Without growth to its top and bottom lines, a business will die. This fact is why one of the first questions I normally ask a business owner is about the future. Where do they want their business to be in five years, ten years, twenty years? The answer I receive usually depends on the lifecycle of that particular business. Businesses early in their cycle are all about cash. Revenue growth is a given or the business will fail. As the business grows and prospers, profitability growth is added to the mix and revenue and profit growth are the main drivers, but cash is normally still tight. But, there comes a time when the owner can make a choice. As the business matures, revenue and profitability become more stable, cash is still king, but there is enough to sustain the business, invest and still have some in reserve. Cash is no longer the main factor in business survival. This is just as dangerous a time as earlier in the cycle. The danger is real because growth can be compromised by the decisions of the owner.
As the owner and business mature, the business model may become one of comfort and lifestyle. Perhaps thoughts of an exit begin to creep into the process. At this time the business comes to a crossroad. The owner can continue to feed growth through investment, but it may affect their personal plans in the form of a reduction in their cash accounts. Or, they can decide not to invest and focus on cash preservation. Unfortunately for the owner and the business, should they choose the latter instead of the former, wealth destruction will begin. The business will begin to decline and long-term value will be seriously compromised. Unfortunately, this decision plays out more often than one would think.
When an owner decides they don’t want to grow any larger and choose to preserve cash rather than invest in innovation, they are beginning a new phase of wealth and value decline. Even to stay the same size, growth must be part of their strategy. Cost reductions may not be an option, especially if the business is small, and after a while, even for businesses where reductions are feasible, investment will be inevitable. But even with a cost reduction strategy, growth is still a necessary strategy to preserve the business value.
Growth is important to drive the long-term value of the business. I recently attended a Financial Executives International seminar about mergers and acquisitions. The focus was a panel discussion about the buy side of M&A. During the Q&A I asked the panel a question I ask fairly frequently. ‘What are the top three to five things a business should focus on leading up to a sell strategy or to build long-term value?” The panelists all agreed growth as their number one focus recommendation. I would have been surprised if any of them cited another number one focus.
This is a very important point. In order to generate above average valuations, a company must have a history of growth, especially over the previous few years. A company without this pattern will most likely be much tougher to sell or transfer and the multiples will most likely be compromised. In the case of a transfer to an owner’s children or other family members, the transfer price would be equally compromised, and if the transfer price is artificially high, the new owner will most likely be saddled with an unsustainable valuation, one that they will most likely walk away from within a few years. This scenario isn’t good for anyone. Not the owner, their family, employees or community.
Unfortunately for us we are entering what I will term the “retirement boom”. It started early in 2007 with the official first retirement of baby boomers. Over the next ten years the number of retirements will be staggering. As a result, millions of businesses will change ownership, control or close. Pressure on business valuations will be intense due to the sheer number of businesses in this situation. Unfortunately, those owners who did get comfortable will be the most likely to close. So, my advice to all business owners is regardless of how long your long-term outlook is, keep growth as the central focus. Growth is value, and keeping your business a valuable asset is good for everyone.