Organic growth or funded-growth?
In this blog Damian outlines how your chosen growth path can influence your outcome when it comes to selling your business.
By Damian Woodward
3 minute read
As Founder and/or CEO, you choose which path to take for company growth. The organic path or the funded path - and both routes have their merits.
Ultimately the choice will depend on your exit vision for the business, something we always encourage Founders and CEOs to have clear in their mind.
The organic path…
Organic growth, where cash generated by the business is used for growth, can continue over decades and multiple generations. There are many examples of successful companies built organically.
The organic path gives the owner total control in most cases, as well as the majority of the share capital in the business. This means they can decide how much to reinvest into growth in balance with personal income needs.
Over a period of time, a level of earnings is reached and the benchmark multiple achieved. This path is right when the owners’ priority is consistency of income over time.
The funded path…
In this case capital is brought into the business to accelerate earning’s, growth, and scale.
In theory, this should lead to a higher level of earnings over the same time period as the organic path, because the business can deploy capital into sales, marketing, product development, territory and market expansion, in order to achieve a higher growth rate.
The growth rate indicates to a buyer the ‘Future Earnings’ potential of the business, and this can then drive up the valuation.
For business owners looking to achieve a significant capital event at exit, the funded path will typically yield greater results, more quickly.
Let’s review a case study…
A software business achieved $3m revenue in Year 3 (Y3) as a result of a year-on-year growth rate of 3x.
In Y4 the revenue doubled to $6m indicating a growth rate of 2x, and by Y6 they reached $14.5m. As you can see, the growth rate was slowly declining despite the revenue increasing - an expected journey on the organic path.
The shareholders in the business achieved a sale at the benchmark multiple of 3x Revenue by Y6 without having to dilute - $43.5m - not a bad result.
Had the business chosen the funded path they could have used the additional capital to enter new territories, and to develop new products to access new industry verticals and maintain a higher growth rate of 100% each year.
This growth rate would indicate higher Future Earnings of the business AND would demonstrate having a bigger market share, ruling out some of the competition. For these reasons the business would look much more attractive to a buyer.
Realistically the business could have achieved a 5x multiple in this case. The same shareholders would have increased their return by 3.9x to $170m (after the VC took their share). Note that despite owning less of the business, the owners took home more capital; they had a smaller piece of a bigger pie.
Not every business has the potential, the assets or the opportunity to achieve the sort of growth rates that are described here, however the example demonstrates the potential that external capital can create for your business.
Core to making external capital work is understanding its purpose (including a clear deployment plan) and clarity on how it will positively impact both earnings and multiple - the core factors that drive valuation.
So, does this impact your decision on whether organic or funded growth makes sense for your business?