I recently wrote about the war between driving growth and profitability and how you cannot successfully maximize both at the same time. The key point was that driving growth requires an additional investment in your business, in the form of new sales and marketing activities, expenses of which put negative pressure on your bottom line. So what happens when that additional investment takes a short-term toll on your business?
You’d be surprised how most entrepreneurs would answer that question, especially in family-run businesses where every business expense is perceived as taking resources away from personal expenses.
There seems to be a general aversion to losses and taking on debt to cover those losses. So, instead of raising the required capital needed to fund the full need, they try to cut expenses in other areas of their business to make room in the budget for the sales and marketing need. Or, they simply lower their growth objectives to a more affordable level within their current budgets. All are reactions of entrepreneurs who typically don’t know what is required for long term success.
You should fund the full amount needed for the plan.
At the end of the day, your long-term goal should remain your long-term goal.
If your management team has collectively been hired to help you grow a $10 billion business into a $100 billion business over the coming five years, you are going to ruffle a lot of internal feathers if you suddenly switch directions to building a $20 billion business.
Those executives signed on to help be part of an exciting 10x growth story, not a 2x growth story, and you most likely will lose them with that move. Especially, if they were recruited with an equity stake in the business, and they suddenly realize it is only worth 20 percent of what they thought it was going to be worth.
Think through the ripple effects of your actions.
It’s perfectly acceptable to incur debt.
Where in the Business 101 handbook did it ever say debt was bad and should be avoided at all cost?
That certainly could be the situation for companies with no reasonable way of paying the debt back, forcing them into bankruptcy if they miss their payments. But, for most healthy companies, which are producing long-term cash flow, debt is a perfectly acceptable vehicle with which to fund your short-term needs.
It’s certainly a lot more affordable than diluting your equity ownership with a new equity financing.
Debt is not a bad word. It is a perfectly acceptable way to capitalize your business for up to 50 percent of its needs, provided you have a credible plan to pay it back.
How do you think private equity firms make all their super-sized returns on their portfolio investments? It’s not by investing 100 percent equity in those companies.
Debt helps them leverage their equity resources to stretch their equity farther and drive a higher return on their equity investment.
It’s perfectly acceptable to take on losses.
If you look at the growth curve of any startup, almost all of them start by incurring losses in their formative months or years, as the revenues are simply not there yet to cover their startup expenses.
It is absolutely no different for later stage companies. Think of your increase in growth investment as another startup-like event that is perfectly normal and expected.
It is not a bad thing to incur losses if there is a logical reason for the expenses, like needed investment to help jumpstart long-term revenue growth.
That $1 billion loss today, could be the difference between $50 billion and $100 billion in revenues five years from now. So, don’t focus on the short-term impact of the loss, focus on the opportunity cost of what you are leaving on the table by not incurring the loss.
Don’t cut money from other departments.
Taking money from other departments is not the answer either.
Let’s say you need $1 billion of new investment in sales and marketing, but your technology department also needs $1 billion for new product development needs. The problem is you only have $1 billion of free cash flow to work with.
Sure, you could give each $500,000, but that only helps the business accomplish half of its desired goals. And if you tell the technology department to delay your investment in new products for a year, it won’t be long before your engineers quit or your customers move to your competitors for lack of innovation. Then you will have an even bigger financial mess to deal with.
There’s only one time you should cut expenses.
The only time you should take out the hatchet and start cutting expenses is when your business is broken and your economic model is flawed, or when there’s an economic slump you are navigating through.
But, if you have a healthy business, and you’re trying to accelerate growth, you really shouldn’t should take the hatchet to any part of your business in order to better afford the additional expenses. Instead, you should finance the full need of the plan, either with debt or equity – whatever is appropriate for your situation.
And, if you are simply trying to avoid diluting your ownership stake, I ask you one question: Would you rather own 100 percent of a $20 billion company or 80 percent of $100 billion company?
Managing Partner at Red Rocket Ventures