scalability

Scalability refers to the growth and profit potential of a business per unit of work or investment put into the business.  A "scalable" business is one that is that will yield significant growth and profitability with investment or work.  A "non-scalable" business is one that yields relatively little growth and profitability with investment or work or that requires a significant amount of work and investment to grow.  

At Early Stage Legal, we like to discuss two types of scalability: legal or structural scalability and business model scalability.  Legal or structural scalability refers to how the company type, its governance structure, its incentive programs, and its fundraising capabilities affect its ability to grow.  Business model scalability refers to how the companys product or service offerings, business process decisions, pricing structures, and customer base affect its ability to grow.   Highly scalable businesses are attractive to investors because the bang per buck of investment is, by definition, quite high.  Investors seek to optimize value created per dollar invested.  Scalable businesses will create higher amounts of profit per dollar invested than non-scalable businesses. 

scalability doesn't mean no work

The perfectly scalable business would grow to a huge size with very little work or investment.  While there are some examples of businesses that almost seem to fit this model, the vast, vast majority of businesses should expect a more difficult road.  Most businesses, especially new ventures, require an enormous amount of work to achieve success.  So it is important to keep in mind that even highly scalable businesses may require an enormous amount of work.  It is just that highly scalable businesses grow faster and achieve much better results per unit of work or investment. 

Legal or Structural Scalability

Nearly all businesses that ultimately scale to a large size will require two things to achieve this goal:

  • Some form of external funding
  • The ability to attract and retain a team of talented employees

Businesses whose legal structures are scalable are designed to accomodate investors and to attract and retain the right kinds of employees:

Ability to Accomodate External Investors

  • Ability to offer preferred stock
  • Strong governance structures
  • Limited liability
  • Standard legal structures that investors are used to

Ability to Attract and Retain Strong Employees

C-Corporations

C-Corporations are designed for scale from the outset.  They allow for multiple classes of stock (i.e., preferred and common stock), creating an employee incentive program is easy, they provide built-in governance structures for investors, and they limit liability.  Learn more about C-Corporations>>

LLCs

LLCs are highly customizable and few standards exist for the type of structure you should implement in an LLC.  As such, LLCs vary widely in the way they handle things like governance, voting, buying and selling shares, incenting employees.  Nearly all LLCs, especially those from cheap online competitors, are not designed for scalability at all.  They lack provisions that would allow any LLCs can be designed for some form of scalability.  The Early Stage Legal standard LLC package is designed to create a "scalable" LLC.  It includes investor protection provisions and equity incentive programs for employees.  However, because most LLCs have historically lacked many features to enhance scalability, investors typically avoid LLCs.  Many will actually require that an LLC convert to a C-Corp before investing.  Learn more about LLCs>>

S-Corporations

In many ways, S-Corporations are the least scalable entity.  S-Corporations can only have one class of stock which immediately eliminates the ability for outside investors to have preferred shares with all of the protective provisions and rights that follow.  S-Corporations can however grant stock options just like a C-Corporation.  Further, if an S-Corporation decides to raise equity from outside investors, it is very simply and inexpensive to convert to a C-Corporation.  Learn more about S-Corporations>>

Business Model Scalability

A scalable business model offers high amounts of profitability and growth potential per unit of work or investment.  These are the building blocks that allow a business to do this: 

  • High-margin revenue--higher margin revenue will generate more profit which can be re-invested in the company to create more growth.  So all things being equal a company with high-margin revenue will be able to grow faster per unit of work and investment than one with lower margins. 
  • Efficient and effective customer acquisition opportunities--the abiltity to find and capture new customers with relatively little work or investment is a key element to a scalable business.  Obviously a business that can acquire new customers relatively easier than another business will have higher profitability and growth prospects.
  • Recurring revenue--recurring revenue allows a company to spend more time finding new customers and revenue sources than a company that has to continually recreate its revenue base every month.
  • Automation--a company that has automated many of its business processes can grow much faster and more profitably than others.
  • IP or Competitive Advantage--a company with a strong competitive advantage or IP can spend much less time fighting competitors.  It can also enjoy a natural pricing advantage due to the uniqueness of its offering.  Both of these create profits and growth potential.