Organic vs. Inorganic Growth – Pros, Cons, and an Investor’s Perspective
Every company loves to see growth – it’s a signifier of potential success and that things are “working” within the organization. However, not all growth is created equal.
In general, growth is considered either organic or inorganic. Organic growth comes from expanding your organization’s output and by engaging in internal activities that increase revenue. Inorganic growth comes from mergers, acquisitions, and joint ventures.
What are the benefits of each type of growth, and what type of growth do most investors prefer to see?
Pros of Organic Growth
Management knows the company inside and out. Since organic growth occurs in a relatively tighter-knit organization, management knows the company strategies and operations more intimately than an organization that has recently undergone a merger or acquisition. This means the company is typically able to adapt to changes in the marketplace more quickly.
Less integration challenges and restructuring. During a merger or acquisition, there’s typically restructuring of personnel and operations that occurs to manage the new volume of business. This can often mean layoffs, changes in the leadership team, and overall figuring out how to monitor more employees and assets. During organic growth, integration challenges or management/personnel changes are typically more gradual, which can feel more comfortable and natural for the internal culture.
Stay true to your dream. Without mergers or acquisitions, entrepreneurs have more control over the direction the business is headed.
It’s more obviously sustainable. Sustainable growth is the ultimate goal of any company. Without organic growth, there’s no investor interest, little possibility of becoming an acquisition target, and virtually no chance that the company will become vibrant enough to sell. Bringing in consistent or growing revenues is a sign that things are working within an organization and is an important step in business success.
Cons of Organic Growth
Growth can be significantly slower. Since there’s no infusion of market, product, assets, or resources, a company growing organically must do so at a sustainable pace. This means growth can’t overshoot the personnel, support, and resources available.
May decrease your competitive edge. We all know that the best way to succeed in any industry is to out-play your competitors. If your competitors are growing quickly or if your industry has high M&A activity, then growing too slowly can mean you’ll be quickly overtaken by competitors.
There is sometimes a glass ceiling. Businesses that rely on organic growth often find that they lack the resources to continue to grow in a way that allows them to achieve their goals. As business and customer needs grow, receivables and other cash-consuming items and resources grow as well.
Competition drives the market. M&A activity is like dominoes—once companies in an industry begin merging, it puts the heat on all the other companies to grow more quickly than is organically possible, or they may be left behind. Competitor’s influx of resources and business may allow them to lower prices or employ other tactics to steal market share, making it more difficult for smaller companies in the industry to grow.
Pros of inorganic growth
Growth is much, much faster. According to Quickbooks, many business nearly double or triple their client list with a business merger. Since this growth occurs through a transaction, this inorganic growth is much faster than is possible for organic growth.
Gain an immediate increase in market share. One of the greatest benefits of a merger or acquisition is the increase in market share. Through inorganic growth, you are gaining the benefits of an entire company’s prior sales and relationships, which means you’re immediately gaining markets and clients that you otherwise may not have had access to.
Increases knowledge and experience. By combining your company’s forces with those resources of another company, you are gaining the knowledge and expertise of their key players. This increased knowledge and experience means you have a stronger roundtable in making strategic decisions moving forward.
Create a stronger line of credit. It can be easier to take on debt financing after a merger or acquisition as some inorganic growth results in a stronger line of credit with the combined value of the two businesses.
Gain a competitive edge in the market. Your newfound resources, assets, and market share, means—if the implementation goes well—you will be a force to be reckoned with in your industry. You’re setting a new pace for growth that can push you ahead of competitors and give you a strategic advantage in pricing, purchasing, volume, and overall reach.
Cons of inorganic growth
Significant upfront cost. Funding a merger or acquisition usually means a sizable upfront cost. If your company doesn’t have cash on hand, you’ll likely have to rely on taking on debt, which can make the merger or acquisition less attractive to investors. If the integration doesn’t go well, this could also mean a lot of debt that you’re suddenly unable to pay off.
Management challenges. The sudden growth from a merger or acquisition generates complexities associated with properly scaling operations such as systems, sales, and support. Without proper management of growth, a merger or acquisition’s roots won’t be able to take hold and the integration will ultimately be unsuccessful.
Financial systems sustainment. There are plenty of operational aspects that an organization can fumble through inorganic growth. Since finances support all company actions and is a key for all future growth, not having systems in place that can sustain the new growth is a huge (and unfortunately common) mistake.
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Less control over the direction of the company. Combining forces with another organization means you often have less control over the ongoing company vision. It can also mean you grow in directions you didn’t necessarily anticipate.
Integration, restructuring, and culture differences. In the end, mergers or acquisitions rely on the buy-in of both parties for a successful implementation. If cultures are too different or operations don’t adapt to manage the influx of employees, resources, or sales, then the merger or acquisition will likely become unsuccessful.
What do investors like to see?
As is commonly the case, it’s not as simple equation of growth equaling good and more growth equaling better. If a company is showing slow (yet strong) organic growth, then that organization may still be more attractive to a company that saw significant growth due to an acquisition, especially if that company took on significant debt to acquire a company that had negative growth.
A common misconception is that inorganic growth will repair the currently declining growth of a company. It is typically more prudent to fix your company’s internal problems before taking on more customers and business. Remember the phrase, “Can’t get out from under a sky that is falling.” Your organization’s shortcomings and struggles will follow you regardless of growth, so make sure you’re in a stable position to take on more weight.
The ultimate question an investor is answering is how strong is the company’s story, and do they have the forecast, proof, and track record to back it up?
The key is formulating the best strategy for your organization and designing a strong business case around that strategy.
Utah & Becoming an Acquisition Target
Utah’s economy is becoming increasingly conducive to deals. M&A activity has seen drastic improvements since 2011, which only had 24 deals. There were 110 transactions with a combined $10 billion value in 2012, 173 with nearly a $6 billion value in 2013, and 196 with a $6.8 billion value in 2014. These deals have been driven primarily by a stronger state economy and low interest rates.
Leading these deals has been Huntsman’s acquisition of divisions of Rockwood Holdings for $1.3 billion, SanDisk’s acquisition of Utah-based Fusion-IO for $1.3 billion, and Warburg Pincus’ acquisition of Electronic Funds Source for $1.0 billion. An interesting fact about these deals and others in Utah is that the mergers often extend across state and even national boundaries. This allows them to enter into markets that would be impractical or difficult to enter alone and creates a lot of potential.
The ultimate takeaway is that the average fast-growing company in Utah has a greater chance of positioning themselves as an acquisition target for a larger company to grow inorganically. Consider which niche markets or advantages you hold and the companies that could benefit from buying your company rather than trying to enter your space and compete with you.
Whether you choose to grow your organization organically or inorganically, your greatest focus should be on doing so in the most strategic way possible. Formulate the best strategy based on your company’s current health, competition, industry trends, and financial capacity, then design a strong business case around that strategy by projecting short- and long-term financial forecasts. Having this level of detail for whichever strategy you commit to will give you a detailed blueprint to make the most intelligent decisions to support and sustain growth.
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Which strategy will work best for your company?
Are you unsure whether your company should grow organically or inorganically? Schedule a free financial consultation with one of our experienced CFOs today by calling 801-804-5800 or filling out the form below.
About the Author
Jerry Vance – Founder & Managing Partner
Jerry Vance is the founder and managing partner of Preferred CFO. With over 13 years of experience providing CFO consulting services to over 300 organizations, Jerry is Utah’s most experienced active outsourced CFO. Jerry specializes in forecasting, equity fundraising, cash flow diagnosis and solutions, and strategic advisement.