The question that everyone who’s ever launched a business has wanted an answer to is, what is the formula, the recipe, that when followed will result in a sustainably profitable enterprise? Furthermore, how does a business owner avoid the landmines that can tank the enterprise?

In 1983 Neil Churchill (1927-2010), former Professor Emeritus of of entrepreneurship at INSEAD in Fontainebleau, France and visiting professor at the Anderson School at UCLA and Virginia Lewis, a senior research associate at the Caruth Institute of Southern Methodist University, conducted an intriguing study that examined and (indirectly) answered the question. Specifically, Churchill and Lewis examined small businesses and, despite the obvious differences that distinguish every business and every entrepreneur or solopreneur who goes into business—B2B, B2C, products, services, business model, target markets, level of owner’s expertise, experience and funding— identified patterns of success and problems that typically occur in small businesses. Unfortunately, the two were not able to write the recipe for a secret sauce, but they did identify and categorize growth stages and difficulties that can arise in those growth stages, information that is actionable and highly valuable.

You might say that Churchill and Lewis created a map that can help you find the path to success for your business idea and also help you side-step common pitfalls. I’m happy to share a few take-aways from the study and provide the link to the original research. https://site-453261.mozfiles.com/files/453261/Harvard_Business_Review_-_The_5_Stages_Of_Small_Business_Growth.pdf

While every business venture is an unique entity, with some having potential for enormous profitability and (most) others that only sputter along, hobbled by obstacles that frequently include some combination of insufficient funding, an unrealistic business model, or a limited number of customers who are inclined to purchase its products and services, there are foundational similarities throughout the spectrum of possible outcomes. In a study of a range of business types ,one that documents which actions or circumstances encourage positive results and which lead to unfortunate outcomes, patterns become visible.

First, the research showed that all businesses evolve through identifiable stages in their life cycle. Second, it was discovered that certain successes, challenges and decisions that must be made are typically associated with the different life cycle growth stages. When business owners know what to expect throughout the business life cycle, they can prepare themselves and the company to maximize what is likely to go well, if only by skillfully navigating through what is likely to cause problems.

In other words, a company’s development stage determines the leadership and managerial skill and pivotal decisions that promote success and avoid problems. The type of business that you’re operating will influence which factors will eventually appear. An awareness of the development stage of the business, as well as the most logical future plans for that stage, enables business owners and managers to make informed choices and prepare themselves and the company for the inevitable challenges. Below are typical circumstances that pertain to business owners and the entity as the business life cycle adapts over time.

The four factors that relate to the business owner:

1. Owner’s goals for himself /herself and for the business.
2. Owner’s operational abilities in doing important jobs such as marketing, inventing, selling, producing and managing distribution.
3. Owner’s managerial ability and willingness to delegate responsibility and to manage the activities of others.
4. Owner’s strategic abilities for looking beyond the present and assessing the strengths and weaknesses of the company with his or her goals.

The four factors that relate to the business:

1. Financial resources, including cash on hand and borrowing power.
2. Personnel resources, financial prowess, quality of strategic relationships and other human capital, particularly at the management and staff levels.
3. Systems resources, in terms of the degree of sophistication of both information and planning and control systems.
4. Business resources, including customer relations, market share, supplier relations, manufacturing and distribution processes, technology and reputation, all of which give the company a position in its industry and market.

Stage I: Existence

Basic survival is the objective in the earliest stage of the company. The primary goals of the owner(s) are acquiring customers, delivering the product or service in a way that satisfies customers and providing pleasant and efficient customer service.

Other key objectives of the owner(s) are:

• Doing what is necessary to make the entity become a viable business.
• Successfully expanding beyond one or two important customers to a much broader customer base.
• Having sufficient capital available to finance the considerable cash demands of the start-up phase.

At this fledgling stage, the owner does everything and if there are employees, the owner directly supervises them. Systems and formal planning are minimal to nonexistent. The company strategy is to survive. The owner is the business, s/he performs all important functions. Many early stage entities never gain sufficient customer base nor product/service demand to become viable. If that is the case, the owner is forced to close the business when the money runs out. Companies that are lucky enough to survive Stage I will graduate to Stage II entities.

Stage II: Survival.

Businesses that survive to enter Stage II can be considered viable. They’ve attracted enough customers to generate the necessary sales revenue and customers are satisfied with the products and/or services offered. The most likely problem that surfaces in the transition from Stage I to Stage II is the balance between revenues and expenses. The owners’ primary objectives are:

• In the short run, generate enough cash to break even and cover the repair, renewal, or replacement of subscription software or other services and capital assets /equipment as they wear out or expire.
• At a minimum, generate enough cash-flow to stay in business and finance growth to a size that is sufficiently large, given our industry and market niche, to earn an economic return on our assets and labor. In other words, can you make enough money to make staying in business make sense?

Additionally, the Stage II company may have a small number of employees, often supervised by a sales manager or a general foreman. Alternatively (or simultaneously), there may be outsourcing of certain functions—bookkeeping, accounting, HR. payroll, IT network management, for example. The business owner(s) remains in charge of major decisions and the foreman or sales manager may have limited decision-making authority. Survival of the business remains the overwhelming goal.

While in the Survival Stage, the enterprise may grow in size and profitability and graduate to Stage III. Or, as many companies do, it may remain in Stage II for some time, earning modest profits on invested time and capital. Such businesses may eventually close when the owner gives up or retires. “Mom and pop” stores are in this category, as are manufacturing businesses that cannot attract a buyer for their product or process sold as they hoped. Some of these marginal businesses have developed enough economic viability to eventually be sold, usually at a slight loss. Or the entity may fail completely.

Stage III: Success.

The decision facing owners at this stage is whether to leverage the company’s achievements and strategize to grow, or maintain the stable and profitable success that has been attained. Business is good and to handle more complex functions, the first professional staff members will be hired, often a controller in the office or a production manager, perhaps administrative or sales employees may be hired as well. Basic financial, marketing and production systems are in place. Planning in the form of operational budgets supports vital business strategies and action plans. The owner and, to a lesser extent, the company managers, are advised to monitor the performance of business strategies to maintain desired profit margin.

The question becomes, will the owner(s) decide to promote growth and pursue the attainment of a substage III-G company, or will the owner(s) completely or partially step away from intensive involvement in the company and transition to substage III-D company?

Substage III: Disengagement

In the Success-Disengagement substage, the company has attained economic viability, has a sufficient customer base and product-market penetration to reasonably ensure financial success and earning average to above-average profits. The company can remain at this stage almost indefinitely, as long as a catastrophic external event (like a pandemic shutdown of business?) doesn’t erode its customer base, or ineffective management and poor decision-making doesn’t diminish its competitive abilities.

When disengagement is the choice, it is often driven by a wish to start a new enterprise, or simply to (finally) participate in hobbies and other outside interests while maintaining the business as is. If the company can continue to navigate the inevitable business environment changes, the owner can either continue in substage III-D, sell the entity at a profit, or at some point elect to once again pursue a growth trajectory. For franchise holders, this last option would require the purchase of additional franchises locations.

Substage III: Growth

In the Success-Growth substage, the owner consolidates the company and utilizes its resources to stimulate accelerated growth, typically using accumulated business cash and borrowing the amount needed to finance growth. Maintaining optimal business profitability is key, so that it will not deplete cash (the lender will be looking). Having on board talented and dedicated company managers to meet the needs of the growing business is another must-do. This second task requires hiring managers with an eye to the company’s future rather than its current condition.

The right business systems should be in place to provide the operational needs that a larger entity will require as growth proceeds. Proper budgeting and the development and execution of strategic planning is critical. The owner(s) are intensely involved in all aspects of the company’s affairs, in contrast to the disengagement stage.

If the growth plan is successful, the III-G company proceeds to Stage IV Take-off. If the III-G company is unsuccessful, the missteps might be detected in time to make a smooth landing in substage III-D. If not, a return to Stage II Survival may be possible, in lieu of bankruptcy or a distress sale.

Stage IV: Take-off

In this stage the key problems are how to grow rapidly and how to finance that growth. The most important questions, then, are in the following areas:

Delegation. Can the owner(s) delegate responsibility to the appropriate staff or Freelance outside experts to improve the managerial effectiveness of a fast-growing and increasingly complex enterprise? Further, will the action be true delegation with controls on performance and a willingness to see mistakes made, or will it be abdication, as is so often the case?

Cash. Will there be enough to satisfy the great demands growth brings (often requiring a willingness on the owner’s part to tolerate a high debt-equity ratio) and a cash-flow that is not eroded by inadequate expense controls or ill-advised investments brought about by owner impatience?.

This is a pivotal period in a company’s life. If the owner rises to the challenges of a growing company, both financially and managerially, it can become a big business. If not, it can usually be sold—at a profit—provided the owner recognizes his or her limitations soon enough. Too often, those who bring the business to the Success Stage are unsuccessful in Stage IV, either because they try to grow too fast and run out of cash (the owner falls victim to the omnipotence syndrome), or are unable to delegate effectively enough to make the company work (the omniscience syndrome).

Stage V: Maturity The most important responsibilities the owner has at Stage V is to first, preserve and encourage the continuation of the substage III-G growth and second, to retain the advantages of small size, meaning a nimble response to the economic landscape and maintaining the owners’ entrepreneurial spirit.

The organization must install a management team and operational processes that will eliminate the inefficiencies that growth can produce and simultaneously professionalize the company operations by use of tools such as budgeting, strategic planning, staff training and standard cost management systems—and do this without inhibiting its entrepreneurial qualities.

Thanks for reading,

Kim

Image: Abdul and Aisha Tedros, owners of Oasis Coffee & Tea Shop in Phoenix, AZ, ranked #11 on the Yelp Top 100 coffee shops list in the U.S.and Canada.