Quality vs. Growth: Which Creates More Value?

Most business owners’ main objective is to grow their top line, with business advisors and consultants usually reinforcing this growth objective. Growth is a powerful value driver, provided that it aligns around a clear strategy, and that the organizational structure of people, systems, and processes are in place to support it.  

As a business owner, you might wonder:

• What if the organization is not properly prepared for growth?
• What if the growth is not aligned with the company’s strategy? What if there is no strategy?
• What if the growth represents a one-time project that might generate an attractive profit, but will not reoccur?
• What if the growth is at a significantly lower margin than your target, but is still enough to make the absolute gross margin attractive? Is all profitable growth worth pursuing?
• Where do I draw the line?  

The short answer is: It depends on your objectives.

If your short-term goal is to generate some cash flow to support other activities, then you would accept almost any growth that accomplishes your objective. However, if your goal is to build your company’s value, then it’s worth considering whether growth is actually achieving your objectives.

The quality of growth and the quality of the underlying organization are significant drivers of value. Consider this example:

Your company is of average overall quality and valued at four-times its $1.5M earnings ($6.0M). If you accept new revenue that generates a $300K cash flow, what’s the impact on value?

If it’s non-recurring or non-strategic business, you’ve likely only added the $300K of value to the company, since it wouldn’t generate any future value. If it is recurring and strategically aligned growth, then you might have created value at the underlying four-times multiple, adding $1.2M and bringing the total value to $7.2M.  

Instead, assume that you focus on the company’s underlying quality before adding any growth. As a result, you increase the value multiple from four-times earnings to seven-times earnings. The company’s value becomes seven-times $1.5M ($10.5M) instead of the original $6.0M, a 75% increase in baseline value without adding any new growth. If you then add the recurring growth of $300K cash flow, you’ve added value at seven-times the $300K ($2.1M) instead of four-times ($1.2M), bringing the total value to $12.6M, a large difference versus the $7.2M lower-quality value.

Quality impacts the value of your baseline business, as well as new business. On its own, growth only impacts the value of new business, and only to the extent of the whole company’s underlying quality.  

Quality Comes First, Growth Follows

Build your organizational quality and seek growth that closely aligns with a well-developed strategic plan. A higher quality, more strategically-aligned organization will accelerate your overall value multiple, and position your company to grow more aggressively as you successfully create the most value possible.

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