How to Build an Inc. 500 Company
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Tom Golisano did it once with Paychex. Now, he's out to do it again -- and this time he knows what he's doing
We tend to be skeptical of people purporting to have models for creating growth businesses. Not that we're against such models per se. It's just that the people who peddle them seldom know much about building a company. When the speaker is Tom Golisano, however, we sit up and take notice.
At 46, Golisano is a compact, combative, street-savvy entrepreneur who moves the way he speaks -- in short, aggressive forays. What he knows about business (a lot), he taught himself. His school was his company, Paychex Inc., a payroll processor he started in Rochester, N.Y., in late 1970. We ran into him 12 years later, when his company landed in the #8 spot on our first listing of the 500 fastest-growing private companies in America.
Back then, Paychex was still a minor player in an industry dominated by another entrepreneurial wunderkind, Automatic Data Processing Inc. (ADP), but Golisano was determined to change all that. Over the next six years, we watched as he took the company public, fought off challenges and friendly acquisition offers from ADP, and built Paychex into a $79.5-million business, with 1,700 employees in 62 cities. Along the way, he developed a track record of remarkably consistent growth, racking up annual increases greater than 20% in income and revenue for five consecutive years. It is a record that has played well on Wall Street: the last time we looked, Paychex was trading at 30 times earnings.
On the day Inc. visited, Golisano was flushed with excitement over the recent victory of fellow Rochester native Jeff Sluman in the PGA Championship in Edmond, Okla. To be sure, his pleasure stemmed in no small part from the presence of a Paychex visor on Sluman's head during the national telecast. But there was more to Golisano's pride than that. Here, after all, was another favorite son bucking the odds -- a Rochester kid playing a Palm Springs game, joining combat with the world's elite, and beating them all. Golisano liked that. He liked it a lot.
Editors Bo Burlingham and Michael S. Hopkins interviewed Golisano in his Rochester office.* * *
INC.: Do you think there's a way to plan long-term fast growth?
GOLISANO: Yes, absolutely.
INC.: That's certainly not what we hear from Inc. 500 companies. Nine times out of 10, their growth just seems to happen.
GOLISANO: I'm saying that it can be planned -- not that it usually is.
INC.: What makes you so sure? Did you plan Paychex's growth?
GOLISANO : No, but I can look back at what happened with Paychex and see how you could use the same strategy in a completely different business. In fact, I'm doing that right now with another company, Safesite Inc. It's a records-management company.
INC.: Can you describe the approach?
GOLISANO : The idea is that if a business can operate successfully in one city, it can generally operate and be successful in another city. So you find the formula to do it in city A and get a bunch of people to do it in cities B through Z. You set them up as entrepreneurs in their own businesses. Then you consolidate them into a single company, build that company, and take it public.
INC.: You make it sound easy.
GOLISANO: It's simple, not easy. The key element is the common bond, which has to come from the originator. He has to find the people to do it in all those different cities, and those people have to have faith that he can pull it off and that they will be treated fairly. If you can get over that hurdle -- and it's a tough one -- I think the strategy could be used in a lot of industries. I don't understand why it hasn't been.
INC.: Why is that hurdle so tough?
GOLISANO: It's tough because of the trust part. I don't think you could do it with 20 people who independently started the same kind of business in 20 different cities. They will never trust one another enough to pull off the consolidation. But they will trust someone who has helped all of them get started and showed them how to do it. There's a common bond.
INC.: And that's how Paychex did it?
GOLISANO: Right. We had 18 little companies operating in 22 different cities, and we merged them. That was in June 1979. We had a meeting in Chicago, and a big paper signing. There were actually 18 simultaneous mergers into a new company.
INC.: Wait a second. Let's back up. How did you get involved in 18 separate companies?
GOLISANO: Well, the expansion began in 1974. Up to that point, there was just one company, the one in Rochester that I started in late 1970, doing payroll processing for small companies. Then two guys came in who wanted to do the same thing in other cities, under the Paychex name.
INC.: Why didn't they just go out and do it on their own?
GOLISANO: It wasn't that easy. Remember, this was a whole new market at the time.
INC.: Explain that.
GOLISANO: Well, you have to go back to the idea behind Paychex, how it got started in the first place. I was a sales manager at a traditional payroll processor in Rochester, and back then payroll processors were generally interested just in large companies, 50 employees or more. As sales manager, it didn't take me long to realize there were a lot of small companies around that couldn't avail themselves of this service -- for two reasons.
First, the minimum charges were too high. Second, the service itself was not as comprehensive as it needed to be. So I saw an opportunity for anyone who could figure out a way to provide the right kind of product at the right price. It was a market with a huge unrealized potential. That's a major reason why I started Paychex.
INC.: When you say "huge unrealized potential," do you mean you saw an opportunity to do it on a national basis?
GOLISANO: No, I wasn't thinking about that at the time. I just wanted to have a successful business in Rochester, and that's pretty much what Paychex was in 1974. Then these two people came in. One was a salesman I'd recruited in my previous job. He walked into the office one day and said, "Tom, you seem to be making it with this thing. How can I get involved?" And I said, "Why don't we open a branch office in Syracuse? We'll both put in some money and be 50-50 owners.'
That seemed like a good idea, and we did it.* * *
INC.: And the other guy?
GOLISANO: He was an employee of a client. In fact, he was the one who'd decided to take the Paychex service. He came in and said, "This service is great. There's got to be a need for it, and I want to move to Miami and start one there. But I don't want to be your partner. Sell me a franchise." So we worked out a very loose franchise agreement, and I went down to Miami and helped him get set up. From him, I got a royalty and an up-front fee.
INC.: So you had one joint venture and one franchise. Then what?
GOLISANO: I said, "I think we've got something here," and I began to go out and recruit people. Over the next three years, I set up a total of 17 relationships -- 11 joint ventures and 6 franchises. All but one of the people came from Rochester, and they went to different parts of the country. I generally guaranteed them a two-, three-, or four-city territory.
INC.: Who were these people?
GOLISANO: People I'd known in various ways. Friends of the family. Guys I'd played softball with. Vendors that came in the door. High-school friends. One guy whose prior job was doorman at the Boca Raton Hotel & Club, in Florida. I met him playing slow-pitch. My first wife also got a franchise, as part of our separation agreement.
INC.: You're kidding.
GOLISANO: No, she decided that was what she wanted. And she'd never worked before, but she's a very talented person, with very good sales skills. So I set her up in business in New York City. She retired from the company in the early 1980s and today is one of our largest stockholders.
It's a situation that's worked out tremendously well for both of us -- because I had no long-term commitment and did not feel "taken," and she became financially independent. And no better relationship could ever come out of a divorce than that.* * *
INC.: Did all these people succeed with their branches?
GOLISANO: Yes, but I have to tell you, they starved their first two or three years. I can't think of one who didn't.
GOLISANO: It just takes time to develop a client base.
INC.: Did you starve, too, during your first two or three years?
GOLISANO: Did I starve? Listen, I started this company with about two months' worth of money for a two-year project -- which is about how long I figured it would have to take for us to get to break-even.
INC.: What did you do when you ran out of money?
GOLISANO: Every game in the book. I covered my payroll with MasterCard and Visa, and floated them back and forth. I borrowed money from banks on an installment contract -- you know, like you buy a car. I borrowed money from my family. Just crazy things. Once I took my employees out to dinner at a local restaurant, and when I went to pay with my American Express card -- it had been canceled.
INC.: What happened?
GOLISANO: I had to ask the restaurateur if I could send him a check. He was one of our clients. I tell you, the look on his face . . .
INC.: In the end, how long did it take you to get to break-even?
GOLISANO: About four years.
INC.: Did you ever have doubts about making it?
GOLISANO: Only during the first six months or so. That was the scary time, because I was used to dealing with much larger clients, and I didn't know how small companies would react to this idea of buying a payroll service. Nobody had ever sold to that market before. I knew it was going to be an education job, but I didn't know how big a job. I had the idea of getting referrals from CPAs, but I didn't know for sure how they would react, either.
INC.: So what did you find out in the first six months?
GOLISANO: I found out it was very slow -- a lot slower than I expected.
INC.: But you could see it was going to work.
GOLISANO: Right. You see, one thing about Paychex is that, historically, it has been very predictable. Our overhead is predictable, and so is our revenue as long as we keep selling. That's because 75% of our business comes from referrals -- CPA referrals and client referrals. Even today. The older an office is, the more new clients it adds per year because of this referral thing. And the rate of growth increases almost geometrically over time. We can predict all that. Once a branch office reaches 100 clients, we can pinpoint within three months when it's going to break even.
INC.: But you couldn't do that back in 1971, could you?
GOLISANO: No, but I could see what was happening, and we got better as time went along. The overhead was always predictable, and the revenue per client was very predictable, because we deal with a lot of small clients. At the end of three or four years, the selling process was becoming more predictable as well. We were also beginning to learn about things like client retention, although that was not really an issue yet. So I could sit down with the people setting up the branch offices and draw a graph. I could say, "Look, if you sell one and a half clients per week, this is going to be your revenue at the end of 52 weeks, 104 weeks, and so on, and this what your overhead should be.'
INC.: Did that help them get established more quickly?
GOLISANO: Sure, it helped. And in addition, we started the branches with a lot more money, so they didn't have anywhere near the pressure that I'd had. By then, we were starting to make money in the Rochester operation, which was set up as a subchapter-S corporation. The joint ventures were also sub-S corporations. So their losses offset the gains in Rochester, and later their gains helped offset losses in those that weren't making money. That sub-S feature was very valuable in funding the growth of Paychex.
INC.: How long did it take the branches to become profitable?
GOLISANO: Generally, about two to three years.
INC.: But they were still all separate corporations, right?
GOLISANO: Yes, until 1979.
INC.: Why did you decide to consolidate them?
GOLISANO: Actually, it was one of my joint venture partners, Bob Beegen in Detroit, who put the idea into my mind. He said, "Maybe we should consolidate all these companies, make a real organization out of it." The more I thought about that idea, the more it seemed to make sense.
INC.: How so?
GOLISANO: In late '78, we had 22 offices, and we're doing about 5,700 clients. The sales work is still being done by the equity people. We haven't really built any kind of sales force. I start to see some things. Number one, I begin to realize that -- even though they're all so-called entrepreneurs -- there are big differences in their ambition levels. Like one guy goes to a city, does a good job, and isn't interested in expanding to a second city; he just wants to live high. And that bothers me.
Number two, the definition of the service is beginning to change. The guy in City X wants to charge for delivery. The guy in City Y wants to add something locally -- say, a worker's compensation report. So we're developing inconsistencies from city to city.
Number three, we've got a problem with skill matching. Some of the guys are really good in operations but terrible in marketing. And vice versa. We have to deal with that.
Number four, and probably the most important, how the hell are we ever going to walk away from this thing financially? I mean, I had been selling these guys financial independence, and they really weren't going to get it this way.
INC.: Why couldn't they sell their operations?
GOLISANO: Who's going to buy 50% of a joint venture and have a stranger for a partner? The franchises were a different story, but there's a basic problem here. I mean, when you sell a small business, you usually end up with a collateralized note, and the business is the collateral. That's not financial independence to me.
INC.: So what did you do?
GOLISANO: I decided to send all the partners and franchisees a prospectus with the concept that we consolidate. I went through some of the things we could do as a consolidated company. The strategy was, we would spend three years developing a sales organization, opening more offices, and getting into as many markets as we could. In years four and five, we would slow the growth down a bit and concentrate a little more on profitability. Then we were going to either sell the company or take it public.
INC.: Why did you think they'd go for it?
GOLISANO: There were two keys. One was the stock allocation, which had to be perceived as fair. So I sat down with Bob Beegen, and we came up with a formula based on things like revenue, market potential, how long the office had been going. Then we made some adjustments. See, what counted was not the number of shares each person got; it was the number of shares he got compared with his neighbor. So we adjusted the allocations to make them as fair as possible.
INC.: What was the second key?
GOLISANO: The second one was peer pressure. It would have been difficult for one or two people to stay out -- even though we were going to let them keep the name, and we guaranteed we wouldn't come into their territory. But they weren't going to be part of the fraternity anymore.
INC.: What happened when you sent out the prospectus?
GOLISANO: The telephone lines started buzzing like you wouldn't believe. Everybody was calling everybody else. "What's he up to? Six months ago, he told me I should be an entrepreneur. Now, he wants to form a large company, and he wants me to be an employee.'
INC.: When did this all come to a head?
GOLISANO: In February '79, we had a meeting in the Bahamas. We sat around a big table, and all day Thursday we discussed the idea. Then on Friday morning, we came back together, and at 9:00 I walked in and said, "OK, what's your decision?'
INC.: That must have been a fun session.
GOLISANO: Fun? Those were probably the most interesting -- for lack of a better word -- two days I've ever spent in my life. The mental gyrations were just tremendous.
INC.: Was it tense?
GOLISANO: Yeah, fairly tense. But everybody maintained a professional demeanor. It was very orderly. I made as logical a presentation as I could. They knew I was serious.
INC.: But did you have any idea which way they were going to vote?
GOLISANO: I thought the majority were for it, but you're always concerned that some aren't, and they'll talk the others out of it. And I'll tell you, I think some of those people made the decision somewhere between 8:45 and 9:00 -- probably more than I'd like to admit.
INC.: So how did they vote?
GOLISANO: All but two said yes. The other two said they wanted a couple of days to think about it. They were franchisees, Miami and Cleveland. They were the farthest along, and now they were going to be sharing the burden of companies that were just starting. They felt they were taking the biggest risk and had the most to lose. But within a few days, they both came in.
INC.: Were there any lingering resentments?
GOLISANO: Some -- mainly around the stock allocations. See, with the joint ventures, I was a totally unbiased person, because I got half of every joint venture. If Detroit gets 500 shares and Boston gets 400 shares, it doesn't matter to me. People accepted my allocations. The franchises were a different story. I got zero part of them. So, entity for entity, the franchisees ended up with twice as much stock as the joint-venture people, who were somewhat resentful of that. They shouldn't have been, but they were.
INC.: What about after the consolidation?
GOLISANO: Yeah, there was some trauma. I mean, all these people had had "president" on their business card. Now they're all "vice-president." We had 200 employees and 19 vice-presidents. We were worse than a bank. Then there were the management reports, comparing how branch A is doing with branch B. We're comparing cities and measuring job performance. And, suddenly, people have to report to a supervisor, after being their own bosses for the last few years. There was a lot of trauma put on them all at once.
INC.: And on you, too?
GOLISANO: I would definitely say that, for me, the years from 1980 to 1983 were the toughest. I was continually dealing with personalities and egos. There were cliques, backstabbing, high-level politics, fence-building -- all those negative things.
INC.: Did anybody leave?
GOLISANO: A couple of people left voluntarily -- based, I think, on their level of discomfort. I mean, the job wasn't getting done, and they said, "Rather than you guys get rid of me, I'm just going to leave gracefully." But they kept their stock.
INC.: What were you doing as a company during this time?
GOLISANO: Our main focus was on developing a sales organization. Within three months after the consolidation, we recruited, hired, and trained 65 salespeople and put them in the branches. That was very costly, and we didn't do a good job the first time around.
INC.: Why not?
GOLISANO: We didn't have experienced, disciplined sales managers. We had a bunch of entrepreneurs who came from a variety of different backgrounds -- engineering types, schoolteachers, an insurance salesperson, the doorman of the Boca Raton Hotel & Club. They hired the wrong people, and they didn't train them right. We learned some very painful lessons.
INC.: How do you mean?
GOLISANO: Well, in the first half of 1980, we had to suspend our salaries for four months because we got into a cash-flow crisis.
INC.: If everything was so predictable, how could that have happened?
GOLISANO: We underestimated the cost of bringing in those salespeople. And we were probably paying ourselves too much as well.
INC.: This sounds like a very rough period.
GOLISANO: Yeah, but you have to remember, there was a fairly high level of excitement at this point -- positive as well as negative excitement. I think there was a feeling that, even though we had the option to retrench, we'd rather put up with the lost wages and keep going forward. As it turned out, the company was able to resume the salaries, and we paid the money back the next year.
INC.: So how did you solve your sales-management problem?
GOLISANO: A lot of it was trial and error. Fortunately, we had some people in the company who knew how to develop a sales organization. But it took them a while to educate the rest of us.
INC.: How long?
GOLISANO: Probably five or six years before we really understood the sales process and could instill it in our organization. This sort of thing does not happen overnight. It evolves. At Paychex, it's evolved from rank amateurism in 1979 to a point where we are pretty good, in my opinion. And there's still room for improvement.
INC.: But you must have seen some payoff along the way.
GOLISANO: Oh, sure. We saw the payoff when we began selling clients in numbers that we had never thought were possible. To give you an example, I sold 42 clients my first year. In 1982, an average salesperson sold 100 clients a year. Today, the average is 170.
INC.: Meanwhile, you had a goal of selling the company or taking it public.
GOLISANO: Right, but we decided early on that we didn't want to sell -- for several reasons. First, the management team was fairly young, and we were all very ambitious. Number two, we felt we had an unlimited marketplace, and we do. There are millions of small businesses out there. We've hardly scratched the surface.
Number three, if a competitor had bought the company, it would have been dissolved, and I guess that bothered a few of us -- perhaps to a fault. But mainly it was the opportunity and the ambition level.
INC.: Did you have a target in mind for going public?
GOLISANO: The only thing was a seven-figure bottom line. We figured, rightly or wrongly, that we could have our choice of underwriters if we had a seven-figure bottom line.
INC.: When did you go public?
GOLISANO: August '83. It was a fairly successful public offering.
INC.: And did the company change after that?
GOLISANO: You bet. I completely reorganized and restructured the company. Because we were now a public entity. This was no longer a fraternity.
INC.: How many of the original equity partners left?
GOLISANO: Most of them. Some left because they didn't want to work for a company like this, a big company; they wanted to get back and be entrepreneurs again. Another group was just outgrown by the job; they either knew it and left voluntarily, or they didn't know it and were asked to leave. The third group thought we should run a sheltered workshop for them. We got rid of them, too. Today, there are only five or six of the original people left in the company.
INC.: Did you ever have any qualms about this?
GOLISANO: No, not at all. You see, the public offering meant the end of my responsibility to those people. My new responsibility was to our shareholders. And you also have to realize that on the day of the public offering, not one of those people had a net worth lower than a million dollars. We had to separate out those who were committed and understood their new responsibilities. I think that was the first major step of Paychex beginning to mature as a company, but that's another story.
INC.: OK, let's go back to your model. Tell us about this records-management business, Safesite.
GOLISANO: We provide a very secure location where we store records and magnetic media -- like computer tapes -- for customers. The storage can be active or inactive, depending on customer preference. When the customer needs files, he calls you, and you bring them back. Or you have a driver who goes back and forth making pickups and deliveries on a regular basis.
INC.: How did you get into this?
GOLISANO: I was helping my nephew look for a business, and one day somebody tells me about this one. I say, "Gee, that's an interesting business." Recurring revenue. Service-oriented. Very large capital investment compared with Paychex, but still pretty predictable because of the recurring revenue and the overhead. So I bought a company in Rochester, and then I contacted one of my original equity partners from Paychex, the one in Boston. He came here, took a look at it, and said, "I love it. Let's do it." So we started in Boston. This was two years ago.
INC.: Was Safesite the name of the company you bought?
GOLISANO: No, it was Record Retention Center. We wanted a one-word name that said what we did. Sound familiar?
INC.: Yes. Where do things stand now?
GOLISANO: We're about to open our ninth branch, and we've got eight corporations. They're all joint ventures, no franchises. Except for Rochester, which I own.
INC.: Why just joint ventures?
GOLISANO: Instead of franchises? Control. Anyway, why would I want to be a franchisor?
INC.: OK, but why not just own them all yourself?
GOLISANO: First, because I'd have to put up all the capital. But a bigger issue is talent. Remember, my real vocation is Paychex. So I need people who can run these entities. I want them to have ownership. An employee can walk away. An owner can't.
INC.: So are you going to grow this company just like Paychex?
GOLISANO: Yes, but with a twist. After we consolidate, we'll probably get venture capital to take us to the next level -- the next 10 branches or so. Then we'll sell or go public.
INC.: Why do you want venture capital?
GOLISANO: Because of the high cost of getting one of these to break-even. And I think the venture capital is going to allow us to get where we're going a heck of lot faster than with Paychex. Of course, we'll also get there faster because I'm being much more selective about the people this time.
INC.: What do you mean?
GOLISANO: I have a better idea of what I want, and I don't need as many people. I had too many partners at Paychex.
INC.: How are the people different?
GOLISANO: I would say that, as a group, they are more mature. They are also in better financial shape than the original Paychex people were, although they're working their tails off. And they know more about what lies ahead, because of the Paychex experience. For example, they know that when we reach the consolidation stage any of them who are nonperformers may become unemployed. And they know that, after the consolidation, they may be reporting to their peers.
INC.: When do you consolidate?
GOLISANO: Well, there are a couple of issues. Number one, we want to make sure that everybody's paid their dues. That their capital investment is there. That they have proven they can perform. And -- this is very gray -- that they have some appreciation of how to run a profitable operation and some level of pride in having done that.
INC.: What's the second issue?
GOLISANO: We want sufficient models for profitability and performance, because when we have those models, we can really concentrate on execution. Of course, we may have the model in only one or two cities, but I don't care if the combined entity is profitable when we consolidate. If we wait for them all to be profitable, we'll waste a lot of time.
INC.: Do you have any models of profitability now?
GOLISANO: Not yet, but we're getting very close. You see, there's a level of unpredictability at Safesite that we don't have at Paychex. Our largest client at Paychex may be $500 per month, but our largest at Safesite could be $5,000 or $10,000 per month. It's hard to predict how many of those customers you're ever going to sell, and the number may vary from city to city. So one Safesite office may reach profitability at 500 clients, but another at 10.
That doesn't make too much difference so long as the billing comes out approximately the same for comparable overhead. But it introduces a level of unpredictability in the selling process that we haven't quite figured out how to deal with.
INC.: Just in the selling process?
GOLISANO: Yes, because once we get that client, we don't lose him. The client-retention rate is extremely high.
INC.: That's interesting. You're saying there there are different kinds of predictability in a business.
GOLISANO: Sure. There's operational predictability -- the cost of doing business -- which we have at both Paychex and Safesite.
We also have a certain amount of revenue predictability at both businesses, based on existing customers. At Paychex, we have a third level of predictability because we know, based on experience, how many clients we're going to sell this year and what it takes to sell them.
That's what we don't have yet at Safesite, because we don't have enough yeas of history. But we're getting there.
INC.: But even today, at Paychex, there are some areas of unpredictability.
GOLISANO: Oh, sure, there are. Mainly on the people side. Do we have enough satisfactory branch managers, sales managers, and senior management people to grow 25% a year consistently? That's our number-one problem.
INC.: What you've done, however, is to narrow down the major areas of unpredictability, so that you can focus on the few key ones that remain.
GOLISANO: You hit the nail on the head.
INC.: It's no wonder you put so much stock in this predictability thing. If you wanted to find the ideal business, is that the first thing you'd look for?
GOLISANO: No, the first thing would be unrealized potential. Predictability would be second, because it's easier to manage. I also think Wall Street is very attuned to predictability, which is obviously important if you want to go public.
INC.: What else do you look for?
GOLISANO: I don't know. Limited competition, I guess. I also prefer service businesses, because they tend to be labor intensive, rather than capital intensive. That gives you a lot more flexibility. If you make a mistake, you can back off real fast. But I have to say, you can have all those
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