Sunday, June 27, 2010

Growth is Not Always a Good Thing

“Slow buds the pink dawn like a rose from out night’s gray and cloudy sheath; softly and still it grows and grows, petal by petal, leaf by leaf…”

~Susan Coolidge, “The Morning Comes Before the Sun”

We were helping a young entrepreneur who started a business four years ago with $10,000. Through hard work and smart decisions, she has grown the business to $8 million.

Her goal each year has been to grow sales by at least 30 percent, and even in a difficult economy, she has been able to meet or exceed this goal every year. Now she wants to continue this growth path.

She financed her business and growth with internal or retained earnings, and doing so has left her with very low equity. Now, she has financed 99 percent of her assets, and debt financing is her only means of obtaining the capital necessary to continue growing.

She came to us for help because, with her debt ratio so far out of whack, banks would no longer lend to her. She was at a loss as to how she was going to finance this year’s growth. She knew something was not right, but she just could not articulate or diagnose the problem.

This entrepreneur suffered from what I call “Growth At Any Cost Syndrome.” She thought that if she did not grow, her business would fail.

The problem with growth is that even though sales are up, cash flow needs can easily reach double the sales amount. To support increased sales, you must be able to finance additional receivables and larger inventories on top of a multitude of other costs.

If a firm has too much debt and is trying to grow, they have only two options. First, they can try to raise additional equity capital. The problem here is that so many small businesses cannot attract minority shareholders. This is because there is no control with minority equity interest in a small business. In addition, minority shareholders will not have any liquidity. The bottom line is that acquiring new equity capital from outsiders is very difficult – if not impossible – for most small businesses.

With option one ruled nearly impossible for a small business, only one alternative remains: to slow the growth down – even stop it altogether – and allow equity to build up through retained earnings. This is a very slow process, but it is the only dependable way of setting the stage for future financing. Growth sucks up cash, and slowing its progression is the only way to allow your cash stores to replenish.

Our advice for this entrepreneur was to slow her growth rate. While resistant at first, she quickly realized that this was the only way she could get where she wanted to be.

Increasing sales is not always the best strategy because it normally does not allow you to build up the infrastructure you need to grow your company. If you find yourself in a position like this entrepreneur, slowing your growth to allow cash and profits to build up is a very viable alternative.

Now go out and make sure that you have a growth plan in place, and that the plan ensures you are not taxing your resources.

You can do this!

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