The 3 Phases of Business Growth (and how they impact capital or being acquired)

At Hill View Partners, our focus on middle-market and lower middle-market mergers, acquisitions, and capital advisory has given us a deep understanding of the phases businesses go through as they grow. Businesses typically pass through three distinct phases of growth: the Trading or Arbitrage Phase, the Machine Phase, and the Enterprise Phase. Understanding these phases is crucial, as each one has a unique impact on a company’s ability to secure capital and its attractiveness for acquisition.

Early & Intermediate Stages

Phase One: Trading or Arbitrage

In the initial phase of a business, known as the Trading or Arbitrage Phase, the business model revolves around trading time for money. This stage involves buying something at one price and selling it at a higher price, a basic form of arbitrage. The founder is deeply involved, often doing everything themselves to generate profit. This phase can be likened to “Prometheus Starting Fire”—a foundational yet challenging period where the founder’s personal time and effort are the primary drivers of the business.

As the business grows, the main limitation in this phase becomes the founder’s time. There are only so many hours in a day, and the capacity to trade or engage in activities is finite. At this point, the business must transition to the next phase to continue growing.

Phase Two: Machine Phase

The second phase, the Machine Phase, marks a significant shift towards implementing processes and systems. Here, the business begins to resemble a machine with repeatable and scalable operations. Key processes in sales, execution, and operations are introduced, and additional people are brought in to manage various functions. The founder’s role shifts to focusing on high-return activities, such as product development or sales, rather than handling every aspect of the business.

This phase is characterized by a systematic approach where processes are fine-tuned to ensure efficiency and consistency. The business becomes less dependent on the founder for day-to-day operations, setting the stage for further scalability and stability.

Ongoing Growth & Impact

Phase Three: Enterprise Phase

In the third phase, the Enterprise Phase, the business reaches a level where it operates independently of the founder. This does not mean the founder is no longer involved; rather, the business can continue to function effectively without their direct involvement. The founder may still contribute to strategic areas like product development or high-level sales, but their presence is not critical to the business’s survival.

At this stage, the business has developed a robust infrastructure, with established processes and a capable team managing the operations. This phase signifies maturity and scalability, making the business more attractive for potential buyers and investors.

Impact on Securing Capital

Each phase of business growth presents different opportunities and challenges for securing capital:

1. Phase One: Trading or Arbitrage – In this phase, businesses often rely on asset-backed financing, such as lines of credit secured by inventory or receivables. The available capital is more conservative, focusing on the tangible assets of the business.
2. Phase Two: Machine Phase – As the business implements processes and generates consistent cash flow, it becomes eligible for cash flow-based financing. This includes equity or debt financing that considers the business’s ability to generate revenue rather than just the value of its assets.
3. Phase Three: Enterprise Phase – In this mature phase, the business has access to a broader range of financing options with improved terms. The reduced key person risk makes it more attractive to investors, leading to better financing conditions and opportunities for growth.

Impact on Business Exit

The sellability of a business also varies across the three phases:

1. Phase One: Trading or Arbitrage – Businesses in this phase are often sold through “aqua hire” arrangements, where the buyer primarily seeks the founder’s skills and efforts rather than the business itself. The founder typically becomes part of the acquiring company’s team.
2. Phase Two: Machine Phase – With established processes and a team in place, businesses in this phase are more conventionally sellable. The founder remains important but can be gradually replaced, making the transition smoother for the buyer.
3. Phase Three: Enterprise Phase – Enterprise-level businesses are the most sellable, as they can operate independently of the founder. The focus during the sale process is to ensure that the founder’s departure will not disrupt operations, making these businesses highly attractive to buyers.

Conclusion

Understanding the three phases of business growth—Trading or Arbitrage, Machine, and Enterprise—is essential for strategic planning, securing capital, and preparing for an eventual sale. Each phase has distinct characteristics that influence financing options and sellability. By recognizing and navigating these phases, business owners can optimize their operations, enhance their attractiveness to investors, and successfully plan their exit strategies.