Methods of business growth
Businesses grow in two fundamentally different ways, and the specification asks for both methods and their impact.
Internal (organic) growth means expanding using the business's own resources — selling more, opening more outlets, developing new products. It is slower but the owner keeps control and the risk is spread over time.
External (inorganic) growth means growing by joining with another business. It is much faster, but expensive and harder to manage.
Common mistake
A merger is an agreement between two businesses to combine; a takeover is one buying control of another, and is not necessarily welcomed. Questions often turn on which one is described.
- Internal growth
- organic growth: expanding using the business's own resources — selling more, opening more outlets, developing new products; slower, but the owner keeps control
- External growth
- inorganic growth: expanding by merger or takeover, which is faster but more expensive and harder to manage
- Merger
- two businesses agreeing to join together to form one
- Takeover
- one business buying a controlling interest in another
Public limited companies
The specification names one type of business ownership for growing businesses: the public limited company, or plc.
A plc can sell its shares to the general public, usually through the stock market. That is the difference from the private limited company met in 1.4.1, whose shares cannot be offered publicly.
Why a growing business becomes a plc: it can raise very large amounts of capital by selling shares to anyone, which funds expansion far beyond what a bank loan would allow. It also raises the company's profile.
The costs of doing so:
• Ownership is diluted — the original owners may end up with a minority of the shares and can lose control. • Anyone can buy shares, so the company becomes vulnerable to a takeover. • Accounts must be published in full, so competitors can see them. • Shareholders expect dividends and a rising share price, which creates pressure for short-term profit rather than long-term investment. • The process of floating on the stock market is expensive and heavily regulated.
- Public limited company
- a plc: a company that can sell its shares to the general public, usually through the stock market, unlike a private limited company whose shares cannot be
Sources of finance for growing and established businesses
These differ from the start-up sources in 1.3.4, because an established business has options a new one does not — chiefly its own accumulated profits and assets.
Internal sources — from within the business:
• Retained profit — profit from previous years kept in the business rather than paid to owners. Free, with no interest and no loss of control, but only available if the business has been profitable, and using it means owners take less out. • Selling assets — selling equipment, property or a part of the business no longer needed. Raises cash without borrowing, but the asset is gone and the business may later need it. It also only works once.
External sources — from outside:
• Loan capital — borrowing from a bank, repaid with interest over an agreed period. Ownership is kept and repayments are predictable, but interest must be paid whatever happens to sales. • Share capital, including stock market flotation — selling shares, which for a plc means offering them to the public. Raises very large sums with no repayment and no interest, but dilutes ownership and commits the business to paying dividends.
Worked example
A profitable private limited company wants to open twelve new branches quickly. Recommend a source of finance.
- Note the scale: twelve branches at once needs far more than retained profit is likely to cover.
- Note the speed: the business wants to move quickly, which rules out slowly accumulating profit.
- Consider loan capital: available in large amounts and keeps ownership — but twelve branches at once means very large repayments before the new branches generate revenue.
- Consider becoming a plc and raising share capital: it raises the most, with no repayments, which suits an expansion that will take time to pay back.
- Weigh the cost of that and commit.
Answer: Becoming a plc and raising share capital, because the amount needed is large and share capital requires no repayments while the new branches establish themselves. The cost is diluted ownership, published accounts and takeover risk — so if the owners want to keep control, a bank loan combined with retained profit would be the alternative, expanding in stages rather than all twelve at once.
Before you practise
- Internal (organic) growth: new products through innovation and R&D, or new markets through the marketing mix, technology or expanding overseas.
- External (inorganic) growth: merger or takeover.
- Internal growth is slower but safer and keeps control; external growth is fast but expensive and harder to integrate.
- A merger is agreed; a takeover is one business buying control of another.
- A plc can sell shares to the public, raising large sums — at the cost of diluted ownership, published accounts and takeover risk.
- Internal sources of finance: retained profit and selling assets.
- External sources: loan capital, and share capital including stock market flotation.
- Internal sources are free and keep control but are limited; external sources are larger but cost interest or ownership.