Driving growth, driving value

The companies in the Dynamic 100 show why SMEs are the engine room of growth for UK PLC. There are simply so many different routes to the growth performance reflected in these success stories: businesses which are catching the tailwinds in their sector; those which are disrupting established markets and seizing share; and others who are consolidating smaller players to create a platform with more scale.

As M&A advisers at Cavendish, we know that growth is essentially a precondition for any kind of capital transaction: IPO, trade sale or MBO. What gets the next owner excited is the belief a business can do more tomorrow than it did today. No better guide to that than a track record of growth.

All of this begs the question: do all routes to growth create more value in the hands of the owners? Simply put, the answer is no.

Growth which drags on value

A company with a large customer account which then doubles will have a bigger top line and potentially bottom line to its P&L. But in the eyes of a buyer that concentration can be toxic. They will worry about the hole left if that customer goes away.

Or take a company which drives growth via an unsustainable level of marketing spend. They will need to find a way to retain those customers once the marketing budget depletes or risk them being bid away by the next competitor who tries the same thing.

Even when sales growth is sustainable, it can come at the expense of margins. This is a modified version of the adage that “turnover is vanity, profit is sanity.” Profits are how an owner makes their returns. If growth comes at the expense of margins, this calls into question whether profits will come under pressure in the long run.

Growth which drives value

Turning to the flip-side, when does growth move the value in a positive direction? One of the most powerful ways is when a company grows by launching a new product or service. Being able to sell more than one thing to its customer has a transformative effect on its addressable market. A great example of this was when Gü Desserts, known for its chilled chocolate puds and other desserts, launched an ambient range ahead of its sale to Noble Foods. More products = more of a market = more value.

Another route to growing by growing its market is for a business to expand internationally. This is not without risk. When successful however, the benefits are twofold. The business will have proven its offering translates outside the UK so it has a larger addressable market. It will also be on the radar of buyers and investors in that market and data shows that international acquirers typically pay a premium.

So far we have been considering organic growth. A further lever for growth is by acquiring other businesses. On its own this growth driver is not enough – in a flat market 1+1 only equals 2. However, as an accelerator for an already growing business it can add serious value. Over 12,000 UK companies are now backed by private equity or venture capital firms. The easiest cheque they ever write is to fund a business they have already invested in to make another acquisition. So companies which have already proven they can source, negotiate and integrate an acquisition successfully are doubly attractive and this will be reflected in their valuation.

None of these growth levers comes without risk. So how much better to focus on those which bring the most reward in creating value. What the Dynamic 100 shows without doubt is the number of entrepreneurs ready to take those risks and reap the rewards.