Examining the Life Cycle of a Company

Companies, like living organisms, have life cycles, although they are not as actuarially predictable. Companies of all sizes experience the same life-cycle patterns, but all firms are not in the same stage for the same length of time. The main phases are

  1. startup,
  2. initial growth,
  3. rapid growth,
  4. maturity, and
  5. decline

Each of these stages challenges a firm with significantly different financial requirements.

FINANCIAL MANAGEMENT: Your first step in analyzing your company is to figure out what the sales’ long-run, secular trend has been, and what it might be in the future. Are the sales volatile? How are they affected by the business cycle? By commodity prices? Because sales volume is the locomotive that pulls along the rest of the business, understanding sales characteristics is central to understanding your firm’s situation. It is also central to forecasting the company’s future performance.

The descriptions that follow are generalized – a company may simultaneously have products that are growing rapidly, are mature, and are in decline. Companies may skip phases or pass through them very rapidly. Nevertheless, the concepts have use as general analytical frameworks

Life-cycle Phase 1: Start-up phase

During the start-up stage of a venture’s life, the firm is often little more than an idea. Sources of funding are few, but much expenditure is typically required to prove your idea, develop your plans, and get the resources needed to begin operations. You probably provide the funding for your idea during this phase, along with others you can persuade to provide equity funds.

Life-cycle Phase 2: Initial growth phase

The initial growth phase occurs after your enterprise has begun to deliver its product or service. Losses characterize this period of a company’s life, often because the initial sales volume does not generate sufficient profits to cover the overhead and fixed costs of initial operations. During this phase, the company absorbs funds to cover the money it is losing and to build the assets necessary to meet the growing demand of its customers.

WATCH THIS: This is a difficult phase in a company’s life cycle. Your enterprise needs funds to show it can survive, but until you show it can survive, you will have a difficult time getting financing. Funds are still provided by equity or near-equity financing in this stage, so they must be allocated with care to the assets most important to the company’s survival and growth. Unnecessary investment can seriously damage the firm’s chance to survive.

As the owner of an initial-growth company, you may decide to subcontract the low value-added portions of the business, foregoing some profit to avoid committing assets to plant and equipment. The subcontractors also may help finance the venture by granting generous terms on accounts payable, more generous financing than a bank would be able to provide. You also should avoid excessive investments in raw materials – a firm can easily fail by investing so much of its funds in raw material that it does not have the resources to complete the conversion to saleable merchandise.

Once demand for your product or service has been established, life becomes much easier in many respects. If demand then stabilizes at a profitable level without continuing growth, the company enters a mature phase of its business without going through the rapid-growth phase. The reliance on new financing is reduced – or even eliminated.

Life-cycle Phase 3: Rapid growth phase

A period of rapid growth can be challenging, but it is still easier than the initial growth phase. In addition, it is potentially more rewarding for you and any other founders. The company becomes profitable, marginally at first and then handsomely. Demand, however, grows more rapidly than internally generated sources (including sources spontaneously provided by accounts payable and accruals) can support.

FINANCIAL MANAGEMENT: During this phase, you must plan periodic forays into the financial markets. To raise long-term capital in sufficient amounts, you’ ll often have to obtain more short-term bridge financing than needed only for seasonal short-term needs.

If growth is expected to be higher than the sustainable growth rate (SGR), financing should be planned as a sequence,so a complete picture of risks and rewards can be created and assessed. A fund-needs profile should be forecast, and a plan developed to finance these needs. A fund-needs profile is simply a balance-sheet projection, allowing for all existing financial sources, that shows a balancing “plug figure” on the right-hand side representing an additional need for funds.

Life-cycle Phase 4: Maturity phase

Trees do not grow to the sky, however, and the period of rapid growth will end when the consumers’ demands have been fulfilled and the market enters its mature phase. With services and disposable products, the company’s sales may stabilize at a high level – subject, of course, to your competitors’ inevitable introduction of alternatives and substitutes. When the market for a durable item becomes mature, the demand may fall dramatically to a replacement level. This situation can be very dangerous, particularly if you are caught with finished goods that might become obsolete before they can be sold. Many events in the audio, video, and computer businesses provide clear illustrations of this danger.

In an ideal situation, the mature phase of business allows you to enjoy the fruits of your innovation. Profit margins will have been eroded by competition but will remain satisfactory. Cash flows will be positive and strong because funds are not required for new assets to support growth. Without inflation, the accounting allocations for depreciation may even exceed the new investment in plant and equipment. Without growth, the firm will have the cash to increase the proportion of earnings paid its owners as dividends or other compensation. Debt may also be repaid, which can unbalance the capital structure unless common stock is bought back. Alternatively, remember that a high proportion of earnings must be paid as dividends.

WARNING: The temptation at this phase is to use the spare cash from one business to enter another. This is a dangerous route, however. The new business may be one you do not fully understand, it may not be as similar to the original business as you thought it was, and your skills from the original business may not transfer easily to the new business. If problems arise in the new business, it will divert your attention from the existing business, which can then easily go awry. Furthermore, having been successful in the first business, you may be reluctant to admit the skill transfer is not successful. As a result. you may take too long to decide to get out of the venture.

Life-cycle Phase 5: Decline phase

The decline phase is a difficult one for you,your company and your external sources of capital. Profit margins gradually degenerate and ultimately turn into losses. Adverse developments – which could be absorbed by a company in its growth or mature phases – become life-threatening events. During the initial stages of decline, the firm is often generating greater funds than needed to support assets. These funds find their way out of the firm as distributions to the owners or as reductions of debt.

As the losses become more serious, however, the company can no longer generate sufficient internal funds. You’ ll turn to the capital markets, often to the commercial banks, for funds to tide the situation over until the problems can be corrected. This approach is particularly likely if there has been a sudden event – loss of a major customer or a strike – that has created the need for funds. The problem appears a temporary one rather than a symptom of a long-run decline. “Just help us over this hurdle”, you’ ll plead, “and the company’s health will be restored. After all these years, you owe it to us to help. Think of the effect on the community if the company fails.”

IMPORTANT: The skill of getting out gracefully. is an important characteristic for the management of a declining company. This is a rare talent. often one that the growth-company or mature-company managers do not have. The company’s operations must be reduced, assets with more value to others must be sold, and the remainder may have to be shut down.

As this brief exposition demonstrates, by identifying the phase in which your company is operating, you gain insight into the way the company’s assets are likely to develop, into your company’s financial needs, and into appropriate ways to fund them.