Defining the Future Size of Your Business.

I’ve reviewed the structure and profitability of many businesses in order to optimise the returns for owners and shareholders.?

And there are recurring themes.???

We live in a world conditioned for growth at all costs. Growth in profit, growth in consumption, just growth growth growth.??

But “growth” on its own is not a plan.?

Neither is it a guarantee of increased profit or security.?Which means businesses regularly grow in a directionless fashion and endanger their very existence in the process.?

It needn’t be this way.?

What companies really want is profit and influence, reach, options, certainty and control. These are all outcomes. Growth is not.?

Far too much is written about growth and not enough about the outcomes it is actually intended to deliver.?

Intentional growth, with a destination in mind can of course deliver these outcomes and help avoid the issues associated with directionless drift.?

So, what is the optimum size for a company in order to realise its potential? And what roadmap exists to guide this process?

Every business is different, but here are 6 simple steps to consider when building growth into any business planning.?

Let’s get started.?????

Step #1: Who is Driving the Agenda?

Who owns the company and writes the cheques i.e. who is the business designed to serve? This is a fundamental determinant of growth aspirations.?

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All investors bring with them an expectation on financial returns, and it is normal and commonplace for the desired size of a business to be heavily influenced (or indeed dictated) by investors to produce the necessary results.?

Venture Capital (VC) investors for example have a very clear objective. They have investment funds which they allocate to multiple entrepreneurial bidders.?

In the StartUp space most new companies fail (70-90%+) which means VC firms look to “return the fund” on each investment.?

What does this mean??

As an example if a VC firm has ￡40 Million in a fund to invest and they make 20 start up investments (at ￡2 million in each), they will look to achieve a ￡40 Million return (i.e. return the whole fund) on each investment.

This is because most ventures will fail and they’re looking to find one or two diamonds to make all their money back and more.?

This means the ￡2 Million invested in any one StartUp has to have the potential to increase in value x20.

Naturally there is enormous pressure and expectation to run the business such that it grows at breakneck speed.

VC funds tend to focus on a 5-10 year investment horizon.?To increase in value by 20 times over this period involves either 30%+ year on year value growth for 10 years, or 60%+ year on year value growth over 5 years. These are eye watering numbers and the decisions made to achieve growth at this rate may contradict the founding objectives of the company.?

Securing VC funding essentially bakes “size” into the process by setting exit valuation expectations which will need structural and financial growth to support them.?

It is therefore wise to consider the strings that are attached to various investment channels and ensure these are in line with the founding objectives of the business.????

Angel investors don’t generally have anyone else to answer to and can thus make decisions freely based on their own priorities, values and time horizons, so there is more potential to find synergy with the founders objectives.?

To summarise, the overall scale and the pace of growth will both be heavily influenced by the type of investment (if any) which a business secures.?

If however, there is no external mandate then the business itself is afforded the freedom to set a course for a future scale and value of its own choosing.?

Step #2: Delivering for Founders/Operational Management.?

Forward thinking business founders and operational directors will be able to articulate a financial outcome that will fulfil their ambitions.??

These ambitions could be:?

• A desired level of ongoing income.
• Securing a strong market position to build intergenerational wealth for children and dependents to inherit.?
• A size sufficient to achieve an exit at a lump sum that will satisfy the owners aspirations.????
• A work life balance that delivers in both financial terms and also time.?

Example:?

A company owner may have an aspiration to earn ￡200,000 per year in Director’s remuneration and the structure of their company’s market means it isn't feasible to take any more than 5% of revenue as owners compensation and still be competitive.

This means the company would need a revenue upwards of ￡4,000,000 per year to realistically deliver ￡200,000 in compensation to the owner.?

If the business is currently turning over ￡1,500,000 then the size of the growth necessary becomes clear and a plan can be formulated.?

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Step #3: Quantify Size.

“All organisations are perfectly designed to get the results they get” ~ Arthur W. Jones.

Size needs to be quantified.?

In simple terms this may be absolute revenue or profit.?

However this could very much be a strategic goal related to size i.e. market share, biggest product range, most recognisable brand, largest employer etc rather than purely financial.??

Sometimes owners have a desire to build a company and exit at the highest possible valuation. And not all measures of size equate to a higher valuation.?

If this is the stated aim then the target becomes an aspirational exit price from which will spring metrics that buyers will look at such as ROCE (Return on capital employed) and P/E ratio (price to earnings ratio), free cash flow and absolute profit in order to arrive at the desired valuation (selling price).????

A useful exercise is to build an avatar of the future business, quantifying what it will look like.?

Here is how I do it:??

Whatever the aspiration may be, it is extremely useful to start with the end in mind i.e. define the outcome (build an avatar) and then have a specific target to aim at.???

Step #4: What Piece of the Market is Available??

Markets are not limitless, especially for businesses that intend to niche down into specific segments and geographies. This can shrink the potential client base, albeit by being more tailored and focused.?

So does the market exist for your solution at the scale you intend to offer it??

The total available market (TAM) is the complete market size relevant to your products and services. Knowing how a product or service is consumed in a small test area and then multiplying this out can give indications of what the TAM looks like across a region or country.???????

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Within this total market, there will exist a smaller serviceable portion based on the company’s specific business model. This is known as the serviceable available market (SAM). Businesses should not realistically target ownership of their entire market. This just doesn’t happen. So identifying a serviceable portion is the next step.??

And finally within?the SAM, there will be a realistic proportion that is obtainable. Generally businesses do not acquire 100% of the serviceable market either. This final (and smallest division) is known as the serviceable obtainable market (SOM).?

The TAM may represent the whole country and the SAM may represent the geography in which you operate. The SOM represents how much of the serviceable market you realistically think you can capture, bearing in mind there will be competition.??

In many cases the markets are so large or the targets of the business are so modest (or both) that the size of the market will never be a limiting factor and it can be discounted.?

But in other cases this is highly relevant.

Example:?

A dog grooming business specialising in certain breeds and operating in a restricted geography has aspirations to turn over ￡2 Million per year.?

But a look at the SAM suggests there are perhaps 50,000 relevant customers who fit the description in the given geography and the average annual spend of each client is ￡200.?

This indicates a potential for ￡10 Million in revenue. However the market is competitive and fragmented and it would be difficult to acquire any more than 10% of this serviceable market (i.e. we feel the SOM is circa ￡1 million in revenue).???

It would therefore be challenging for the business to exceed ￡1 Million in revenue unless it diversifies, increases its prices, expands its geography, scope of breed that it services etc.??????

Knowing if the market exists is an important step in defining a future growth strategy. Bearing in mind of course that the market is forever changing and opportunities are emerging and disappearing all the time.????????

Step #5: Correlation Between Size and Profit.

Generally speaking, large businesses are more profitable than small and medium sized firms, based on economies of scale, access to opportunities and resources.

So what does this mean for new companies and SMEs?

In my experience the lessons on scale don't translate well into smaller business.

To enjoy the advantages that listed companies have earned involves becoming massive and this is unrealistic in the short/medium term (and in the forever term) for most companies.

The reality is that growth if unplanned and unmanaged can kill profitability.

In my experience businesses reach the profitability point and then begin to dominate their fixed costs as their revenues grow.

Profit begins to rise.

But then it becomes necessary to start adding resources. People, equipment, subscriptions etc etc.

Each investment has to justify its contribution in the long term, but also in the short term cash flow world too.

Profitability can fluctuate during these growth phases and it's important it doesn't push cash flow into the red in an unsustainable way.????

The conclusion is that whatever size is arrived upon as a future destination needs to be carefully considered in terms of what that business would look like structurally.?

I have been involved with a nine figure business which had previously doubled in size from an eight figure revenue position and made less operating profit as a result. Not less margin. Less total profit.?

I have seen micro businesses of 1-2 people grow to 100 staff and then deliberately scale right back down from the peak to make more money and have less headaches.?

Size brings advantages in terms of resources, choices, buying power and reach, but it also creates an ever more hungry beast to feed. Hence the emphasis on planned growth and a target destination.????????

Step #6: Timelines.

Navigating growth is challenging because it’s generally not linear and it involves peaks and troughs and the associated cash flow “famine and feast” scenarios that accompany this.?

Growth also tends to be unpredictable and it’s therefore important to build ambition and also flexibility into the process.?

Ambition is important because businesses that are growing at a healthy rate have momentum and energy that fills them with purpose and optimism. No one wants to sit in a business that ticks over year on year or grows at a glacial pace. Momentum is also hard to generate and therefore important to maintain once it’s been earned.

Flexibility is also very important. Because things may happen faster or slower than anticipated, the program must be able to adapt and accommodate change.?

Think about:

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• Creating stage gates i.e. points along the journey where an action is triggered when other criteria are met. For example incorporating certain software or additional people once a certain level of revenue or cash flow has been achieved.?
• Once stage gates exist, examine how quickly actions can be taken once the time comes. Is there a long lead in period for new equipment or recruitment etc or can you do a lot of prep in order to accelerate the readiness of these so they can be brought online quickly once the time comes??
• How much of the cost can be switched on and off? Sometimes going forward involves going backwards briefly too and this requires flexibility to both add and remove cost if necessary.?
• How much of the growth activities become “baked in” to the business once switched on? For example, if you relocate to a larger office/factory on the back of a single contract and take out a ten year lease, what happens if revenue doesn’t continue to grow strongly?????

As you can see, there are inflection points and moments of jeopardy within a growth journey that need to be understood and navigated.??

Running a lean operation is important because it’s efficient. But the leaner it is, the less resilient it is too. Ideally you want an efficient but also resilient business which requires a really tight hold on everything that is happening.?

The needs of the business will change during growth and good management must recognise and respond to this, or better still predict it.???

Summary.

To wrap up:

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• Understand who’s driving the agenda and be mindful of how investors and new parties will bring expectations relating to company size.??
• Define the desired outcomes for all stakeholders.
• Quantify what size means - i.e. build an avatar to work backwards from.??
• Qualify the market and ensure it’s available. - Do the research, be conservative about what is available and bullish about what you can take of it.?
• Understand the relationship between size and profitability for your business now, in the end and during phases of growth.?
• Have ambitious but realistic timelines and stage gates from the outset.???
• Revisit regularly.?

An intelligent, deliberate and reasoned approach, working backwards from an end goal is the best way to build and execute a business strategy and achieve the outcomes the business is capable of.?

I hope this is useful.

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