context, motivations, accomplishments to date
2. Description of our Approach: Atomic Plan and ESPP
3. Valuation
4. Financing
5. Distributions
6. Lessons Learned
7. Perspectives of Founders and Employees
8. Alternatives and Unsolved Problems

First principles

The best way I knew to reach an agreement was to have a valuation model that was based on first principles, and which was open to examination and testing.

When I thought about the value of Atomic from a first principles perspective, I identified three elements:

• Assets (furniture, computers, cash, AR, investments, etc)
• Liabilities (debt, AP, current payroll, 401k commitments, etc)
• The income stream of future profits

With Atomic, and probably most technology services firm, the assets and liabilities are relatively small and quite easy to value. The only significant and complicated element is the income stream from future profits. That’s also why services firms don’t sell for high multiples of their revenue or earnings. All the “assets” (i.e. people) who produce those profits can leave the firm at any time.

Future profits are determined by factors such as current contracts, client base, reputation, size, operational efficiency, marketing effectiveness, taxes, and market demand. While the individual components of the expected future profits are very difficult to value, taken together, they can be said to have determined past profitability, which is easy to measure, and is a reasonable estimate of future profitability.

Shortcuts to valuation

Many of the 12 valuation models I gathered were simple multiples of key financial metrics like revenue or EBITDA. Inc magazine used to run such an article on a regular basis. It’s easy to conclude from these sources that valuation is a trivial exercise — just do a simple multiplication and you’re done.

What I believe is commonly misunderstood is that these studies are merely reporting on transactions that happened, not what drove or justified the deals. You can calculate that a company is worth 4.5 times EBITDA only after some buyer does the investigation and due diligence, decides what they are willing to pay, then does the division to determine the multiple. The multiple didn’t determine the value, it was merely observed after the fact. The reports that provide these multiples are only useful if they represent many transactions, if the underlying business conditions are similar, and the deals were well done.

Since they are based on market and economic conditions, multiples can vary with factors that have little to do with an individual company. If you were selling the entire company on the open market, then timing would be quite relevant. But that’s not what we were doing. We were selling shares to broaden ownership and perpetuate the existence of the company in the long-term. A first-principles approach is just math done on historical results with assumptions about the future. It isn’t moved by trends and market conditions.

Discounted cash flow (DCF)

Revenue times net margin equals profit. But what about future profits? Since a dollar today is worth more than a dollar tomorrow, a discount of future profits needs to be made. In short, future profits can be predicted from past profits, and the value of that future profit stream can be discounted to map it into a value today. This is known as a discounted cash flow valuation.

We use a 17% discount rate and a 10-year projection of profits. These are probably on the high and long side, respectively. If a buyer were to question the optimism of a 10-year projection, I’d respond by pointing out the company’s history and track record, and the high discount rate. As an intuitive measure of this, I believe many people at Atomic would happily buy $1 of next year’s earnings for $0.83 today.

Since the DCF is just math, the same value could be produced by other parameters of discount rate and number of years of projection. In our case, a 5% discount rate and 6-year projection produce the same present value.

Capital gains versus earnings

When your fundamental business strategy is to be great, not big, then it would be odd to base your company’s value on future growth projections. Venture-backed firms fit into that sort of value; VCs invest with the hope that growth projections come true, not for the profit currently generated.

Atomic’s valuation is one a financial buyer would use. It doesn’t depend on achieving a particular growth trajectory and selling the entire company; instead, it’s based on the financial results that can reasonably be achieved in the future.

For a company with a goal to be 100 years old, it would be pretty silly to buy hoping for a big sale. Instead, Atoms should be buying shares to gain access to the profit stream they produce.

After-tax value

Our valuation is done on an after-tax basis. We reduce future profits and accounts receivable by the amount of tax that will be paid on them. For example, if future profits are worth $10M today, then we reduce that in the model to $7.5M by assuming a 25% effective tax rate.

In truth, I’ve always found this to be strange, and at odds with how people talk about other financial assets. When you think about your salary, I’m guessing you think about your gross salary, not your take home? When you talk about the value of your house, you probably state it in terms of the market value. If you hold shares of Apple, you’d describe the value as the number of shares times the market value, not what you’ll end up with once you’ve paid capital gains taxes.

Using after-tax values makes our valuation more conservative, favoring buyers.

Smoothing historical results

We use the past 16 quarters to calculate an average margin to feed into our model. If our business or the world changed dramatically, suddenly, and permanently, this would become a problem. Using 16 quarters helps smooth out natural variations. It also helps when our margin is reduced by one-time events like buying a building or making an investment. Our simple average may be covering for our lack of sophistication in accounting for operational results versus balance sheet investments.

Stable performance over 17 years also helps make this simple approach work. Our average net margin since our founding is 24.6%. As of Q3 of 2018, our 16-quarter average also happens to be 24.6%.

Our revenue can change quickly as we hire or lose people. We use the trailing four quarters to estimate annual revenue and feed that into our model.

Factoring in growth

We assume a pseudo-inflationary rate of growth of future revenues of 3%. This is a significant aspect of our model.

We are not pricing into shares any future growth in the company’s size and hence revenue, since we never set growth goals. For a company with a CAGR since founding of 22.4%, that makes our model conservative and generous towards buyers.

Mechanics

We update our valuation model every quarter. This schedule is driven by ESPP purchases. A positive outcome of needing to do this every quarter is that we’ve gotten better at doing it. Before ESPP, we only updated the model when I was going to make an offering in the Atomic Plan. That happened sporadically, so each time was somewhat painful.

Bugs

While the spreadsheet model of our valuation isn’t terribly complex (see “What’s your company worth?” for the spreadsheet), we’ve found there’s a lot of subtlety and complexity in the model.

Since 2009 when we first used it, we’ve found and fixed several significant bugs. Luckily (for buyers) all of the errors reduced share price. These mistakes argue against the homegrown approach we took, as presumably a professional appraisal firm wouldn’t make them. On the other hand, I suspect you’d end up with a one-size-fits-all valuation.

Investment assets

I said above that the assets and liabilities of a technology services firm are generally small compared to the value of future profits. Ignoring past investments we’ve made, and the building in Grand Rapids we bought three years ago, the valuation model reduces to future profits, cash, AR, AP, and stuff like office furniture. Future profit is 86% of the sum of these things.

The chart below shows the weighting of all assets in our valuation model.

Assets as fraction of total enterprise value.

As the graph shows, the actual weight in Atomic’s enterprise value of the future profits of our core business is only 60%, substantially lower than it would be if we didn’t make investments.

While valuing a building (and its corresponding mortgage) are straightforward, valuing investments we’ve made in other companies is much harder. One of those investments, Company X in the chart, also represents a substantial fraction of our total company value. That particular company is a software firm we co-founded in 2007. It’s been quite successful, has grown substantially, and until this summer when we sold part of our ownership in it, represented 30% of Atomic’s value.

You can see the effect on share price of this investment in the graph below. The red line shows the value of shares if you subtract Company X from our overall enterprise value.

The impact of a single successful investment on share price.

A challenge shown in the graph above is that, even with Company X down to 20% of total value, employees buying shares today are buying much more than a simple service business with a few hard assets. This can be a problem when the risk tolerance of the purchaser is at-odds with the risk profile of the investment.

Owning investments in a separate entity would solve this problem. But with our large base of employee owners (currently 37 people), these investment entities would have many shareholders. Currently, when shareholders leave the company they must sell their shares back. What would happen with these investment-only entities? If they didn’t sell, then we’d become responsible for shareholder rights and communication with people who no longer worked at the company. This is an unresolved issue for us.

Close readers of this post will notice that we carried Company X at a value of $0 for the first four years of its existence. To be conservative, we waited until we saw clear evidence of the success and value of this company before we added it to our valuation model. Since 2012 we’ve used funding rounds of this company to value our shares.

Compared to market value

I have been able to compare our valuation to market price when I’m aware of a transaction, or a firm expresses interest in Atomic, or someone else shares their experience.

A leader of a large technology consulting firm recently told a small group (including me) that his firm acquires consultancies for 1-2x revenue.

Ryan Stewart recently blogged about the value of the web agency he sold. His was a thoughtful approach that ended up at a multiple of 2.5x EBITDA on top of extrapolating past growth 3 years into the future.

By comparison, our valuation at the end of 2017 was approximately 5x that year’s EBITDA, and 1.3x revenue. This is enterprise value, including substantial investments assets.

I believe our valuation for the core service business is discounted from market value by between 30 and 100%.

Another way to gauge company value is by looking at first-year dividend yield. I calculate this by dividing the dividend distributed on a share by the cost of a share that year. Since the cost of shares since 2011 has included a growing investment component (Company X, for example, currently at 20% of total), and those investments don’t generate any ongoing return, the dividend yield is actually depressed by them. Presuming the investments eventually pay off, the dividend yield underestimates the worth of the shares.

The first year dividend yield on Atomic shares has averaged 18.4% since 2009.

Conclusion

We’ve been using our valuation model for transactions for nine years. Will it change in the future? Is it accurate? Hard to say. Consistency is one of the things that establishes its credibility. Accuracy is in the eye of the buyer and seller.

The post “What’s your company worth?” has more details on our model and a spreadsheet you can download.

The post Atomic Ownership, Part 3: Valuation appeared first on Great Not Big.

      

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Things had been going extremely well. You’re growing, succeeding. But now…

You can’t quite put your finger on what’s wrong. You’re feeling out of control. You had a grasp on things, but now you don’t.

Don’t worry—you likely don’t have a culture problem or a training problem. You just got bigger. Something has fundamentally changed, and now you have different strengths and different needs.

Atomic’s Journey from 4 to 65

We’ve often found ourselves in this position at Atomic because we’ve never explicitly looked to grow. It’s been a side effect of doing good work and being a great place to work. So from our founding to our current size (65 employees in 2 offices), we’ve grown steadily and organically.

And as we’ve grown, we’ve noticed a few key points along the way—each triggered by a new plateau in headcount—that required us to change the way we operate. The changes certainly weren’t all easy, but they were necessary and in the end positive enhancements. They also led to growth opportunities for various team members.

I suspect that growing organizations whose revenue is linearly tied to headcount will see similar organizational inflection points.

Atomic’s 6 phases of growth (so far)

We’ve worked through six of these phases at Atomic. Each began with an inflection point that we tied to an approximate headcount.

The beginning (fewer than 10 employees)

Companies, commonly, start as a collection of friends who are interested in working together. Since the team is small, there isn’t need for a lot of structure, rules, or even organization. Communication is easy.

Long hours and sacrifice are required by the founder and key team members to make sure the organization is properly setup, secures clients, and successfully delivers the initial projects.

The beginning is a stressful but exciting phase. Everyone is working closely together, and the founder is playing a key role in both the sale and delivery of work.

A real company (~10 employees)

In my opinion, companies become “real” when they have 10+ employees. Crossing this milestone means that it’s no longer possible for everyone to work closely with the founder. Most of the founder’s effort has shifted out of delivery and into sales and marketing.

This shift from working directly with the team to primarily interfacing with clients requires a clear written set of expectations for the company.

At Atomic, this is when we introduced our initial set of rules and expectations. Our point of view was to expect high performance and keep our rule set as small as possible to enable smart people to make choices.

This is also the time that we formalized our core set of value mantras. The mantras were developed by observing the current characteristics that we liked about the company. We wrote them down so that we could continue to live those values as we grew.

We continue to use our value mantras daily in our formal recognition program, when we hire, and when we need to fire.

The founder needs help (~20 employees)

When the company grows over 20 people, it’s no longer possible for the founder to manage all of the operations. The founder has become the bottleneck to growth. In order to break through this roadblock and save the founder’s sanity, help is needed.

At Atomic we added more capacity to help address the problem by replicating the founders model (selling, managing clients, managing teams, etc) with two more team members, myself and Shawn Crowley. Instead of dividing the major components of the work, the three-person team shared the load for each component.

Adding two people to this work at the same time wasn’t efficient, but in hindsight, it was a very robust plan. It protected the company from one of us deciding to leave.

We copied this pattern when we opened our Ann Arbor office.

Everyone doesn’t know each other well (~30 employees)

When the company reaches 30 people, it becomes impossible for everybody to have deep relationships with everyone. This is a challenge for any company, especially one that has long project cycle times and a culture of social connection.

In order to combat this challenge, we implemented our pair lunch program, our internal office newsletter (the Nucleus), and a more structured and inclusive approach to hiring.

Delivery consistency needs improvement (~50 employees)

At 50 people, project consistency becomes a challenge. When the team is smaller, you can lean on the individual skills of team members to deliver high-quality solutions. As you grow, project-to-project delivery techniques begin to drift.

When Atomic was about this size, I had lunch with a key client that we were building two different platforms for. Each platform was being developed by a separate team. During the lunch, the client informed me that he was happy with both teams, but the process and project management was different in both situations. This difference required our client to modify his approach during the oversight of each project so that he could take advantage of the unique skills on both teams.

Project situations are unique, but we need to ensure that all projects are being run and managed in an Atomic Way. It shouldn’t be expected that our client needed to modify his approach. We owe it to our clients to provide both high quality and incredible customer experience.

In order to help facilitate this challenge we developed the Senior Strategist job, and Micah Alles stepped into the position. Micah is responsible for meeting with every team in the organization every few weeks. He works diligently to ensure that best practices are spread, helps to identify and build appropriate project management tooling, identifies when help is needed, and shares general project wisdom.

Shortly after rolling out the Senior Strategist job, we also created the Delivery Lead job.

The combination of the Senior Strategist and Delivery Lead has greatly improved our delivery consistency.

More career development desired (~60 employees)

At 60 people, a small people management team is able to support people during emergencies, but it’s impossible to give individuals the attention or focus that they deserve. This is a frustrating situation because individuals aren’t getting the coaching they need, and managers are left feeling guilty because they simply don’t have the time to help.

Recently, instead of hiring an HR professional, we opted to create a new role for experienced Atoms. The title for the role is Career Development Manager (CDM). CDMs are responsible for the career development of a handful of other Atoms. They play the employee support role in our management matrix.

CDMs have helped address both of our above concerns. Being a CDM has also been an excellent growth opportunity for the Atoms that stepped into the role.

The system is scalable, and we’re excited about its long-term potential.

The future

We’re not perfect, and we still have a lot to learn. We are, however, constantly innovating. We’ve already started identifying ways to mitigate the effects of organizational inflection points that we see on the horizon. We’re excited about the future and the opportunities that it presents for our team.

Please feel free to share your inflection point experiences in the comments.

The post Outgrowing our structure – How we navigated 6 phases of growth at Atomic appeared first on Great Not Big.

      

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A few years ago, when I was new to software consulting, I attended my first resource scheduling meeting. Resource scheduling is the act of assigning team members to start projects on a specific date. During this meeting, the project manager wanted my insights into the projects that needed software developers.

It was a four-hour ordeal I will never forget. Between the arguments about building a better solution, who to put on what, and the constant flow of jokes, we faced enormous complexity in assigning people to projects.

I’ve seen many attempts to solve the difficult problem of scheduling work for teams. I witnessed engineers build custom software that never could do the job right. I watched off-the-shelf software solutions such as Microsoft Projects fail miserably. And I have experimented with different teams and processes in an attempt to find a solution to this problem.

It’s only been recently that I fully understood and appreciated the problem of scheduling. It is the infinite game as described by Simon Sinek. You have to commit to playing a game with a never-ending problem and the knowledge that rules will change. If you don’t accept this, the game will beat you, and your company will lose.

Why Scheduling Matters

This insight became clear to me after reading David Maister’s book Managing the Professional Services Firm. David dedicated a whole chapter to the importance of scheduling. I recommend that everyone who runs a software consultancy should read this chapter.

At the beginning, Maister states, “The scheduling of work assignments is the single most important managerial activity in a professional services firm. Whoever makes the work assignment decisions is the person really managing the practice.”

By placing your team members on specific project assignments, you are influencing the quality, cost, and timing of the solution delivery. This greatly impacts the experience your client has with your firm.

You control how your team members (both senior and junior) develop in their careers and engage with the company. All of this ultimately impacts the brand of the company and the collective capabilities that can be applied to future opportunities.

Ultimately, scheduling is a business function that supports the predictability and stability of cash flow. It drives the sales work upstream to fill gaps in the schedule. It drives financial performance on the accounting end.

Do this work well, and you will have clients who return with more work and tell great stories about your firm, along with happy employees who invest in the success of the firm. Do this poorly, and your firm will fail.

How Success Drives Complexity

When your firm is relatively small, the problem of scheduling is pretty easy. A spreadsheet is all you need as a planning tool. The time you need to invest in this work is small. If you hire good people, you will have success in your firm.

As you gain business success, you will have more client projects and gain more employees. The complexity of scheduling grows exponentially, and when you go from a team of, for example, six people to 30, there is real danger.

At some point, the spreadsheet won’t work anymore. Gaps appear in the schedule, and, as people sit idle, the firm loses profitability.

Many people caught in this situation assume they need to do one of two things:

• Find a new software tool to fix this.
• Start pulling everyone into the decision-making process.

This is flawed thinking.

Taking an Investment Portfolio Approach

Tools can provide insights, help manage information, and allow multiple people to participate. But to succeed, they require a consistent process, understanding of your team members, and the discipline to stick to specific principles.

This work involves more than simply scheduling a specific project. You must shift your thinking to the approach you’d use if you were managing a portfolio of financial commitments.

For a large team, this kind of management involves:

• Diversifying project commitments across multiple client industries to reduce risk of market retraction
• Analyzing the benefits and risks of specific team sizes and compositions
• Knowing when to grow and when to shrink specific teams
• Staggering project end dates across the portfolio to avoid the high cost of project startups at the same time
• Introducing junior staff to projects to grow their skills, while shifting senior talent off the project to ensure fresh experiences

Look closely at these considerations, and you’ll see that there’s no algorithm you can put into a machine to solve your scheduling problem. You are better served with simple tools, a good understanding of your team members, and a flexible approach.

Using Traction with Scheduling

In Atomic Object’s Grand Rapids office, we manage a portfolio of work across a team of 36 makers. To make this work, we arrived at a balanced approach that blends specific principles, a simple toolset, a dedicated process, and the right mix of people.

Our scheduling team includes the managing partners (MPs) along with our director of product development (DPD). The MPs have detailed knowledge of the opportunities in our sales pipeline, along with a general idea of the skills and interests of our team members. Our director has deep insights about the project teams in flight, and he’s looking for development opportunities.

Having implemented Traction for our leadership meetings in our Grand Rapids office, we now run our scheduling meetings the same way. We align around the current state of our portfolio and identify issues to solve, and we’ve established a set of to-dos that drive accountability.

We use a simple dashboard to alert us to signals of potential gaps in our portfolio. In addition, this dashboard lets us know when deals need to be closed.

Making Scheduling Into a Game

We manage our portfolio of commitments with a custom tool we call PlanIt.

With this simple tool, we can see who is committed to what project and when the project will end. Moreover, everyone in the company has access to PlanIt. They can see who is working on what AND what future project they may be assigned to.

Our goal with PlanIt is to eliminate the white space that appears. When this happens, we win. We accomplish this by aligning our sales activity to the available team. In this way, it sort of feels like the game Tetris.

Beyond PlanIt, we also use an Excel spreadsheet to model potential scenarios for proposed projects. It is very easy to create a snapshot of PlanIt at a specific moment in time. And, with that moment capture, we can use its flexibility to model various scheduling scenarios. In this way, we learn the best solution to meet our goals.

We also use Excel to keep a Focus List of specific opportunities we are developing through sales. This Focus List has our collective attention as we seek to fill the future white spaces in our schedule.

Focusing on Principles that Drive Scheduling

To help us make the right decisions, our scheduling team has aligned around specific principles:

• We favor written commitments (SOW, email, etc…) over verbal ones.
• Our delivery leads should keep the scheduling team aware of changes in project end dates.
• Active projects get first right of refusal for capacity, as long as they are willing to commit 8+ weeks in advance.
• We make sure we’re aware of active project end dates.
• We filter any sales opportunities in our Focus List with Atomic’s brand and engagement style, favoring engagements with greater alignment.
• We favor client relationships or opportunities that have greater predictability or stability.
• We only schedule work where we believe we can responsibly deliver success.
• We favor long-term relationships. For instance, near-term projects might be small, but future work may be significant.
• We favor long-term project commitments.
• We favor first-to-commit (first come, first served). First-to-commit become more favored as idle capacity within eight weeks.
• We look to provide opportunities for growth with our makers.
• We think long-term.

Using these principles, we can work as a team to meet our brand promise for our clients. We can also keep our portfolio healthy by avoiding taking on too much risk.

This doesn’t mean we won’t have some tricky problems to solve within our portfolio. For example, we sometimes lack information when trying to plan ahead for Accelerator hires. By sticking to our fundamental principles, we can make decisions that create future opportunities for these team members.

The Most Important Infinite Game

The key lesson is that staffing and scheduling decisions are the strategic decision for your professional services business, with very important and real consequences for your long-term success. Don’t take the easy road of using narrow considerations for quick decisions. And don’t make the effort into a fun joke session.

Scheduling and staffing work is hard, but not impossible. Bring together key people, use simple tools to track projects, create a framework to make decisions, and bring a flexible mindset to the task. In this way, you can increase your chances for success.

In conclusion, clients want quality, efficiency, and service. The more thoughtful you are with staffing projects, the more you can meet these desires. That, in turn, allows you to pursue your own goals, increase profit,  improve morale, and create richer learning opportunities for your team.

This is how you play the infinite game of scheduling to win.

The post An Infinite Game – How we schedule teams without losing our minds appeared first on Great Not Big.

      

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Having decided to take the bold step of becoming an employee-owned company, written up a prospectus, determined a valuation, and heard “yes” from seven interested employees, I now had to figure out how to execute the transactions. A big part of that was financing.

In the first offering of the Atomic Plan in May of 2009, the average age of the seven buyers was 32. Many of them were probably still paying off student loans. None of them had yet had the opportunity to build significant wealth. Few if any had equity in a house (or any house at all). They were all going to need financing to make this happen.

We’ve refined our approach to financing Atomic Plan loans over the years. In this post, I’ll describe what’s driven those changes and what’s worked out for us on the financing front.

This post is the fourth in a series on Atomic Object’s ownership and the non-ESOP approach we took to gradually shift from a founder-owned to a broadly employee-owned company.

1. Context, motivations, accomplishments to date
2. Description of our Approach: Atomic Plan and ESPP
3. Valuation
4. Financing
5. Distributions
6. Lessons Learned
7. Perspectives of Founders and Employees
8. Alternatives and Unsolved Problems

The need to finance

While selling 14% of the company for $350,000 seems like a screaming good deal 10 years on, that was a lot of money to finance back in 2009, in transactions ranging from $30,000 to $70,000. Those were also very large loans and down payments for the people buying into the company.

This dynamic of employees being quite young when offered the opportunity to buy shares hasn’t changed in 10 years. If anything, it’s gotten more dramatic, as we’ve established a regular pattern of offers happening in the year an Atom reaches five years of tenure. If you start with the company right out of college, you’re still comfortably in your 20s at the time of that first offer.

Bank financing

While our bank wasn’t willing to extend loans collateralized by shares in the company, they were supportive of our plan. My co-founder and I were willing to use the proceeds of the sale to collateralize the loans. For this first offering, the bank made loans to the seven participants directly to purchase shares, and the proceeds of those sales were put right back into the bank as collateral for the loans. Over the years, as the loans were amortized, my co-founder and I got those sale proceeds released to us. The bank did formal documents, collected payments, sent reminders, imposed late fees, tracked amortization, and generated reports as needed.

This arrangement worked well: the co-founders didn’t need the funds immediately and were confident about the future of the company. The bank didn’t take unacceptable credit risk and serviced the loans. The cost of that servicing was 20% of the interest on the loans; the co-founders received the remaining 80% of the interest charged borrowers.

Loan terms

We asked for a 10% downpayment in the first round, not fully appreciating that the co-founders would be liable for capital gains tax on the entire $350,000 of sale in the year the transaction took place. The downpayment likely didn’t cover my capital gains tax bill that year.

We set the interest rate at 5%. That rate was less than anyone could get an unsecured loan for, and likely less than other loans held by the borrowers. Using a favorable rate meant people weren’t anxious to pay off these loans if they had extra funds. Some borrowers reported to me feelings of conflict about whether it was right to pay off other loans or make other investments if they still owed on their Atomic Plan loan.

Setting the duration of the loan was tricky. I wanted to amortize the loans reasonably quickly, but I didn’t want key employees stuck with a monthly payment they couldn’t afford. The bank suggested a structure of 7 years amortization with a balloon at 3 years. I think they did this to protect the co-founders in the event of a dramatic rise in interest. Neither Bill nor I really cared about this, but we went along.

Later, I heard some FUDA around the balloon feature. As things went, we hit the 3 years, and I refinanced the loans at the same terms. In hindsight, I wished that I’d nixed the balloon feature in the first place.

Since by 2009 we had predictable results and a generous rainy day fund, we’d been doing distributions of profits on shares each quarter. It was clear that new owners would be using those distributions to help them make their monthly loan payment. If we’d set the full amortization duration shorter, thus increasing the monthly payments, the distribution may not have been enough help. If we’d set it too long, my co-founder and I would have been stuck holding these generous (to the borrowers) loans past the time they could have been paid off with distributions. Dialing that in was tricky, since it required predicting our future profitability, predicting future investments we might make, considering individual tax and economic situations, etc.

The riskiest part of the traditional fixed term loans we made in this first round was that it fixed the monthly payment. We put our senior makers and strategic employees in a potential conflict: to pay their loan easily, they wanted short-term profitability; as shareholders they should also want the company to be making investments with an eye toward the long-term. I heard some comments about this conflict and felt some pressure on our investment strategy.

We resolved this tension when we took the loan processing in-house.

Self-financing

The main motivation for using the bank to administer loans in the first offering was to act as an isolation layer between the co-founders and the borrowers. I didn’t want to be chasing late payments, considering hardships, imposing penalties, etc, while I was actively managing these same people.

Things went so smoothly that by the next offering in September of 2012, we decided it was okay to bring the financing in-house. This saved the lenders (only me by that time) the interest held by the bank for their services. It also created work internally that was born by the whole company, something which seemed fair given the goal of employee ownership.

The loans I’ve personally extended for the Atomic Plan since that time have been simple interest with no balloon and a dynamic period.

The novel feature we introduced on the duration or period of the loans was to address the conflict discussed above. Instead of a fixed duration which determined a monthly payment, we moved to a small fixed monthly payment with a mandatory additional quarterly capital payment tied to distributions. The small fixed monthly payment was intended to first of all work for the borrowing Atom’s family economy regardless of our profitability level. Secondarily, it was supposed to cover the interest on the loan.

In addition to the regular monthly payment, each borrower was required to make an additional capital payment on the loan of 70% of the amount of the distribution paid out on the shares associated with the loan. The intent was that if we were very profitable the loan would be amortized more quickly, and if our profitability (and hence distributions) were lower due to either performance or investments, they’d amortize more slowly. The loan would “breathe in and out” naturally, never putting the employee borrower in a bind. 70% was intended to leave 30% for the Atom to pay taxes on the distributions with.

The only changes we’ve made since 2012 were to move to a 50% quarterly additional payment, to ask for a 20% downpayment (not always enforced), and very recently to use a floating rate tied to prime with annual adjustments.

The move to 50% came about because I found myself feeling resentful of the way some Atoms who used the financing of the Atomic Plan characterized the opportunity to buy into the company. From my perspective, I was selling my personal shares at a favorable valuation. I was also financing their loans at a low interest rate, carrying the credit risk, and allowing for a variable period of payback. It seemed pretty generous to me.

From their perspective, until their loan was paid off, they weren’t benefitting from owning the shares. No new kitchens, windows, nice vacations, or college saving contributions. I sometimes heard comments that made it seems like this generous thing I was doing was, in fact, a burden on those buying in. Not a good place for any of us to be.

Since we moved to the smaller mandatory additional capital payment of 50%, each Atom can decide whether they want to pay off their loan more quickly, or slow it down a little, pay more interest in the long-term, and have the immediate enjoyment of more money in their checking account. I haven’t heard any complaints or negative comments since this change. Whether that’s because of the change or because people learned I didn’t appreciate the perceived ingratitude, I’ll probably never know.

Mechanics of in-house loans

When we took the loan processing in-house, we insisted that all payments were done electronically into an investment account owned by me. Statements from this account were then used to reconcile loan accounts.

A small but handy innovation here is that we used the cents portion of payments as an identifier of payee. By assigning each payee a unique number of cents to add to their payments we could reliably match payments to payees when the investment account statements didn’t contain this information (which, strangely, was the common case.)

The entire system runs off interconnected Google sheets, with each individual having read-only access to their personal sheet as a record of their loan and payments, and a central sheet which aggregates all loans and allows for easy reporting to me about outstanding balance, interest paid, etc. Handling multiple loans per person, tracking installment loans, and allowing for interest rate adjustments have required additional complexity.

This system was created and has been extended and improved over time by Mike Marsiglia. He also authored the custom tool we use to keep track of our cap table and share purchase and sale history.

Mike has also taken on the responsibility of reminding people when loan payments are missing, late, of the wrong amount, or sent to the wrong place. My sense is that this has been a manageable burden and required a relatively small amount of time overall.

The post Atomic Ownership, Part 4: Financing employee ownership appeared first on Great Not Big.

      

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As leaders within organizations, we rarely get to start our own team from scratch. We receive teams as they were formed. Often, we have limited ability to change the makeup of these teams effectively. As a manager, how then do we manage the team we were given?

I’ve gotten a lot of inspiration and instruction from two leaders within their perspective fields. The first is Kim Scott. Kim has led teams at all the biggest and most successful technology companies of the 21st Century: Apple, Google, and Facebook. Her book, Radical Candor, is an evergreen manual for anyone who manages people. The other leader is (counterintuitively) Bill Walsh, a late NFL coach who found unparalleled success with the San Francisco 49ers in the 80s and 90s. His book, The Score Takes Care of Itself, is a fascinating look at leadership and management within a team with constraints around resources, growth, scalability, and turnover.

1. Evaluate

Both Scott and Walsh align around spending time to get to know the team you have. Taking any sort of action before deeply understanding the state of your team is folly.

During this evaluation period, Walsh says that a manager has two jobs: communicate what you are evaluating team members against and watch how they respond. In Walsh’s case, this meant communicating his “Standard of Performance”. He had a detail-oriented standard he wanted his staff and teams to perform at. This standard governed everything from how to answer the phones at 49ers HQ to how a wide receiver ran routes. He expected everyone to perform at a very high level all the time. His theory (and proven practice) showed that when you focused on your own ability to perform at a high level, the score would take care of itself.

Bill Walsh communicated his Standard of Performance through various mediums, but the most important was through modeling. He never asked anyone to do anything he wasn’t already doing himself. As he communicated, he monitored the response of his staff and team. He took time to connect with many one-on-one to understand how his message resonated with those individuals.

Kim Scott takes a slightly different approach, which I identify with and have utilized in the past. She suggests that before you can really manage a team, you must know them. To know them as colleagues and team members, you need to make a connection on a personal level. She suggests conducting one-on-one meetings with all your direct reports to focus on a couple of different things. First, you ask your direct report to walk you through their work history. Ask questions about what they did, who they worked with, and why the work they did was important for them. Next, have a conversation about where they want to end up in their career.

When I’ve done this, I encourage the conversations to veer toward idealistic dreams, not pragmatic plans. We don’t have to figure out how to get there or what the next steps will be to get on the right path. What we do want to do is understand what our direct report wants to get out of work. That way, we’ll know how to equip them for opportunities as they arise. After these two conversations, we’ll have a much better handle on the experience and dreams of the people under our management.

2. Understand

Once you’ve had some time to get to know your team, it’s time to start building understanding about your team makeup. The question is: What do we evaluate for when seeking to understand our team? Do we evaluate for talent? I would venture no. As managers, we need to accept the fact that not every team will be populated by extremely talented individuals. We will always have a broad spectrum of talent on any team. Additionally, just because someone isn’t as talented as another, it doesn’t mean they can’t be useful toward your organizations’ goals. Give me an engaged, less-talented team member any day over an unengaged, talented team member!

Both Scott and Walsh agree that, as a manager, we can’t be in the talent management game. The game we should be playing is the growth management game. To play that game, the key metric for evaluating our teams isn’t talent, but growth. How do you manage growth? By identifying where the different members of your team are in terms of performance and planning how you’ll move them from where they are to where they need to be. Walsh and Scott both take a 4 quadrant approach to team evaluation.

Walsh’s four quadrants are along two axis. The X axis is “cultural alignment” and the Y axis is “performance”.

• The upper right quadrant is for people who are culturally aligned and highly performant. He calls these people “Superstars”. Athletes like Joe Montana and Jerry Rice slot into that quadrant. These are the cornerstone members of your team.
• Team members on who are highly aligned, but not very performant he identifies as “Rookies”. They are people who are new to the org, hungry to prove themselves, but are still learning the ropes. The goal with these folks is to help them gain proficiency and move into the “Superstar” quadrant.
• The lower right-hand quadrant is for people who are highly proficient, but not very culturally aligned. Walsh calls these team members “Free Agents”. They aren’t going to be around forever, but they are very useful at the moment. The next best job offer they get means they’ll probably take it and move on to other pastures. You want to work to depend less on Free Agents than you do on Superstars and Rookies.
• The last quadrant is for people who aren’t aligned and aren’t performing. Predictably, this quadrant is called “Waivers”. People who are in this quadrant need to move on to another organization where they can be aligned and perform better.

Scott’s four quadrants are also along two axis. The Y axis is also performance, but the X axis is for growth, divided between steep growth and gradual growth. In her quadrants, team members grow in performance from left to right on two different tracks: steep growth trajectory and gradual growth trajectory. How do you know what side of the X axis people land on? Scott’s approach is pretty straightforward. She sees teams being divided between two types of members: Superstars and Rock stars.

Superstars are people whose eventual ambitions probably lie outside your organization. They are extraordinarily gifted leaders with big ambitions. They will push your organization toward growth along many vectors. However, there may not be room in your organization for their next career step. You hope you’ll be able to hold onto them for as long as possible. Superstars are on a steep growth trajectory that may end up with them leaving your organization (or taking your job).

Rock stars are the undergirding stability of your team. They may not be on a steep growth trajectory, but they are continually improving at a gradual rate. They perform well in their given role, but they may never grow out of that role. Any company needs more rock stars than they do superstars. People of either the rock star or superstar persuasion who aren’t growing should probably also be managed out of the organization.

3. Execute

Having taken time to get to know your team, it should be relatively easy to see where the different members lie on either of these quadrants. Each quadrant has an indication of the strategic outlook you can take as a manager to add value to each team member’s employment experience. It will be up to you to determine if you have the right people in the right positions for your team to flourish.

You might have to make some tough choices to get the right team mix. The most important thing to remember is that you’re managing for the growth of the individual, not talent. As your team aligns and grows, you’ll find that your dream team was there all along.

The post Inheriting A Team Successfully by Managing for Growth appeared first on Great Not Big.

      

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The Atoms of Atomic Object at our recent internal conference, AtomicCon.

Why own shares in a company with a goal of being 100 years old? You definitely shouldn’t be hoping for a big payday when the company gets acquired. While there are non-financial benefits of ownership, the decision to buy is a financial one, and thus there should be a financial return to shareholding. In our program, that reason is distributions. This post describes the philosophy and mechanics behind what we do with our profits.

This post is the fifth in a series on Atomic Object’s ownership and the non-ESOP approach we took to gradually shift from a founder-owned to a broadly employee-owned company.

1. Context, motivations, accomplishments to date
2. Description of our Approach: Atomic Plan and ESPP
3. Valuation
4. Financing
5. Distributions
6. Lessons Learned
7. Perspectives of Founders and Employees
8. Alternatives and Unsolved Problems

Philosophy

When I created our non-ESOP employee ownership program, I wanted share ownership to be a positive thing for my younger colleagues from the moment they bought in. I wanted to encourage Atoms to stay around the company for a long time, but I also wanted them to benefit immediately and consistently over time from their shares. The solution I came up with was a 10-year vesting period for capital appreciation and quarterly distributions of profits.

The first goal in our early years was building up a rainy day fund. While we shared profits with employees from the start, all of the remaining profits went to building our cash reserves. The return on those profits was my peace of mind. After a shocking first-year tax bill (we’ve always been a pass through entity, so retained earnings show up as income for owners), we got more sophisticated about distributing at least enough to pay the taxes on our retained earnings.

Profit distribution circa 2005.

In hindsight, it would probably have been better to start as a C corp, build the rainy day fund, then convert to an LLC or S corp. The simple diagram below describes the distribution of our profits in the first few years. After employee profit sharing, tax distributions, and rainy day fund contribution, there wasn’t anything left for share distributions.

When we reached the milestone of having three months of expenses in cash reserves, we started distributing remaining profits to shareholders (at the time, the two co-founders). The capital requirements of our service business were minimal, and there didn’t seem to be a reason to hold more cash than three months of burn. Over time, we found investment opportunities, and we gradually developed our philosophy of looking at our profits as something we could either re-invest in the company, invest in other companies, or distribute. Employee profit sharing fits into the re-investment bucket.

Profit Distribution Today

Nowadays the waterfall that determines where profits end up is a bit more complicated. The figure below shows how we start with book net income to get to the amount to distribute via shares.

Profit distribution in 2019.

When past investments pay off, we add those returns to the pool. We then subtract any new investments we’re making. We do some earnings smoothing (cash flow adjustments) when we see unusual and large expenses on the horizon.

We long ago formalized through convention the sharing of 25% of the pool to employees via a 5% 401k PS plan and a 1/N cash bonus (where N is the number of people in the company). I’ve come to see this 25% commitment as having given away 25% of a profit interest in the company to a theoretical entity known as “current employees”.

The next step in the waterfall is money that comes in from Atoms purchasing shares through our ESPP program. Since those shares are activated from a dormant pool of shares, this increases the total share count. The money from these sales is then distributed to shareholders, making it in effect a mandatory pro rata sale of a portion of everyone’s ownership interest. When people leave the company and these ESPP shares are bought back, that money comes from the shareholders and the shares are destroyed, lowering the share count.

The rainy day fund still needs to be maintained at the proper size, so if we’re growing, we subtract money from our profits to add to our cash reserves. In the rare quarters when we’ve contracted, we actually reduce the rainy day fund and distribute the extra money to shareholders. (More on this below.)

Lastly, if we have exercised our option to buy back a departing shareholder with a promissory note, we make those loan payments from the profit pool.

The profit that remains at the bottom of the waterfall is then distributed through shares.

Financial return

Over the 10 years of our employee ownership experience, the first year dividend yield on share purchases have averaged 17.8%, with a low of 10.4% and a high of 26.2%. The low occurred when we bought and renovated a building for our Grand Rapids office. The high occurred when we had an unusually nice payout from a prior investment.

In contrast, even the earliest participants in our plan, who are just now hitting their ten year vest for capital appreciation, have only see a 12% IRR on the value of their first share purchases. While that’s a pretty good return, it’s still quite a bit below the value of having gotten the dividend on those shares over the years.

Mechanics

Profit distribution is a somewhat complicated process. Some of the details we’ve figured out over the years are described below. We make sure to educate all shareholders on the mechanics of our approach.

Decision making

The managing members of the LLC (me, Mike Marsiglia, Shawn Crowley) act as the investment committee. Mike, wearing his CFO hat, decides on cash flow adjustments to smooth earnings.

Rainy day fund maintenance

We define our rainy day fund to be the sum of cash in the bank and our accounts receivable. Our rainy day fund target was originally 3 months of full expenses. Eventually, we moved to 1.5 months as we gained confidence in our client diversification strategy, as well as the consistency of the demand for our services.

It’s easy to calculate monthly burn. We do some averaging of cost of people and expenses, then multiply by 1.5x to get the rainy day fund target amount.

What isn’t easy is to actually measure the current size of the rainy day fund. While it’s easy to check AR and the bank balance, it’s harder to know about accounts payable and accrued expenses. Without good knowledge of those, we may in effect not have as much money in the rainy day fund as we might think. The current level of cash reserves can also change day by day as bills are paid or come in.

We resolved this problem by simply declaring the rainy day fund to be full, and then switched to what I call a dead reckoning approach to keep it that way. Every quarter we measure whether our monthly burn has gone up or down compared to the past quarter, then we either add or subtract that difference from the quarter’s profit and retain more cash or distribute more profit. The key insight that resolved the messy business of measurement was that we really cared about the changes we should be making to our cash reserves, not its absolute value on any given day.

The graph below show three years of tracking the rainy day fund level (red line), the RDF target (black line), accounts receivable (purple line), and cash (green line).

Three years of tracking the rainy day fund.

Notice that the trend line on the RDF shows a consistent upward trend. This has to do with a “leak” we have that causes money to build up in the company because it doesn’t flow through the profit distribution waterfall. We periodically distribute extra money to shareholders and reset the RDF.

Notice also that the actual RDF and the trend line are well above the RDF target. This results from executing the RDF adjustment algorithm approximately one month after the close of the quarter. During the course of that month roughly the first third of the next quarter’s profit has accumulated. In effect this means our target of 1.5 months of expenses in the RDF is consistently more like 2 months.

Frequency of distributions

We like quarterly distributions because it fits well with our open-book management practice. We see results for a quarter soon after the quarter ends and can thus more easily correlate events in the quarter, and efforts made by all of us, with profitability and profit sharing.

If our performance was more seasonal, or our quarters more variable, quarterly distributions might not work. For example, distributing profits on Q1 and Q2 only to find that Q3 and Q4 were losses would put the company in a difficult spot, with no easy recourse. Without a strong and consistent track record (we haven’t had a quarterly loss since 2003) we’d probably use an annual profit distribution approach.

Tax distributions

Each quarter our accountant computes a minimum amount we need to distribute to cover pass through taxes of shareholders. We always distribute more than this amount, so it serves only as a safety check.

Timing gotchas

To do quarterly distributions required that we have accurate quarterly results. That, in turn, required us to get better at handling quarter boundaries of payroll and invoicing. See my earlier post on how we do this.

We have run into tricky situations when a year has seen unusual variations of profit between quarters as well as significant changes in ownership. Problems arise when the earnings attributed to a shareholder on the K1 statement at the end of the year represent an average for the year, but the distributions that have already been made are tied to share count and profits for each quarter.

Accrual results

We track our financial performance on an accrual basis. We also distribute profits on those accrual results. This means that if we have bad AR and write it off, we may already have distributed both employee profit sharing and share distributions on invoices we never collected. This happens rarely enough for us that it’s not a huge problem, and we do take an adjustment in a future quarter if necessary. Some inequity may arise if the body of employees or shareholders has changed between the time of distribution and adjustment.

Investment returns

The guideline we’ve developed for investments is to make investments out of book net income, i.e. before the 25% employee profit sharing. If the investments provide a return in a period of time fairly close to the investment period, we also bring the returns into the top of the waterfall. In one case we have had a significant investment return occur 11 years after the investment was made. For that case, we decided the most fair thing was to distribute that money only to shareholders and bypass the 25% employee profit sharing stage.

Conclusion

Our approach has been created and evolved over time to work well for us. Some of the ways we do things wouldn’t work very well if these things weren’t true:

• we can easily manage our regular capital needs from cash flow,
• our financial results are stable and predictable,
• we don’t have significant seasonality in our revenue or earnings,
• we have a very, very low rate of bad AR,
• and we’re consistently profitable.

The post Atomic Ownership, Part 5: Distributions appeared first on Great Not Big.

      

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“A plan that’s too dependent on any one person is too fragile.”
Derek Sivers

Pairs of people working together make a project or situation more robust. We knew this, and yet somehow we forgot.

It was an easy mistake to make—under pressures, we sacrificed robustness for expediency. So despite all our hard work, our fragile plan fell apart. It’s a simple lesson, but it bears repeating.

Sales Under Pressure

In 2015, Atomic’s sales team consisted of me and Shawn Crowely. Together, we were entertaining roughly 400 leads a year.

As you might imagine, this put a tremendous amount of pressure on us. In addition to the sheer volume of work, we bore the responsibility of delivering work to the Atomic team. We also had to undergo the emotional toll of helping clients process their challenges—often including their most important and high-stress problems.

Frankly, we were drowning, and we needed help quickly.

An Accidentally Fragile Plan

We decided to add a talented long-term developer to our team. He had the skills and qualities to be successful—product experience, creative, curious, and personable. We reduced his client work to 50% of his time so that he could spend 50% of his time helping with sales.

Learning how to effectively sell custom software services doesn’t happen quickly, and it requires more work to onboard the help than simply doing it yourself in the short-term. However, in the long-term, you build more muscle and are able to effectively spread the work. We’d selected correctly with this individual. He was starting to find some nice successes around the 3-month mark. This allowed Shawn and I to back down our sales hours a bit and focus on other areas of the company. The addition was a huge success!

It was too good to be true. 3 months later, our new sales team member was given an offer to become the CTO of another company. It was an offer that he couldn’t refuse. He was a solid fit for the new job, and it was a good growth opportunity for him. As his manager, I was happy and excited for him. However, I was also incredibly disappointed that our 3 months of pain on-boarding a new sales team member was lost. We needed to start over again.

“Expect [people] to change their minds and disappear.”

After feeling sorry for ourselves for about a week, Shawn and I realized that we were to blame for the situation we were in. We had accidentally created a fragile plan. We should’ve built a robust plan. Derek Sivers’ “Fragile Plan vs Robust Plan” does a wonderful job describing why this matters.

This lesson caused us to reflect on the robustness of our operations. Losing our sales team member didn’t sink us because we still had two effective sellers – e.g. a team. However, it didn’t allow Shawn and I to create true leverage for ourselves. Hiring and training the next individual still required our help. We had lost the opportunity to train the next individual with someone else that we already trained.

Moving forward, we’ve decided to grow sales and office leadership in pairs. Pairs aren’t always as efficient, but they produce more sustainable results.

Pairs are a robust plan. Losing half of the pair doesn’t require you to start over. The remaining part of the pair can hire or promote and train another team member without your help.

Building pairs into our plans creates better leverage.

The post Sacrificing Robustness for Expediency – A Story about Fragility appeared first on Great Not Big.

      

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Atomic’s most valuable resource is our people (whom we call Atoms). It’s our goal to provide them with meaningful work, pay a fair salary, live our values in how we treat them, help them learn and grow, and give recognition to their efforts. We think that’s the secret to a company that’s going to last 100 years.

Unfortunately, the larger Atomic grows, the harder it gets to consistently help people learn and grow in their careers.

The Career Challenge

Our Grand Rapids office now has nearly 50 people, which has created some challenges for us Managing Partners (MPs). We weren’t finding the time to help Atoms with their career planning. Between important sales work, helping with project issues, and managing the day-to-day activities of the office, career planning was not happening consistently.

This was very difficult for us since we care deeply about each Atom’s employment experience with Atomic. It was leading to feelings of failure about some of our relationships and the job we were doing. It also was not giving individuals Atoms the career attention they deserved. And it wasn’t good for the long-term health of their office.

A solution already exists for our Accelerator program to help new developers. But if an Atom was not part of the Accelerator program, how could they get help with their career growth? And was there a way to leverage senior Atoms while also helping them grow?

Career Development Managers

The solution we created was the Career Development Manager (CDM) role, which distributes the important people work that we MPs were doing to a group of senior Atoms.

Each CDM mentors between 3-5 makers. They lead weekly check-ins, help with annual and quarterly goal planning, and perform annual compensation reviews with their assigned Atoms. The CDMs themselves report to the MPs.

The Atoms who take on the CDM role need to be passionate about helping others to:

• Develop strengths and manage weaknesses.
• Navigate their professional and career development as a consultant and in their craft.
• Connect their individual work to company goals.
• Overcome challenges.
• Understand and live Atomic’s Value Mantras.
• Understand and follow Atomic’s Rules, Policies, and Guidelines.

Each CDM still has to perform their original duties as either a Developer or Designer. The expectation is that 5-10% of their time will be dedicated to the CDM role and the other 90-95% will stay focused on their craft.

MPs support CDMs in handling exceptional issues or situations. CDMs are not responsible for hiring or firing decisions. That authority still lives with the MPs of the office.

Implementing the CDM Role

Having CDMs is a big structural change for Atomic. It meant moving some control and power from the hands of the MPs into those of other Atoms who have (often) never managed people before. There was a danger we might create a lot of confusion and end up hurting the relationships we were trying to improve.

To make this change happen, we assigned an MP to work with our Accelerator Manager and create an implementation plan for our office. We carefully thought the details of the role, how we would communicate the change, the process for selecting the CDMs, how they would be trained, and which Atoms get assigned to each CDM.

When we announced the role, we opened it up to all the Atoms to apply. We handled the selection with a mini-hiring process to make sure we were being fair to all the Atoms in our office. In the end, we selected five senior Atoms to take on the CDM role. We then assigned the individual makers in our office to each CDM and distributed the remaining Atoms to our leadership team.

We brought in external coaching to help our new CDMs work on the interpersonal skills needed to succeed in the role. And we created some simple, lightweight tooling to help the new CDMs with the career planning aspects of the role. Finally, our Accelerator Manager pulled the CDMs together as a team to help learn about the role from each other as well as provide a support structure outside of the MPs.

Where We Are Today

While it’s only 18 months old, the CDM program has been a success:

• The implementation went well.
• The MP job became more sustainable.
• We learned some of our policies were not as clear as we thought.
• Our CDMs have grown as they’ve begun caring for and leading their peers.
• The response from our makers has been very positive.

As our Accelerator members have graduated from the program, we’ve moved them under a CDM. And we’ve added another Atom into the CDM role as a result.

I see this as a natural time to do a review of the CDM program, learn where we are, and make any necessary adjustments. And I’m excited by all the grow happening through this important people work.

The post Encouraging Professional Growth with the “Career Development Manager” appeared first on Great Not Big.

      

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