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ask SCORE: How to Tell the Difference Between Right and Wrong Decisions in the Life Cycle of a Business
How to Tell the Difference Between Right and Wrong Decisions in the Life Cycle of a Business
By Richard Walton
Assistant District Director for SCORE
The Business Life cycle is made up of four parts, the Start Up, The growth phase, The Maturity Phase, and the Exit phase. Each of these phases requires different managerial actions, as well as focus on the critical issues unique to that particular phase. The theme of this paper is that we have to focus on the right issues and in so doing direct our energies to the most important tasks, and thereby avoid wasted energy through focus on the wrong tasks. For each phase of the cycle I will present the wrong approach (or approaches) followed by the right approach. The content of this paper is based on the research I have carried out for the past five years as a member of SCORE, most recently as co-chairman of the Hagerstown Chapter.
PHASE 1, START UP, WRONG APPROACH
An entrepreneur comes to SCORE and says: 'I have a great idea for a new business and I need to get a grant or a loan to start up. Can you help me get the funds I need?'
PHASE 1, START UP, RIGHT APPROACH
Any funding source, whether it be a bank or a foundation, or even private lenders would have a series of questions that must be answered before funding can be provided. Some of these questions are: 'Do you have a Business Plan? How much of your own money is invested in the venture?, Have you proven the basic concept of your business model through contact with the market and received assurances of support from potential customers?, When and how would our money be repaid?, What is your background and experience in the functions needed to operate profitably?, and lastly, Describe your innovation and its value to potential customers, and how will you organize your company, such as its structure and process elements?'
The right approach is to seek validation of the business concept through emphasizing the value of the entrepreneur's innovation, and to determine through reference to the business plan and other questions as listed above, how the organization will be structured, staffed and managed to operate profitably and repay monies advanced according to loan agreements. Then we at SCORE can help the entrepreneur seek the necessary funding with some degree of success assuming that the questions provide positive feedback.
PHASE 2-GROWTH, WRONG APPROACH
An entrepreneur comes to SCORE and says 'Now that we are an up and running business, we need more funds to grow, and we will do so profitably. Can you help me get the funds I need?'
An entrepreneur comes to SCORE and says 'I have made a sales projection that shows steadily advancing sales levels and profit levels which will ensure that the plan will be successful'
PHASE 2-RIGHT APPROACH
The entrepreneur should have a growth plan that presents in order, the present level of output (sales) capacity and the present level of funding, followed by the growth projection both as to sales and associated costs and resulting profit, the level of expected profit from both the bottom up (individual products and/or services) and the top down (total sales for all products), the resulting cash flow statement showing when and how the loan or other funding mechanism will be repaid. But there is a critical element to any projection of sales and profit levels, and that is the reliability of the source for the information provided. In some cases it may be merely a guess, and therefore totally unreliable.
Any information provided should be supported by a combination of research and experience that validates the quality of the statistics. And also the right approach for creating and managing growth is to have an emphasis on quality and continuous improvement, not on low prices or pressure on customer prospects. Finally, the value of current information tracking projections is critical. For example, the validation of cost estimates must be done in order to ensure projected profitability outcomes (and all costs are estimates until measured after the transaction/s is/are completed).
PHASE 3-MATURITY, WRONG APPROACH
An entrepreneur/manager comes to SCORE and says 'Well, now we have made it through the tough times, and we want to relax a bit, and maybe take more money out of the company in salaries. Essentially we feel we are 'home free'.
An entrepreneur/manager comes to SCORE and says 'The fact that we made it through these last few years means that our business model works, and there is no need to change it.'
PHASE 3-MATURITY-RIGHT APPROACH
The right approach is to begin an assessment of the sustainability of your business model and practices in order to prepare for the possible need for change. Any successful business needs periodically to examine its business practices and competitive environment to determine what modifications might be needed in order to maintain its stability and cash flow (through sales and profits). And you are not 'home free' ever in business, particularly in small businesses. When a business has matured to the point where growth has slowed up the main focus of the management now is to maintain viability and start receiving rewards (such as higher salaries, and/or the withdrawal of capital funds that were provided by the manager/entrepreneur at the start up and growth phases). While this be an objective, perhaps even richly deserved, it should be viewed in connection with the coming need for an exit strategy (a catchword for small business owner's/manager's retirement) in which the withdrawal of funds would weaken the company's balance sheet and therefore its value at the time of sale.
The right approach is to maintain and even grow the value of the business, be aware of the need for change, and ensure the sustainability of the business model.
PHASE 4-EXIT-WRONG APPROACH
An entrepreneur/manager comes to SCORE and says 'With all the effort and money I have put into this business over the years, I deserve a high return on my investments.'
An entrepreneur/manager comes to SCORE and says 'It is easy for potential buyers to see the value in this company. Customer loyalty and satisfaction tells the story.'
PHASE 4-EXIT-RIGHT APPROACH
Exit strategy has to be thought of early and often in the process of setting up and managing a small business. This is primarily due to the fact that a small business is usually owned privately and therefore does not have its shares listed on a stock exchange for the purpose of buying or selling ownership rights. Therefore a sale of the business in whole or in part (it is possible to sell parts of a business, such as inventory, account receivable, assets (buildings, equipment, etc.) customers, intellectual property rights (if any). The keys to a successful sale of the business or its parts are first, valuation, and second, the options that are open to the buyer and the seller to maximize their respective interests.
The value of a business can be determined initially by 1) valuing its earnings stream, from the profit and loss statements of at least several years, 2) valuing its net worth as per the balance sheets for at least several years, and 3) inclusion or exclusion of special situations, such as intellectual property rights, specialized machinery, and/or the willingness of the present owner to stay on as a consultant during the period of transition. The present owner can and should raise the value of the business through paying down debt as much as possible, maximizing earnings, and providing any information that should be considered by the buyer as an increase in the value of the business.
The right approach summarizes to a concentration over the life of the business from start up through to exit on sound and ethical business practice, and concern for the triple bottom line, profit, people, and planet.
Mr. Walton teaches Financial Management, Operations Management, Corporation Finance, and Entrepreneurial Finance at Frostburg State University and is the assistant district director for SCORE, Western Maryland, and is president of ERMACORP, a Hagerstown based Management Consulting Firm. Call 301-462-9850 or him at Richard@ermacorp.com. Find him on Facebook(r) at "Small Business Life Cycle" for inquiries and an exchange of ideas on small business management, issues, resources, and experiences.