Profitability vs growth: what makes a ‘quality’ company?

At a glance

The hike in interest rates has meant securing funding to invest in growth is harder for businesses – so you need to place a greater emphasis on corporate quality.

Quality comes from the factors that drive the long-term value in your firm, such as a healthy cash flow, agility, innovation and intellectual property, in addition to strong profits.

To improve quality, you should look at what makes your firm attractive to clients and investors, and the processes and strategies that will build on this.

A recent refrain in the investment world is that the ‘growth at all costs’ era is over and ‘investors want quality’. Growth versus quality is a critical concept for entrepreneurs as they look to secure funding, build long-term value or prepare for an eventual sale. But what does it mean?

The period 2009 to 2021 was mostly characterised by rapid growth in share prices fuelled by low interest rates that made it easy for firms to borrow and invest in expansion. This growth was particularly fast in the 18 months to September 2021, with many technology companies growing revenues aggressively rather than focusing on short-term profitability.

But this has come to an end, as central banks have shifted their focus towards controlling inflation by hiking interest rates. This makes growth harder for most companies, as it costs them more to borrow money. It means they need to put a bigger focus on efficiency, profitability and other elements that contribute to corporate quality.

Growth versus efficiency

This doesn’t mean companies no longer need to grow. Venture capital firm Octopus Ventures summed up the changing attitude recently when it said: “Rapid growth is still important, as people still want to invest in growing businesses – but it’s no longer about growth at all costs. You want to grow efficiently, and you want good-quality growth.”

Speaking to SJP Entrepreneur Club, Malcolm Ferguson, Partner at Octopus Ventures, says in recent years, the valuation environment for businesses rewarded growth above all other factors. This led to considerable investment in growing companies in order to maximise revenues and therefore valuations.

But now the cost of capital has returned to historical norms, efficiency of revenue growth is relevant, he says.

This efficiency comes from each firm’s quality, the definition of which can vary with each company and sector. Essentially, it describes all the things that drive long-term value in your firm.

What is business quality?

Revenue growth can come simply from solving a problem for a particular customer segment. But once you achieve revenue growth, the challenge shifts to delivering value in a repeatable way and building quality, which will support your long-term sustainability.

Profitability is a measure of success, but one misconception is that improving quality simply means boosting profitability – it’s much more than that.

In addition to strong profits, a quality business has healthy levels of cash flow, agility, innovation and intellectual property. It also protects cash flow through strong credit and cost-control processes and protects intellectual property through patents, for example, as well as employees’ knowledge and skills by building staff retention.

Malcolm says that people are the biggest determinant of quality in your company.

“This means being obsessed about who you recruit and never compromising,” he says. “A successful start-up will have more aligned, motivated and unconstrained individuals compared to a large incumbent. They have no legacy infrastructure or bureaucracy holding them back and their minds are sharpened by understanding the razor-thin line between success and failure.”

How to improve business quality

Martin Brown, CEO of business-growth advisors Elephants Child, says a useful perspective when looking to improve your firm’s quality is to think about what makes your business attractive to potential clients, acquirers and investors. Analysing everything in your company through that lens will show you what drives long-term quality.

Quality is also about building long-term value in a structured way through better systems and processes, and mixing revenue streams to avoid over-reliance on one customer or product. Quality can also include better management of product lifecycles – for example, the way versions of a mobile phone are timed to maximise customer demand and satisfaction.

“A business will also need efficient capital structure to fund and support growth,” says Martin. “Consider a business that borrowed through bounce-back loans and other support schemes in the pandemic – as they emerge and set their growth plan, they may need to consolidate these and other debt instruments with funding that’s a better fit for purpose.”

Another indicator of quality is how you benchmark against your competitors and present testimonials, which provides solid evidence about your performance. Telling those stories is a powerful way to reinforce your quality.

Environmental, social and governance (ESG) also play into it. For example, are you working towards carbon neutrality and reducing waste? Are you improving your social impact through community and charity projects? Does your business have strong governance processes?

Another factor is understanding the risks in your business and being open about them. “Some companies say, ‘We don’t see any risks.’ But it would be odd if there were none,” says Martin. “Some also claim they are the next Facebook or Google, but that’s unlikely. Perspective and authenticity are important.”

Market cycles come and go. Ultimately, your firm’s quality factors can help you remain relevant long term and attractive to potential investors or buyers.

How we can help

If you need help growing your company, we’re well placed to help you because we can work with business consultants such as Elephants Child. Talk to us today.

We work in conjunction with an extensive network of external growth advisers and SME specialists, such as Elephants Child, who have been carefully selected by St. James's Place. The services provided by these specialists are separate and distinct to the services carried out by St. James's Place and include advice on how to grow your business and prepare your business for exit and sale.

Where the opinions of third parties are offered, these may not necessarily reflect those of St. James's Place.

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