When you think of the businesses that drive the economy, what comes to mind? No doubt the tech giants come to mind – Amazon, Facebook, Google, Apple, Microsoft, and so on. Or maybe you think about long-standing corporations such as Exxon/Mobil, GMC, General Electric, and IBM (all of which are still in the top 50 of the Fortune 500). We know about them because they’re always in front of us, but they are not the true drivers of the economy. Smaller businesses of less than 500 employees are can-do engines that really keep the economy chugging along.

There are five stages of small business growth.

When it comes to generating new non-farm GDP (gross domestic product), more than half of it comes from small businesses. New jobs? 60-80% are created by small businesses. Innovation? Small businesses are doing it all the time, and file a lot more patents than you might think. Nearly half of the nation’s entire private sector workforce is employed by small businesses. Given these statistics, it’s important to understand the small business growth and the challenges faced by them each step of the way. This might sound like a fool’s errand given how much variety there is among small businesses. But there are patterns that do emerge where small businesses tend to experience the same kinds of challenges various stages of growth. Being able to anticipate those challenges could boost the survival rate among small businesses regardless of their current stage of development.

A Small Business Growth Model

Various frameworks have been suggested over the years for modeling small businesses, but they all tend to suffer from the same limitations. They tend to approach it as a do-or-die where if a business doesn’t progress through the various stages, it must necessarily die. They also don’t go into enough granular depth on the all-important early stages of starting up. Finally, they tend to boil “size” down to annual sales when there are many other important size factors to consider. In this article I’m exploring an alternative model put forth by Neil Churchill and Virginia Lewis back in the early 1980s that tried to correct for the deficiencies of previous models. They called it The Five Stages of Small Business Growth. Here are the five stages:

Stage I: Existence

The big challenge faced here is acquiring customers and delivering the product or service. How well the business does at this stage determines whether or not it can become a viable business. Not surprisingly, a primary concern is whether or not the business has or can get the cash it needs to make it through this stage. In this stage the business and the owner are largely synonymous and there will be very few employees. If the new business cannot gain traction with customers, or cash runs out, or the founder can’t hack it, the business will have to close or be sold (fail or exit).

Stage II: Survival

This is the stage where the business has shown it has enough customer traction and good enough offering to keep going. What comes into high relief in this stage is the intersection of revenues and expenses. The business has to bring in enough revenues to not just break even, but cover repairs or replacements of any key capital assets that wear out. It’s also going to be asking itself whether it can generate enough cash flow to not just stay in business but grow the business enough to generate a return. The organization will still be pretty simple. There will be more employees, and probably a new layer of management between the owner and the other workers. Formal systems and planning are still minimal. Businesses that don’t progress to Stage III can stay stuck in Stage II for quite some time. They may stay in business until the owner decides to retire, as is the case with many “mom and pop” operations. Ultimate outcomes in this stage for those that don’t go on are failure or exit (typically sold at a slight loss).

Keeping a close control on financial resources is important throughout all stages of business growth.

Stage III: Success

In this stage, things are going well enough (profitability) that the question is whether to go for expansion or keep things steady-state, which can free the owner up to do other things. The company that goes for the growth option becomes a III-G company while the owner who just wants to live off the steady-state successful business becomes a III-D company (the “D” means the owner essentially disengages from the company and lets it run itself). For the III-D company, good managers are in place, there’s enough cash on hand to make it through downturns, and professionals have been added for all essential business operations. If economic conditions change and a III-D can’t adapt, it will either have to close or could fall back into a Stage II survival existence.

If the company chooses to go the growth route, the owner takes whatever money is available (from profits and/or borrowing) and risks it on growth. While pursuing growth, however, the core business has to stay profitable to not run out of cash. This is because if the business does grow, it will need more employees and other things to make it happen. Managers have to be hired who are future-oriented rather than present-oriented. More formal systems and planning will need to happen, and the owner will be deeply involved in all of it. If the company can’t make it through this stage, outcomes include seeing the signs early enough to switch over to a III-D mode of existence, or potentially fall back into Stage II instead of total outright failure through distress sale or bankruptcy.

Stage IV: Take-Off

If the company’s growth effort starts to really take off, the primary concern is how fast it can grow and how continued growth will be financed. The owner is going to have to learn how to delegate to trusted managers/leaders or could end up holding the company back. Cash is still king, so the owner is going to have to decide how high a debt-equity ratio can be tolerated while conscientiously controlling costs and avoiding bad investments. The organization in this stage is often still pretty decentralized, but departments or divisions are beginning to appear, and key managers have to be good enough to head them up as complexity increases. In this stage the owner may be more separate from the business than before, but will still be seen as exercising a strong presence and control. The business that does well in this stage has a shot at going on to become a large business. There is also the option to sell it, and probably for a good profit. But this is also a dangerous stage for owners who can’t see they don’t have what it takes to succeed at this level. They might try to grow too fast and run out of cash or can’t let go of enough control for the company to work well. In some cases, however, a company can get past those situations by replacing the founder either voluntarily or in some cases involuntarily with the support of the company’s creditors and investors. If the company can’t move on to Stage V, it might find a kind of Stage-IV equilibrium, or could fall back into Stage III and even Stage II. And of course it could fail as well.

Stage V: Resource Maturity

This is the stage where the business has to take decisive action to counter the kinds of inefficiencies that inevitably crop up during rapid growth. Financial controls, good managers, and highly competent professional staff are key, as are solid tools and systems for budgeting and strategic planning, all while still keeping the entrepreneurial spirit. In general, however, Stage V means the company has arrived. It has size and resources working in its favor. Management has been sufficiently decentralized. If the company, however, does not learn how to keep the entrepreneurial spirit alive, it could slip into a kind of sixth stage – ossification – where there will be a lack of innovation. A major shift in the environment that catches the business not paying attention can do major damage if the company’s competitors were paying closer attention.

As you can see, there has to be a shifting of responsibility through each stage away from the owner and to decentralized, departmentalized management, which means hiring the right people has to be a top priority. Keeping a close control on financial resources is important throughout. It’s also essential to be developing systems along the way. In so many cases businesses grow faster than their organizational systems, which eventually kills the growth. With a better understanding of these five stages of small business growth, many more could be successful, which would be good news given their vital role in the overall economy.