When you’re growing a new business, there’s a long list of to-do’s to check off. Near the top of that list, if not at the very top of that list, is getting money.
Getting funded and raising capital is a must for every new-growth business, and so many articles and resources will focus on how to get money. But today, I am going to touch on something that, although still money-related, is a little different. This piece will explore the type of money that you should be looking for when you’re looking to grow your business.
It may seem like a privilege to question the type of money you are in search for, rather than happily accepting any capital that comes your way. However, the type and amount of money you accept will define the investor expectations that you’ll have to meet. And, so, looking for a specific type of money is less about privilege, and more a necessity for the survival of your business.
There is good money and there is bad money
During the early stages of a new-growth business, the best money to invest is patient for growth but impatient for profit, and the worst money to invest will be patient for profit but impatient for growth.
Let’s break that down. If money is patient for profit but impatient for growth, then there is a risk of growing a failing business—a risk of investing in a strategy that isn’t and won’t produce any profit—hence, dooming the new growth business from the start.
On the other hand, money that is impatient for profit accelerates the emergent strategy process of a new venture. It rushes managers to test their assumptions that customers will pay a profitable price for their products. Expecting early profitability also helps managers keep fixed costs low, and in both new-market and low-market disruptions, a business model that can make money at low costs is crucial to attract the best customers.
That isn’t to say money should remain patient for growth. Once a winning strategy has been identified in later stage deliberate strategy circumstances, then money should be impatient for growth.
Good money can go bad
Identifying the right money to invest in a new-growth business is just the first hurdle, because even good money can go bad. Good money goes bad in a self-reinforcing, downward spiral and, ironically, it all starts with success.
First, companies succeed. When a winning strategy becomes clear, all money tends to be invested toward that strategy; and although this investment is essential for success at this stage, it leaves no resources for new growth. Instead, it pushes the new business up its sustaining trajectory, and the business will typically start to lose its lower-end customers because it’s leaving behind its lowest-margin products.
Second, companies face a growth gap. This happens because investors incorporate expected growth into the present value of a stock—meeting growth expectations results only in a market-average rate of stock price appreciation. To create value for shareholders, managers have to exceed the growth rate that investors have already built into the current price level. Now, investor expectations are usually met through sustaining innovations which maintain share prices, and creating new disruptive businesses is the only way in the long term to exceed investor expectations and create shareholder value…but if you remember from step one, succeeding companies aren’t investing in new growth, because all money is being used to exploit the winning strategy.
Third, good money becomes impatient for growth. At some point, the growth gap becomes too large because you’re targeting your existing customer base and ignoring new customers and nonconsumption, where the biggest (but not fastest) growth opportunities lie. This is when managers are pressured to accelerate the existing growth rate, and this is when the new-growth process turns sour. When confronted with a large growth gap, the company’s priorities change and resources won’t be allocated toward anything that can’t grow fast—triggering a domino effect of bad decisions.
By definition, disruptive markets are going to be small for a time. But when managers need business to get big fast, disruptive innovations will be shot down in favor of common strategies that cram businesses into large, obvious markets whose size can be statistically supported. This pressure leaves no resources for the necessary emergent process of disruptive, new-growth businesses.
Fourth, executives temporarily tolerate losses. Because the new-growth business is in a large, obvious market and is competing against consumption, manager’s will expect large losses. After all, if customers are going to buy the new product, it has to be better than the one they are already using, and making it better will be expensive. Investors expect these expensive losses and will convince themselves that they need to invest for growth in order to grow, which eventually leads to overfunding a failing strategy.
Fifth and finally, mounting losses precipitate retrenchment. It’s harder to break through competition in sustaining circumstances—revenues will fall short, managers will realize their growth expectations won’t be met and most likely they’ll go back to investing only in the core business. Unfortunately, they’ll still need new, fast growth, which eventually makes the entire process repeat itself and tanks the entire business.
The lesson? New-growth businesses have to be launched while the core business is still thriving—that is how good money stays good money. So, when you’re launching your new venture and you need to determine whether the money you’re being offered will be good for growth or not, here’s what you need to know: look for capital that’ll be patient for growth, impatient for profit, and that is constantly being reinvested toward new-growth business, even when your core is already succeeding.
For more of our Thursday Theory Tips, read:
Thursday Theory Tips – Who are your best customers?
Thursday Theory Tips – Is my business model working for me?
Thursday Theory Tips – Culture, management’s secret weapon
Thursday Theory Tips – How do I plan my new venture?
Thursday Theory Tips – Disruption, a theory of competition
Thursday Theory Tips – On creating new markets
