How to Scale a Business
What to Consider Before Expanding Your Business
Sooner or later almost every successful business owner faces the decision of whether or not to expand the business to meet potential growth opportunities. While there are many advantages to expanding a business, to do so requires research and planning. This article discusses some of the issues involved in how to scale a business successfully.
Why Scale Your Business: The Advantages of Expanding
The primary reason to scale a business is to increase profitability. (Gaining market share via expansion is pointless unless it leads to increased profits.) Other benefits to having a larger business may include:
- Access to a wider variety of financing (at a lower cost) from banks and financial institutions. Smaller businesses have a much more difficult time qualifying for traditional small business loans.
- Moving into new product lines and broadening the customer base
- Economies of scale
- Expanding geographically to take advantage of opportunities in other locales, or relocating the business to a lower-cost jurisdiction
- Increased ability to attract additional qualified staff who can further improve the organization
- Eventually becoming a public company so that shares in the business can be bought and sold on a stock exchange, giving the owner(s) an opportunity to sell shares and recoup their investment
Many successful organizations start out as home-based businesses. While a home office has many advantages including minimal overhead it is more suited to solo entrepreneurs and virtual businesses. Other home-based businesses that are in an expansion phase may eventually prefer to move into commercial office space to give a more professional look to the organization, especially if additional staff is required and the business requires regular face-to-face meetings with clients.
Issues to Consider Before Expansion
Scaling a business always involves a degree of uncertainty so careful planning and prior consideration of the potential issues is a must:
1. Increased Sales vs Costs of Expansion
Business expansion and increased sales are often a chicken and egg syndrome. Expansion may be necessary to increase sales but increased sales may not be forthcoming unless it is apparent to the customer(s) that the business is large enough to handle the additional sales volume. The ideal situation is to have new sales secured before expansion.
Do your market research and make a sales forecast for expansion, taking into account the potential increase in sales tempered by other factors such as the outlook for your particular industry, the fluctuations of the business cycle, and the local economy in your sales area (or elsewhere if you intend to expand geographically).
If you are relocating a significant distance, take into account that you may lose some of your existing local customers. You may also need to incur additional advertising costs to drive business to your new location.
Make a forecast of the costs for the expansion—depending on the type of business this may include estimates for:
- Leasing new building space (and possibly paying out an existing lease)
- Additional staffing
- Additional manufacturing equipment, machinery, vehicles
- Office equipment and furniture
- Additional inventory
- Increased utilities
- Additional property taxes
Do a breakeven analysis to determine whether expansion is likely to provide the expected return on investment.
2. Is Financing Required?
If scaling your business requires capital investment, financing will be needed unless the business has sufficient retained earnings to cover the costs of expansion. As with starting a business, banks and financial institutions provide lending based on the perceived ability of the customer to repay, but if your business is on solid ground and in particular has a track record of loan repayment it will be much easier to secure debt financing than during startup. Established businesses tend to have collateral in the form of assets and accounts receivable.
If your business is incorporated or you intend to incorporate as part of the expansion then you have the option of raising capital via equity financing. Equity financing involves selling shares in the business to angel investors, who are usually family or friends of the business owners(s), wealthy individuals, or (increasingly) organized groups of investors who provide financing for small businesses. Typically the amounts invested are small (less than $500,000) and the terms are favorable. Angel investors do not normally involve themselves in the management of the business but expect a significant rate of return (25 percent or more) on their investment.
Whether you intend to seek debt or equity financing, you will need an updated business plan with the above-described cost and sales forecasts that will clearly demonstrate to financiers or investors that expansion will be profitable and in the best long term interests of your business.
3. Are Qualified Staff Available?
Ask almost any business owner and they will tell you that one of their main problems with business growth (or even maintaining their existing businesses) is acquiring qualified staff. The problem is particularly acute with skilled trades, information technology and other occupations that require specialized training and experience—such people are almost always in demand. If you are unable to obtain experienced staff to handle growth you may need to train new employees (which will consume more of your time). If qualified full staff is unavailable or expansion is temporary, contractors or part-time employees may also fill the gaps.
Another option for expansion that can solve the hiring problem is to take over or merge with an existing business, assuming that staff can be retained.
Keep in mind that in some jurisdictions you may be required to provide health insurance or other benefits if the number of employees exceeds the threshold. In the U.S. the Affordable Care Act mandates that larger businesses (those with more than 50 full-time equivalent employees) offer health benefits.
For one-person consulting or freelancing businesses hiring new employees (or adding partners) may involve additional considerations. Such businesses are often sole proprietorships—to reduce owner liability it is preferable to change the legal structure of this type of business to a corporation before hiring payroll employees. If expanding by entering into a partnership is being considered, keep in mind that approximately 70 percent of partnerships ultimately fail.
Another issue to consider when scaling a business is the increase in management duties and responsibilities. Dealing with more clients and supervising additional staff will occupy more of your time and energy. Given that the typical solo entrepreneur does everything from product development to marketing, learning how to delegate is a must when growing a business.
Opening additional business locations can be particularly challenging if your presence is vital to the success of the business. Customers that are used to your personal attention may be reluctant to form relationships with unfamiliar employees or partners and finding qualified personnel to manage other locations may be difficult.
5. Personal Circumstances
Running a small business is no walk in the park—long hours, stress, and fatigue can take a toll on personal relationships, health, and family life. When deciding whether to expand your business you may wish to take into account the additional demands on your time and the potential impact on your personal life and well being.
Summary: How to Scale a Business the Smart Way
Scaling a business can be very profitable but also very challenging. Before embarking on business expansion, do your homework and develop a plan for growth that will minimize risk and maximize the odds of a successful transition to a larger organization.