Growth Constraints

Jan 5, 2013   //   by Skip Nagelvoort   //   White Papers  //  No Comments

Survival versus growth options for small businesses

It is well known that most small businesses fail within the first five years of start-up. Those that survive are the subject of this article. Many of these firms that survive rarely have sufficient depth of financial capital or access to financial capital to fund the working capital part of the additional capital needed to fund growth. Growth is expensive. Most small businesses have marginal growth beyond a certain point and rarely prosper to the point of being able to hire management specialists.

Financial Growth Constraints

It is our experience at the Collaboration Center that the greatest immediate constraint for these firms is financial capital to support the rapidly expanded working capital demands required by growth. The proper analysis is to carefully estimate from prior years changes in sales the increase in working capital per dollar of incremental sales. Such increases in working capital can equal or exceed $1 of incremental sales for a period of time. This can be a great hurdle.

Analysis of the marginal funds needed to generate the next level of growth is one of those measurements that is usually ignored or left for whatever reason just undone. Thus, in the effort to expand sales, illiquidity becomes a very unpleasant companion. Trade payables get stretched and suppliers become unhappy. The supply base becomes problematic as their exposure increases with expanded payable balances. These factors unfortunately can result in delayed shipments and inefficient operations. And unfortunately, the actual amount of dollars is, in fact, often rather modest. The financial analysis for growth is often ignored because the financial function at small business is more along the lines of bookkeeping and basic accounting instead of more sophisticated projections that take into account the peculiarities of the specific small business. Often advisers are not equipped to go beyond their software and are limited by their resources in terms of providing more accurate and more dynamic estimates of need that could be helpful to negotiate expanded arrangement ahead of time and prepare for this liquidity need. This we refer to as the invisible demand for liquidity with increasing sales. It is the financial gremlin of growth.

It is really remarkable that there is a greater opportunity to raise capital for fixed capital expansion like plant and equipment. In fact, financial markets(commercial banks) are oriented to providing capital for long term fixed asset expansion, not working capital. Certain SBA loans are helpful here in terms of 504 or their 7 (a) program loans. There is what is generally accepted more “solid collateral” in these hard assets. While this feeling of solid collateral is common place, we know that it is often not true and even

“solid collateral” can be illiquid or have a decline in value. Recent experience in the last few years has reinforced this uncomfortable reality. After all, it is cash flow that repays successful loans and not collateral.
The final fact of small business funding is that there is rarely a liquid reserve for growth. This is often due to the comingling of personal funds and corporate funds, not in irresponsible way, but induced, in part , since the personal guaranty of the owners is invoked. There can be a reversed motivation not to be overly liquid in personal accounts. One alternative here is a “C” corporation that accumulates cash with an effort for the owner to avoid a personal guaranty. See our recent white paper on taxes, corporate structure and growth, the changing tide of corporate organizational activity.

The More Precious Capital

We believe that the really scarce capital for small business growth is intellectual capital. We believe this inevitably trumps financial capital needs , because it provides financial capital solutions in more than the short term; therefore solving that constraint. Again, our experience with small firms is that they are very heavily reliant on one or two key people with critical skills. The growth of those firms tend to be constrained or ignited directly in proportion to the efficacy of those skills.

These skills are usually vital to the survival of the business. However, they are often not necessarily the skills needed to bring the business to the next level of growth. In this context, we are talking about the ability to drive the business from a survival level of X sales to a more permanent 2-5X level of sales. The entire architecture of management decisions, planning and resource needs are highly expanded in this process.

The owner needs to find human capital to fuel this growth. Decisions on the appropriate human capital additions are needed, but in smaller firms there is little expertise in the organization to identify and evaluate this talent. It often means bringing in people with different approaches that test the status quo and may change reporting systems. These are in fact very big risk decisions to be made by people not experienced in these matters. The other issues, of course, are if a poor people decision is made here it is expensive and can be harmful to the organization, even setting it back for a year or two. The other fascinating factor is that the right person at this juncture may not necessarily be the right person three years hence as the business grows.

The Collaboration Center exists to help small businesses identify these needs, to provide the talent on a short term basis and to minimize the risk and costs of these decisions.

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