Effects of the Ecosystem on Business Growth Decisions

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Companies of all types and sizes want their companies to grow in one way or another — whether in terms of growth of revenues, profits, number of employees or customers, market share, or number of locations. Not everyone has aspirations to build the next Roman Empire, but everyone wants to see progress from one year to the next, even if just in the amount of money that they can take home to their families.

Given the rapidly moving changes in the global marketplace, the challenge for the small entrepreneurial company is how and when to grow. In facing this challenge, entrepreneurs must consider questions such as: What strategies should be used to facilitate growth? Will the growth strategy present new risks or vulnerabilities? Are market conditions ripe, and is capital available to fuel growth? Compounding these questions in many emerging markets around the world is the lack of a supportive environment that promotes growth. Too often, entrepreneurs are prevented from expanding their small businesses because their country lacks the necessary ecosystem.

The challenges associated with building a company beyond the start-up and initial growth phases certainly take a toll on many entrepreneurs. Growth means hiring new employees, who will look to top management for leadership. Growth means increasing decentralization of management systems, which may create internal dissension over company goals and the allocation of resources. Growth also means additional capital will be required, creating new responsibilities to shareholders, investors and institutional lenders. Thus, growth brings with it a variety of changes in the structure, needs, and objectives of a small business.

Before a business owner can prepare a company for sustainable, profitable growth, he or she must analyze the strengths and weaknesses of its operational foundation. This includes an across the board review of organizational performance as well as the economic climate in which the company operates. To successfully complete such an evaluation, an entrepreneur must have an understanding of market principles, business management best practices, and marketing strategies. While a business degree is not necessary to start a business, to achieve growth entrepreneurs must have access to education, coaching, and advice that will equip them with the skills to successfully manage through periods of growth.

An assessment of the operating climate begins with legal and regulatory analysis. From a legal perspective, the more things change, the more they seem to stay the same. Owners of entrepreneurial companies across the globe continue to worry about issues that plagued them at the turn of the last century, such as a multitude of labor and employment laws, minimum wage standards, regulatory compliance and red tape, personal injury and workmen’s compensation claims, and product liability litigation. Even as these issues may never be entirely resolved, new legal, financial and organizational issues have begun to emerge involving protection of intellectual property, doing business in the global village, transacting business via the Internet and the renewed focus on satisfying (and keeping) the customer. Cross-border competition and rapid technological advancements are creating new business management models, such as geographically-dispersed work forces, flattened organizational structures and strategic partnering among customers, vendors, suppliers, and even competitors. The virtual workplace brings still more challenges in the areas of protection of privacy, confidentiality and copyright laws. To cope with all this, entrepreneurs must be able to rely on a strong rule of law and a predictable regulatory regime.

An efficient regulatory system that keeps barriers low is vital to ensuring businesses maintain momentum, and thus are able to raise additional rounds of capital as well as attract and retain talented employees. When, for instance, registering or obtaining a permit requires multiple trips to several locations, business owners become bogged down in the administrative process. The system must provide for efficient and cost-effective procedures to establish entities that limit personal liability (corporations, limited partnerships, etc.). Without such structures, entrepreneurs are hesitant to shoulder all of the risk that comes with growing a business. Anti-trust laws help to keep competition open to new entrants and fair. Entrepreneurs must also have exit options available, such as through mergers and acquisitions or initial public offerings, and bankruptcy provisions that do not unduly penalize risk-taking.

A supportive environment for entrepreneurial risk-taking begins with a culture that embraces and rewards individual achievement and success stories, and that does not stigmatize failure. Accessible capital and private equity markets that provide risk capital are imperative for entrepreneurial growth. Tax incentives and pension management rules can also allow for innovation and entrepreneurial risk. Finally, corporate governance provides for appropriate management of risks and protects minority investors and stakeholders.

What Are the Variables That Need to Be in Place to Support an Entrepreneurship Ecosystem?

  • An overall democratic society and governmental structure
  • Accessible and stable capital markets; private equity markets; low interest rates in debt markets
  • Tolerance for risk
  • Enforceable rule of law; effective court system
  • Reliable and fair intellectual property law
  • A culture that embraces and rewards successful individuals
  • Business entities that can be formed efficiently and cost-effectively, which limit personal liability (limited liability corporations, limited partnerships, etc.) and foster fair governance
  • Flexible labor and employment laws (which allow for hiring and firing) and reasonable enforcement of covenants not to compete
  • Strong educational systems and excellence in universities
  • Bankruptcy laws (which allow for failure without undue penalty or stigma)
  • Technological resources and internet access that level the playing field, expedite start-ups, and open up access for smaller companies to global markets and trade
  • Access to mentors, coaches, professional advisors, mentoring programs, etc.
  • Research and development partnerships between government and private business as well as between universities and private business
  • Low tax and regulatory barriers
  • Vehicles such as mergers and acquisitions, initial public offerings, employee stock ownership plans, etc. that provide exit strategies for successful entrepreneurs
  • Estate planning and wealth transfer laws and systems that allow for wealth preservation, asset protection, succession planning, and management transition
  • Antitrust laws that encourage competitive but fair markets

Specific Legal Variables Which Facilitate Entrepreneurship and a Growth Oriented Ecosystem

  • Court systems that allow for enforcement of contracts and obligations (including cost-effective alternative dispute resolution systems)
  • Tax incentives that encourage innovation and investment in smaller companies
  • Pension management rules that allow for risk capital
  • Intellectual property laws that protect the rights of innovative entrepreneurs and allow for licensing and franchising
  • Corporate governance that creates fiduciary duties for leaders and protects reasonable decision-making by the board without dilution of the rights of minority investors
  • Securities laws that ensure public and private offerings are made with full disclosure and decisions are made by informed investors
  • Bankruptcy processes that protect creditors and encourage risk-taking via orderly resolution of failures 

Setting the Stage for Growth

Effective and durable growth management involves: (1) understanding why the company wants or needs to grow; (2) clearly defining the objectives that growth will achieve or problems that growth will solve; (3) the management’s understanding of the challenges and risks that rapid growth will pose to the company, especially if the growth process is not well managed; (4) understanding the various phases of growth the company will experience as it evolves towards maturity; and (5) implementing a growth management process that is responsive to and reflective of the company’s current stage of growth.   

Any entrepreneur contemplating growth should start with these key questions:

Costs and revenues. Are revenues rising or falling? How about profit margins? Which divisions or departments stand out and why? Is there strong positive cash flow?

Personnel. Do certain employees show exceptional skills or produce outstanding results? Where in the company is the strongest management, organization and planning? Is there the talent on staff to handle anticipated growth?

Operations. Are there areas that seem to be trouble-free, functioning with little supervision but always delivering results? How do the managers in these areas achieve consistent results?

Philosophy or mission. Does the mission statement define the essence of the business exactly so it is clear which activities fit the company’s goals and which don’t? Are resources diluted by engaging in activities outside the mission? Have core values been embraced by employees?

The market. Is market share — the company’s percentage of estimated total business available — increasing or decreasing? Is marketing strategy based on careful research or on instinct and hunches? Is the customer or client base shrinking?

The competition. Where do competitors pose the largest threat? Which part of the business is most vulnerable to competition and which is least vulnerable? Are some parts of the market becoming crowded with competitors?

Economic climate. Are changes in economic conditions — interest rates, inflation, housing starts, industry earnings — likely to affect the company? Can changes in the marketplace be anticipated, or is the company often surprised by new developments?

Andrew J. Sherman, Esq., is a Partner at Jones Day.

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CIPE

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