Q: What should go into the decision to expand?
A: The answer starts with your strategic plan. Are you building a company with the aim of selling within five years, or one that you hope will continue growing for the next 50? The shorter the time frame, the more you'll need to focus on putting out a great product in lieu of diversifying or investigating new markets. If, however, your focus is on the long term, you'll want to figure out where your current operation can best pursue these three key areas for growth:
Geography. This entails replicating your business in a new location to attract new customers.
Capability. This broad category includes investing in people, skills, technologies, processes and products. Here's one way it can play out: A printing firm I worked with expanded by buying a shop that offered high-speed web press services, then selling these new services to existing customers.
Markets. To keep things simple, I define markets as the selling of your existing product or service to a new demographic or for a new use. For example: A restaurateur who previously served only lunch and dinner opens for breakfast with a new menu.
Once you identify how your company can best grow in one or more of these areas, move on to figuring out how to make it work. Understand that you're making a bet that you could lose. Therefore, you'll want to build several financial models of what your company needs in order to complete the expansion, and what it will look like after. (Your financial advisor or CFO can do this for you.) Here's what you'll need to do:
- Create models that encompass low, assumed and high expectations for success. You want to be mentally prepared for the deal to work out in any way. List projected revenue, gross margins, operating expenses and EBITDA. The models should also project accounts receivable, inventory, fixed assets (such as buildings, vehicles and equipment), accounts payable, any debt incurred and the effect on retained earnings and your equity.
- Account for changes in your current operation due to the new addition. Will you have layoffs or discontinue or combine certain operations? You'd be surprised how often these factors get overlooked.
- Estimate valuation of the company both before and after the expansion process. You may discover that the increase is not big enough to warrant the effort and headaches.
- Figure out how to pay for it all--bank loan, private investors, cash or equity stake.
Bear in mind that successfully integrating with another company or expanding into new territory can take more than a year. It's expensive, messy and more work than anyone expects, which leads me to my last piece of advice: Don't forget to run your current business. It's not uncommon for entrepreneurs, consumed by their shiny expansion plans, to lose sight of the day-to-day operations of their already profitable businesses. By the end of the process, they end up with a company that's in worse shape than when they started.
Joe Worth, Vice president of operations and partner at B2B CFO, has been a CFO for several public and privately held companies.