Handling the growth pains

Sales are up. Is it time to expand? The answer is not as easy as you think. Here are some points to consider on some of the most common ways to expand:

Expanding product lines/service offerings

Often, successful entrepreneurs think their past success will translate into other businesses. Sometimes it works out, sometimes it doesn’t. Keep in mind the core competency of a person running a lumberyard is distribution. To be successful every day, this person’s job is to get material from A to B in the most efficient manner. How about the hardware business? The requisite skills to run a successful hardware store/department: Dealing with homeowners, retailing, advertising/marketing and hyper-focus on inventory turns by SKU. Competencies necessary to run a successful component business: Manufacturing, with skillsets in production economics, and a much higher level of focus on safety. Seasoned investors would push you to ask yourself if your team or you have these skills, and if not, go out and hire someone who does.

Expanding existing product lines or getting into a new product line altogether is a common way to expand. Food for thought: Do you have the space to carry all of the complementary products necessary to make an impact with customers? Will manufacturers and distributors in this space make you competitive in the marketplace? Do you have enough focus to compete with those who specialize in these product lines? Can we treat each product line/service offering as a business within our business? We’d expect a learning curve in new product lines and capitalize these projects properly; it might take some time to get momentum.

Expanding the sales force

We’re always in the market for a good salesperson, aren’t we? Keep in mind the typical lumberyard’s working capital is approximately 20% of sales; hardware stores are a little better. This means that for every $1 increase in sales, your cash flow decreases by $0.20. Do you have the capital (equity or debt) to take on a salesperson, which will increase your sales 25%?

If you have the balance sheet, a great salesperson can be a game-changer for a business. Keep in mind it’s in a salesperson’s nature to always believe they’ll bring 100% of their customers with them. Budget for 50% of their estimate, and expect margin pressure. Also, make sure you can budget the hard cost of the new salesperson for two years, and give them some runway so that they have a chance to be successful.

Expanding geographically

There is nothing more exhilarating than completing a deal or opening up a new store. Whether or not you should pull the trigger on one is a whole other matter.

We want to buy low and sell high. It’s an age-old adage, which has made folks money forever. The current environment is probably one of the best times in the last 50 years to expand geographically, and if you’re successful, drive significant shareholder value. Plus, diversifying into multiple geographic markets may reduce the overall business risk profile from things like a new competitor entering the market or a military base closing. At the same time, nothing scares us more than a deal gone bad, as bad deals have sunk many great companies.

Questions to consider before you do so:

  • Are you bringing unnecessary capacity to a market which doesn’t need it? What would a new competitor do to margins? Will you have to “buy” customers to gain market share?
  • Does your management team have the time to analyze and then integrate the deal/start up the new location? Losing focus on the core business, that which is making you money today, can get you in trouble.
  • Is the timing right? Those near retirement, who are considering selling the business in the next year or so, should tread very carefully.
  • Is it prudent to spend the company’s hard-earned capital in a fragile recovery, with the stock market at or near all-time highs, our country’s dysfunctional political atmosphere or the inflation outlook?

As a business owner or manager, your job is clear: Drive shareholder value. Wanting to get bigger is simple. Getting there comes down to strategic planning, risk tolerance, balance sheet strength and potential return on investment relative to the risk you assume. As you look to expand, do your diligence and try to take on reasonable risk as you navigate the opportunities.

Jason Fraler is principal and founder of Anchor Peabody, a private equity investment and financial advisory firm specializing in the U.S. building products and construction industry. Contact him at jfraler@anchorpeabody.com.

“Make sure you can budget the hard cost of the new salesperson for two years, and give them some runway so that they have a chance to be successful.” — Jason Fraler

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