How do rapid growth firms deal with potential cash flow shortfalls?

Rapid growth firms are an example of businesses that may experience cash flow problems

Your business has hit on a successful product or service and sales go mad. But the sales are so rapid that the growth is outstripping the cash flow. This is generally referred to as overtrading. Overtrading can be a real problem for all businesses. So how do rapid growth firms deal with potential cash flow shortfalls? Let’s take a look…

How do rapid growth firms deal with potential cash flow shortfalls in 15 seconds…

The way in which rapid growth firms deal with potential cash flow shortfalls is to plan ahead of time and prepare cash flow forecasts and business plans. Additionally, it’s always useful to learn from others mistakes: For example making an informed decision between bank finance vs venture capital money; renting and not buying business premises, whilst looking at the scale of premises expansion with care; watch out for fads or trends; invest any excess cash wisely; plus to keep on innovating to stay ahead of the competition.

Examples of rapid growth firms

Entrepreneur.com have written about 5 companies that grew too quickly, which include Wise Acre Frozen Treats, 180s, Crumbs Bake Shop, Zynga and KIND Snacks.

The lessons learned from each company is slightly different, but thanks to Entrepreneur.com, these are some of the lessons. These lessons will help in answering the question to the question of this article: How do rapid growth firms deal with potential cash flow shortfalls?

5 fast growth companies that grew too quickly to learn from:

• Wise Acre Frozen Treats: Jim Picariello the entrepreneur who started Wise Acre Frozen Treats took on a 3,000 square foot manufacturing facility and hired 13 employees within 6 months, but by the end of that same year the business had gone bankrupt.
• 180s: This fast growing business achieved rank 9 on Inc’s list of 500 fastest-growing private companies. But the problem in this case-study is that the company had overloaded itself with debt. Had it not been for a buy out by Patriarch Partners, it’s likely 180s would have gone out of business too.
• Crumbs Cake Shop: This business rode the way of the trend in cupcakes. The business was founded in 2003. It very quickly began to open up stores in many different cities. But the growth rate wasn’t sustainable, and due to the high cost of maintaining all the physical stores and the decline is sales due to a change in trends, the business finally closed down in 2018. This was even despite being bought out of bankruptcy in 2014.
• Zynga: Zynga is a gaming business. It was founded by Mark Pincus. It was noted for games like Poker and Mafia Wars and secured millions of downloads of both. However, the excess cash of $100 million the company made was invested in their own data centres. However, due to a lack of new innovation, the business slowly declined, leaving it with having to make lay-offs and had to close it’s own data centre in favour of a data service instead.
• Kind Snacks: Entrepreneur Daniel Lubetsky found it difficult to turn a profit. But he admitted that he spent to much time and energy trying to grow fast and expand before the company was ready. But Lubetsky was fortunate, as he received $20 million of venture capital from VMG Partners, which allowed him to grow steadily. This story has a happy ending, as Lubetsky managed to buy back his business in 2014 for $220 million in cash!

How do rapid growth firms deal with potential cash flow shortfalls

Using the above five examples of rapid growth firms, lets’ take a look at how businesses can deal with potential cash flow shortfalls in this situation.

1. Prepare sound business plans accompanied by cash flow forecasts.
2. Venture capital finance vs bank debt.
3. Expand your business premises slowly and carefully.
4. Rent rather than buy business premises.
5. Watch out for fads or trends that are not sustainable.
6. Invest excess cash wisely.
7. Don’t stop innovating in order to stay competitive.

Let’s now take a look at each of these in more detail:

1. Prepare sound business plans accompanied by cash flow forecasts

To have well a prepared cash flow forecast together with an up to date business plan will help you to set out your business growth plans. Armed with cash flow forecasts that are aligned to a well thought through business plan, will help you to avoid any potential cash flow shortfalls.

With professional cash flow forecast and business plan reports at your fingertips, these will be an important tool if and when you look for any bank finance or venture capital money.

2. Venture capital finance vs bank debt

The are crucial differences between bank debt and venture capital finance. Normally, venture capital money is provided in return for a stake in the business. Whereas bank finance is received as debt.

Bank lending will have certain conditions attached, which includes certain debt covenants. Debt covenants such as debt to EBITDA, Interest coverage, Debt to equity, Debt to assets and so on. This means that if your business falls outside of these covenant limits the bank has the right to call-in the loan.

However, venture capital financing is different and doesn’t usually have covenants in the same way.

You therefore need to be careful with how you run your business. What some fast growth firms run fowl of in this regards is borrowing more money from another source and inadvertently falling fowl of the debt to equity ratio covenant.

You therefore need to think carefully about which type of finance you seek. But there’s nothing to prevent you from seeking both types of finance.

3. Expand your business premises slowly and carefully

When you are in the early stages of growth, it’s important to not get carried away. You have the option to either purchase your premises or rent them. Each method has its advantages and disadvantages.

Looking at the above example of Zynga who spent $100 million on new premises turns out to have been the wrong thing. Whilst hindsight is always easy to look at, it’s important to use other people’s mistakes to avoid making them yourself.

For example, add Zynga spent the $100 million ( a part of it) on innovation, the story may have been w whole lot different. If the business had rented their data service centre instead, they would have saved money and might have continued their early success.

4. Rent rather than buy business premises

Following on from point 3 above, I would therefore suggest that no matter how tempting in the early stages of business growth, to rent premises. And even then to think very carefully about the size and cost of the business premises in question. You should also think very carefully about the length of your leases, together with having break clauses built-in to the lease agreement.

5. Watch out for fads or trends that are not sustainable

The biggest mistake that Crumbs Cake Shop made was to go head-long into a business that turned out to be a bit of a fad. Easy to say now in hindsight, but once again use their mistake to learn the lesson. Whilst it might not always be easy to spot a fad, be mindful of this being the case when you start any new business.

6. Invest excess cash wisely

Having cash for a ‘rainy-day’ is always wise advise. I certainly know this from my own experience. Looking at Zynga again, this entrepreneur invested $100 million in new premises, which could easily have been put aside instead. If the business had rented premises or data centres, invested more heavily in innovating new games and products, plus set a portion of the $100 million for a rainy day, things may have been a lot different.

7. Don’t stop innovating in order to stay competitive

All businesses should keep innovating, not just high growth firms. Innovation is what keeps you ahead of the competition. It also allows you at times to charge a premium for products and services, especially if your innovative product or service is unique to the market and in demand. This in turn makes the business increased profit margins, which in turn should convert to cash and therefore avoid the potential cash shortfalls that growth firms experience.

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