Avoiding the Pitfalls of Growth

Warren G. Purdy -- Expert Business Source, 1/31/2007 6:25:00 AM

In our business culture, it is fair to say that growth is the predominant preoccupation of most business leaders. After all, is there a better yardstick of success?

But a business owner embarking on a growth plan must be aware of several potential pitfalls along the way. In particular, owners must understand important financial implications that can extend well beyond the initial capital investment used to expand operations. Here are four:

Expansion often takes far more money than we anticipate. Several years ago, what is now a well-known regional restaurant made the first of several expansions into neighboring cities. Every part of the owners’ plan (building and equipment costs, sales projections, etc.) was on target, except one: They did not allow for enough working capital. The owners suddenly found themselves running two restaurants without enough cash or credit to cover their day-to-day expenses.

The lesson from this common problem: It is better to overestimate your working capital needs than to wind up short and have to go back to the bank.

As you expand, your pay scale must adjust accordingly. Many businesses start based upon the owner’s particular skill or avocation. When it’s time to grow, you will most likely need to hire persons with the expertise you need to run a larger, more complex organization. This may require you to pay a salary higher than your own, or even reduce your salary or borrow in the short run to offset the expense.

The investment is often worth it. In his new book on the history of L.L. Bean, company chairman Leon Gorman describes a critical time in the company’s history when he had to search for talent to help take the business to the next level. This ultimately enabled the company to break through its growth barriers and become the successful global retailer it is today.

Cash is the fuel that will run your business. For most business owners, growth means significant increases in accounts receivable. This in turn drives the need for increased levels of working capital. A business may look profitable on paper (e.g. a positive quarterly P&L) even as creditors are pounding on the door. If you find yourself in this situation, try these three tactics:

Forecast your cash shortfalls as accurately as possible and request a line of credit with your bank to cover those needs
Try to negotiate more favorable payment terms with your suppliers
Consider using a “factor” who buys your receivables at a discount. (You can usually only use this alternative with larger volumes of receivables from well-known companies.)

Promotional costs will rise disproportionately as your business starts to take off. Entering new markets with your products or services will most likely require a substantial up-tick in advertising or other promotional costs. To ensure your additional investment is well-spent:

Evaluate the techniques that have worked best in the past, prepare to increase those efforts, but cut back in areas that have been less successful
Pay close attention to competitors’ strategies and seek input on the best promotional tactics from your salespeople, agents, distributors, etc.
Prepare to invest not just more money in your promotions, but time and effort as well. If potential customers are not aware that you have products that meet their needs or they don’t understand how your value proposition is different than your competitor’s, then having a better mousetrap really doesn’t matter!

Warren G. Purdy is an Associate Professor at the University of Southern Maine and a consultant with Inc. Magazine’s Growth Strategy Consulting Group. He is also a Senior Associate with Marketing Services Associates.

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