By Simon Philips, CEO, Scale Up Capital
As we look to recover from the pandemic and the economy starts to flourish again, we must ensure that small and medium businesses are properly supported. They are the backbone of the economy in terms of job creation, economic growth, innovation, and diversity. The UK benefits from a strong entrepreneurial culture, but many businesses stumble or plateau during their scale up phase, which is why, according to the OECD, the country ranks 3rd in the world for start-ups but only 13th for scale-ups.
Studies by Enterprise Research have shown that only 6% of UK companies with more than ten employees at the start of a three year period grow at more than 20% per annum over that period, and only 2% of start-ups grow to a revenue of over £1 million by the end of the three years. This failure to scale-up more companies means we are leaving prosperity and jobs on the table, and many worthwhile businesses are not fulfilling their full potential.
Many organisations have to make this difficult scale-up transition while being underfunded, because they fall in the funding gap between venture capital and private equity. Private equity investors look for more mature and profitable businesses that can be acquired with leverage, while venture capital investors are looking for big hits and hypergrowth moonshots. The result is that an emerging business with revenues of £1-£10 million, growing at 10-25% per annum and reinvesting all its profits to fund its growth will struggle to raise money from either the PE or VC community. Despite many small businesses falling into this funding gap, there are an increasing number of specialist scale-up investors like ScaleUp Capital who focus precisely on funding these types of companies.
But small businesses at the start of their scale-up phase require more than just funding: they need skills, support, expertise and a methodology. Research by Crunchbase shows that 83% of founders are doing it for the first time. Many founders are subject matter experts who know their product and market inside-out but have never scaled a business before. Founders who have done it three or four times before are twice to four times more likely to succeed. Therefore, alongside the funding gap there is a skills gap.
The scale-up phase is a tough challenge. These are the difficult adolescent years in the life of a business, during which it will undergo more change than during any other period. It will need to transition from a founder pulling all the levers to being run by a well-rounded management team. Processes need to be professionalised, systems need to be installed, and the product or service often needs to be upgraded to be made robust and scalable. Scale-ups need an injection of methodology, governance and expertise from external scaling experts to ensure they avoid the missteps that can so easily take the wind out of their sales.
Accountants are often the first to spot when a business is entering its scale-up phase and facing big new challenges. There are three areas in particular where accountants and advisors can help:
Find the sweet spot and focus on it – emerging businesses are often solving too many different problems for too many different types of customers. The trick is to laser in on the very best user cases where the product or service really nails the problem and is better than most alternatives in the market. Find that sweet spot product-market fit and focus on it.
Work on customer acquisition before the marketing – don’t invest in scaling the sales and marketing until the unit economics are strong enough. It is key to optimise before you scale to avoid a lot of wasted time and money. Keep working on customer acquisition until the Customer Acquisition Cost (CAC) is low enough and keep working on Average Order Value (AOV) and retention until the Lifetime Value (LTV) is high enough. Once the ratio of LTV/CAC is strong, then go for it and scale up.
Is the market large enough – make sure the prize is big enough. Small businesses can go all-in without making sure that there is a large enough market and before their processes and product are truly scalable. Work out the Total Addressable Market (TAM) bottom up, not top down – ask yourself what problem are we solving for what user case, how many companies have this exact user case and problem, and what will each pay to solve it. Get the selling and implementation processes ready to operate at scale.
At ScaleUp Capital, we have helped many successful companies reach scale and profitability, and we would like to see more investors involved in this exciting part of the market. Plugging the funding and skills gaps that are limiting these businesses is vital for the economy, and hopefully more investors like us will start to realize the potential of scale up companies.