Management Challenges During Growth and Expansion

The AllianceSeptember 16, 2005

John C. AplinCID Equity Partners

Growth in Organizations can create four major management challenges

Shift in the basic culture and foundation of the company

Loss of control in critical areas Quality Service and delivery Cash management

“Profitless growth” and financial crises

Strategic drift and loss of company focus

Creative and Maintenance Transitions

Organizational Cultures

Entrepreneurial(Creative)

Externally Oriented Line – Dominated Irrational/Emotional Intuitive Thrives on Change Ill-Structured “Action” is Philosophy Leadership is Norm

Administrative(Maintenance)

Internally Oriented Staff – Dominated Rational/Logical Analytical Threatened by Change Bureaucratic “Evaluate” is Philosophy Management is Norm

Addressing the challenges of cultural change

Restructure and reconstitute the management team

Invest in information systems and improve operational and financial control systems

Increase leader communications and presence

Understand priorities, plans and tactics and insure clarity throughout the company – maintain “focus”

Growth hides problems – continual critical evaluation and assessment of performance and operations

Loss of control becomes problematic

Managers do not have information about “key result” variables on a timely basis

Activity level overwhelms existing systems’ capabilities

“Must do” priorities force out “Should do” priorities

Coordination efforts deteriorate and integration problems arise

Mission, priorities and plans quickly become obsolete and “action” dominates “planning”

Addressing the control challenge

Fundamentally an information issue –review, evaluate and invest in IT systems

Consciously spend more time in planning, coordination, and communication

Establish easily tracked “key result” metrics and a financial dashboard to constantly monitor potential problem areas

Stay on top of everything to prevent a catastrophic control problem – there are no “little” problems

“Profitless Growth” Trap

Revenue

$ 5 million$10 million$15 million$20 million$25 million$30 million$40 million

Profit

$ 500,000$1,000,000$1,000,000$ 500,000

$0$ 500,000 loss“Work Out” Group

Constraints on a Company’s Growth

A company’s growth rate is generally perceived to be how fast it can increase its sales

A company’s financial dynamics, such as profit margin and asset ratios, determine its “sustainable” financial growth rate

The two must be in reasonable balance or a company becomes financially unstable

Sustainable Financial Growth Rate

SFGR = the rate of growth a company can finance without excessive

borrowing or raising newequity

Implications of SFGR for Growth Companies

If actual sales growth>>SFGR then eventually financial solvency is threatened

When SFGR is exceeded, owners must: Personally invest more money in the business Sell new equity to outside investors Continue bank borrowing (to a point) Reduce dividends and owner compensation Liquidate the company Sell to or merge with another corporation

Longer-Term Implications for Strategy

Watch for competitors and companies who don’t understand SFGR – acquisition candidates

Explore all sources of capital – develop options Banks Mezzanine groups Private equity groups

Develop and maintain “balanced” financial growth strategy to ensure stability

Strategic “Drift” and Growth

“Drift” occurs when a company loses focus on its core business purpose and unknowingly pursues actions or objectives because the opportunity arises and the “excitement” of growth and greater success gains momentum

Symptoms: • Aggressively seeking risky customers • Excessive customer concentration • Pursuit of opportunistic

acquisitions • Ill-conceived hiring plans • Failure to conduct regular strategic planning sessions

Avoiding strategic drift

Commitment and dedication to strategic planning and effective communication of “game plan” to organization

Critical analysis of all significant decisions and actions – “bullet proofing” the decision-making process

Utilize an effective Board of Directors with adequate outside members to insure objectivity and senior level attention on the basic company strategy and mission

Summary

Managing a rapidly growing company can be an extremely challenging endeavor

Leadership and management becomes critical during periods of turbulence and rapid growth

Prior financial and organizational success is no guarantee of similar success in periods of rapid growth and change

Growth and expansion is an exciting organizational dynamic and needs to be understood and managed effectively to assure financial and company success

John C. AplinManaging Partner

(johna@cidequity.com)

CID Equity PartnersOne American

SquareSuite 2850Indianapolis, IN

46282317-269-2350

“The Sustainable Financial Growth Rate”

Information to accompanyThe Alliance presentation on

September 16, 2005

John C. AplinCID Equity Partners

Exhibit 1a: SFGR Model

SFGR Model:

The rate of growth a company can finance without excessive borrowing

or issuing new stock

P = profit margin (%) retained earnings (%)

R = retention rate = net income

salesA = asset turnover ratio = assets (interest)

T = ______assets__________ (interest) beginning of period equity

g* = PRAT

Exhibit 1b: SFGR Principles

The sustainable growth rate – what it means: g* is the only rate of sales consistent with

stable values of the four ratios

If a company increases sales at any rate other than g*, one or more of the ratios must change

i.e. operations must improve and/or financial policies must be altered – “it takes money to make money”

Exhibit 1c: SFGR Example

Analog Devices, Inc. 1992 1993 1994 1995Required ratios:

Profit margin, P (%) 2.6 6.7 9.6 12.7Retention ratio, R (%) 100 100 100 100Asset turnover, A (times) 1 1 0.9 0.9Financial leverage, T (times) 1.59 1.81 1.89 1.92

Analog Devices’ sustainable growth rate, g(%) 4.1% 12.1% 16.3% 21.9%Analog Devices’ actual growth rate, g (%) 5.5% 17.5% 16.1% 21.7%

_________What if?__________ Asset Financial Both Occur turnover leverage 1.1 times 2.2 times_________

Sustainable growth rate in 1995 (%) 26.8% 25.1% 30.7%