Pitfalls of Growing Too Fast
A factor that I have often come across in my extensive career as an Insolvency Practitioner, is a company recently incorporated which has a successful first year in business, expands dramatically in its second year and comes crashing down soon thereafter. Often, although not always, at the helm of the company is just one youthful (between 25 – 30 years of age) director and shareholder. They often embark on the business venture with scant experience and without proper systems in place. Usually, the business venture is unsuccessful from the start, but sometimes they get lucky.
A matter, to which I was recently appointed to, is a case in point. The business, in the construction industry, was incorporated in April 2020 and for the year ended 31 March 2021, showed gross profit of $462,437 on turnover of $1,740,219. Net profit was $308,931. The balance sheet was healthy with cash in the bank and a positive net asset position.
The young director, flushed with success, decided to expand the business operation rather than consolidating on the first year’s results. The company tended for, and won, a number of significant contracts which caused it to grow exponentially. The company’s employees increased from two to nearly forty, and the volume of work increased from a single manageable contract to seven large contracts. Towards the end of 2021, the company started running into cashflow difficulties, due to defects, incomplete work, or similar issues.
The company was undercapitalised to embark on such ambitious projects and inexperienced at managing multiple large contracts. Rapid expansion is often accompanied by significant exposure to risk. Wages and salaries increased from $26,093 in the company’s first year to $632,446 in its second year. Turnover had increased by $5,072,355.87, but gross profit declined by $1,674,326. Net profit, however, declined by $2,373,027. The company’s net asset position had declined by $1,999,034 mainly due to a substantial increase in liabilities.
A sad tale of rapid rise and swifter decline. If only the director had sought professional advice before embarking on the ill-fated expansion of his business. If the director had consolidated on the first year’s success, I think that there is little doubt that the company would still be in business today and doing reasonably well. Instead, the company failed and the director faces bankruptcy due to personal guarantees given for certain of the company’s obligations.
Will the lesson ever be learnt?