It is a dilemma that most entrepreneurs face at some stage in their business journey; should they invest in growth or focus on making a profit? Choosing the former can, in the short-term, have a negative impact on the latter and having a choice at all can depend on the business structure. External investors for example, are likely to demand dividends.
“Broadly speaking, young businesses usually look for growth rather than profit, because they need to get known, and are maybe challenging established players, if not industry assumptions,” says Stefano Maifreni, founder and director of Eggcelerate, a business advisory firm focused on start-ups and SMEs. “However, focusing on growth or profit, does not mean that the business model shouldn’t be profitable, nor that it should give its products or services away for the sake of reaching as many customers as possible.”
It’s a balance that can be tricky to find. Rachel Roberts is the founder and CEO of marketing and communications firm Spotty Dog Communications. Over the past three years, the business has achieved consistent year-on-year growth. Roberts has reinvested to open a second office location, grown the team, and expanded business capability to bring graphic design, photography and video production skills in-house.
She says: “Our target margin is 30%, which we would achieve, but the continued investment means that I am continually reinvesting cash and profits in the business to grow our infrastructure. [Because of this] margins have been in the 10% to 15% range. The continued growth is amazing for the business, but it means I’ve not been taking very much reward out of it.”
The changing work the business does has influenced Roberts’ decision to do this. In the early days, their client work was mainly project-led, so winning a glut of projects meant that, for a short time period at least, they had good income coming in.
Roberts says: “When we won a large project there was money available to upgrade our IT infrastructure. At this point my preference was to fund expansion and investment with available funds rather than use banking facilities.”
The business now has clients with bigger retainers and a more regular income stream, although Roberts says even an annual plan can be pulled at short notice.
She adds: “However, generally, we have a much more sustainable client base, which means I have greater confidence in using banking facilities to fund growth rather than keep reinvesting profits.” This will also enable her to take dividends from the business.
While the profit v investment dilemma is likely to strike businesses early, entrepreneurs need to have the vision to take a long-term view. Growth must be sustainable and profits will ultimately mean survival. Many rising stars in the technology sector, for example, bolstered by venture capital, have found that going for a quick return can lead to self-destruction.
Glen Manchester is the founder and CEO of software company Thunderhead, and one of only a handful of British tech pioneers to successfully scale a UK startup into a global company. He did so in 2001, when the recession was starting to bite.
While venture investment was difficult around this time, he decided to self fund, primarily because he wanted to have a greater degree of control. The decision paid off, as his small but solid UK customer base quickly scaled into a US operation, which now consistently represents over 50% of sales each year, and has an annual growth rate of more than 30%.
It was an early risk with a long-term plan and it allowed the business to grow quickly. “To build a successful global cloud business in enterprise technology, growth is paramount,” says Manchester. “[But] we have never questioned long-term growth over short-term profitability.”
By using private funding, Manchester has been free from many of the pressures that entrepreneurs face from investors – he’s able to make decisions quickly and with a greater degree of control. This year, for example, he has sold the company’s smart communications’ division to a private equity firm to focus on their latest technology venture, the ONE Engagement Hub.
He says that the business environment will always be in a constant state of flux and entrepreneurs need to be agile enough to change course between profit and growth as and when it makes sense: “Strategy is absolutely key, but situational awareness and continually testing your strategy is critical too.”
Rune Sovndahl launched domestic services platform Fantastic Services seven years ago, offering a range of household services, from cleaning and gardening, to waste removal and pest control. With no outside investment, he and business partner Anton Skarlatov built the company up using only their own savings and planned to do so until they absolutely needed it.
Sovndahl says: “Investing in that growth was a priority. Where you have unsustainable growth, and a vision that isn’t necessarily profitable, you could end up with a company whose only purpose is to raise another round of funding, and will need to be bailed out to return investment to investors. We made a firm rule to reinvest everything, and pay ourselves just enough to sustain work while building value.”
Initially, the founders chose not to take investment for the sake of taking investment, in other words, if they didn’t absolutely need it. Now they are in growth phase, they are seeking the right investment specifically to support that.
Sovndahl says only now are they looking for the external investment to support growth into the next stage. Interest is there, but they are waiting until they find exactly the right one for their company. He says: “We were fortunate in that our skills complement each other, which enabled us to press ahead, do what we are good at, and to keep growing our business.”
As a general rule, business owners should focus on both growth and profit, but in realistic, achievable terms. Profit enables growth of course, but focusing on the bottom line on a daily basis can cloud the bigger picture. However, that’s not to say that a business can’t be profitable on paper and investing back into the company.
“’On paper’, is the key point,” says Maifreni from Eggcelerate. “I’ve seen profitable businesses go bust because they didn’t manage the cashflow. [The business needs to be] profitable or not, cashflow positive or not for the business itself, not for investors.”
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