Business growth

Business growth means increasing the size or scale of a business over time, for example by selling more, employing more staff or running more sites.

Internal (organic) growth

Internal growth, also called organic growth, happens when a business expands from within by increasing its own operations, rather than joining with another business. You can think of it as the business growing under its own steam.

For example, imagine a small chain of indoor climbing centres that uses its profits to open a third site, hire more instructors and buy extra equipment. It grows by doing more of what it already does, using its own resources and reputation instead of buying a rival.

Benefits and limits

Organic growth is often slower and steadier than external growth. That can be an advantage: the business can build on its existing strengths, brand and reputation, because customers already recognise and trust it and staff already understand how it works. Growing at a steady pace, in line with market growth, may also be lower risk than a sudden jump in size, because the business has time to train staff and adjust. Lower risk does not mean no risk, though — a new site can still fail.

However, organic growth can be limited by the size and growth rate of the market. In a small or shrinking market there may be few extra customers to win. It is also harder if the business already has a large market share, because most potential customers already buy from it. Finally, it usually needs sufficient profit to fund expansion, so a business earning little profit may only be able to grow slowly.

Organic growth means expanding from within, and one way to do this is by developing new products. As well as selling more of its existing products, the business creates something new to sell alongside them, so its sales can rise without joining with another business.

Where new products come from

Innovation means coming up with new ideas or better ways of doing things, and research and development (R&D) is the work of investigating those ideas and turning them into products that can be made and sold. For example, a firm making garden furniture might spend a year testing designs for an outdoor heater that runs on a rechargeable battery, then launch it once it is safe and reliable.

Why it can grow a business

A new product can attract customers who were not interested in what the business sold before, and it can increase sales because existing customers buy more. It can also help the business enter a new market segment: a smaller group of customers within a market who share similar needs that other customers do not have. The garden furniture maker could reach people who want to sit outside in autumn, rather than only those buying summer furniture.

The drawbacks

Development can be expensive and time-consuming: design, testing, machinery and marketing all cost money and take months. There is also no guarantee that customers will buy the product, so the money spent may never be earned back.

Entering new markets means selling to groups of customers a business does not already reach. It is a way of achieving organic growth, because the business expands using its own resources rather than joining with another business. A new market is not only a foreign country.

Two types of new market

• A new customer segment in an existing market: the business keeps selling in the same country but targets a different group of buyers. For example, Harbour & Co, a Bristol maker of reusable water bottles, launches a smaller, tougher bottle aimed at primary school children and sells it through schools. The customers are new even though the product and country are familiar.
• A market in another country: the business starts selling to customers overseas. For example, Peak Trail, a Manchester brand of walking boots, begins selling in Canada, where cold, wet weather creates similar demand.

Reaching these customers often means adapting the marketing mix, such as changing the price or the way the product is promoted, and using technology, such as a website that lets customers order online, including from abroad.

Why it can grow sales, and why it is risky

Expanding overseas can increase the number of potential customers, so sales may rise well beyond the sales possible in the home market, especially if demand at home is flat.

Entering a new market can be expensive and risky. For example, expanding overseas means research, translating packaging, meeting different laws and setting up distribution, all of which cost money before any sale is made, and the money may be lost if customers do not buy. A business may also misunderstand customer needs, because tastes, habits, incomes and religions differ between countries, so a product that sells well at home can fail abroad. Peak Trail might find Canadian buyers prefer a different style of boot, leaving stock unsold.

External growth (also called inorganic growth) happens when a business grows by joining with another business, rather than by expanding on its own. Instead of winning new customers one at a time, it gains them all at once by combining with a business that already has them.

Mergers and takeovers

A merger is an agreement between two businesses to unite as one new company. Both sets of owners agree to pool the businesses and share ownership of the new company. For example, two small garden centre chains might merge into one larger chain, with the original owners holding shares in the new business.

A takeover happens when one business gains control of another by buying enough of its shares. The buyer now controls the target business, even if it keeps its own name. A takeover is friendly when the target's owners and managers agree to it, and hostile when they do not, so the buyer has to persuade shareholders to sell anyway.

Advantages

• Speed — external growth can be far quicker than organic growth, because the customers, staff, factories and reputation already exist.
• Market share — buying a rival instantly adds its sales to yours, which can give a bigger share of the market and more influence over prices.
• Less competition — combining two rivals removes a competitor and can mean shared costs, such as one delivery fleet instead of two.

Drawbacks

• Expense — buying another business can cost a great deal, and a hostile takeover may mean offering more than the shares are really worth.
• Duplication — two head offices, two warehouses or two managers doing the same job waste money, and removing the extra roles often means job losses.
• Integration problems — staff may have different ways of working, pay, systems and cultures, which can lead to poor communication, low motivation and customers leaving.

External growth is fast and can boost market share, but it is expensive and risky to make work.

A public limited company (plc) is a legal status that allows a company to offer its shares to the general public. Anyone can buy a stake, so a plc is owned by its shareholders — the people and organisations that hold its shares. Those shares can be bought and sold on a stock exchange, a market where the shares of plcs are traded. "Public" here means the shares are open to the public to buy; it does not mean the government owns the business, and floating does not mean selling off stock or equipment. Floating also does not give a business limited liability for the first time, because a private limited company already has that. The real change is who is allowed to buy the shares.

Raising share capital

A plc can issue new shares to raise share capital for growth, such as opening new sites, buying machinery or hiring staff. The money does not have to be repaid, but shareholders expect a return through dividends.

A stock market flotation is the process of offering a company's shares for sale to the public for the first time. It can raise a large amount of share capital in one go. For example, Kestrel Outdoors Ltd, a private limited company with 12 camping stores, needs £6 million to open 25 more. It floats — becoming Kestrel Outdoors plc — and sells 35% of its shares to the public, raising the money far more quickly than retained profit could.

What the owners give up

• Diluted control: the founders keep 65% of Kestrel's shares, so they still outvote everyone else, but 35% of the votes now belong to strangers. Selling a larger share could leave the original owners unable to outvote the rest.
• Pressure from shareholders: outside investors want dividends and a rising share price, so directors may feel pushed to chase short-term profit rather than long-term plans.
• Hostile takeover: because plc shares can be bought by any outside investor, a rival can buy enough shares to take control even when the current directors object.

Internal sources of finance come from inside the business: money it has already earned, or things it already owns. The two internal sources are retained profit and selling assets.

Retained profit

Retained profit is profit kept in the business instead of being paid out to the owners. Rather than taking all of the profit, the owners agree to leave some behind, where it builds up as a reserve the business can spend on growth.

Because it is the business's own money, retained profit can fund growth without borrowing. That avoids interest payments and the repayment of loan capital, so growth costs less overall and the owners keep full control of the business.

For example, a bicycle repair workshop making £60,000 profit might keep £21,000 of it towards fitting out a second workshop, paying no interest on that money. The catch is that retained profit is limited to the profit the business actually makes: a new business, or one with thin profit margins, may not earn enough to pay for large-scale growth, and owners must wait longer for a return.

Selling assets

Selling assets means raising finance by selling resources the business already owns, such as machinery, vehicles or property. It raises money without creating debt, because there is no loan to repay and no interest to pay, which keeps financial risk down.

However, the business may lose resources it needs. Sell a delivery van and deliveries slow down unless another van is hired or bought, which adds cost and reduces capacity, so the business becomes less efficient. The finance raised can then cost more in lost output than it provides.

External sources of finance come from outside the business, usually from a lender such as a bank, or from investors who put money in.

Loan capital

Loan capital is money borrowed by the business that must be repaid, with interest added on top. For example, a garden centre might borrow £40,000 to build a second glasshouse and repay it in monthly instalments over five years.

The main benefits are speed and size: a large sum can arrive quickly, and because the lender is only owed money and does not become an owner, the existing owners keep control of decisions. The drawbacks are cost and risk. Interest makes the borrowing cost more than the amount received, and the repayments must be made even in a quiet month, which can squeeze cash flow and increase financial risk — the danger of being unable to keep up repayments if sales fall.

Share capital

Share capital is raised by selling shares in a company, so investors pay money in and become part owners. It does not have to be repaid and no interest is charged, which makes it less of a drain on cash than a loan.

In return, shareholders may expect a share of the profit as dividends, and they usually expect a say in how the business is run. Selling new shares also dilutes existing owners' control. If two owners each held 50% and new shares are sold so that outsiders own 40%, each original owner falls to 30%. The two of them still hold 60% between them and keep control if they vote together, but neither can outvote the new shareholders alone.

When a business needs money to grow, it compares the sources of finance available. Internal sources come from inside the business, such as retained profit or selling assets; external sources come from outside, such as loan capital or share capital.

Internal sources are usually cheaper because there is no interest, fee or dividend to pay, and owners keep control of the money. Their weakness is the amount: a business can only use profit it has kept or sell assets it owns, which may be far below what a big expansion needs. Selling an asset can also remove something useful, such as a machine.

External sources raise larger sums, often quickly: a loan can be arranged in weeks, and a limited company can issue shares to many investors. They add costs, because loans are repaid with interest, and share capital, which never has to be repaid, may bring dividend payments. They can also reduce control, as lenders set conditions and new shareholders gain voting rights.

Weighing up the choice

Cost, speed, risk, control and the amount needed are the main factors, and the same five help you compare other routes to growth, such as a merger or a takeover.

Worked example

A chain of three indoor climbing centres wants £150,000 for a fourth site and has £40,000 of retained profit. Using that is cheap and keeps control, but leaves £110,000 to find. A £110,000 loan is quick and large enough, but interest raises monthly costs and the lender may ask for security. Issuing shares could raise the money without interest, but the owners would lose some control. The best choice depends on how soon the site must open, the profit it should make and how much control the owners will give up.