The Sharks talk a lot about ‘scalability’; but what is it and why is it important to start-ups? And how does a good IP strategy come into play?
Scalable businesses can grow fast without borrowing or diluting shares. But how fast is fast? There’s actually an easy way to measure this. It’s called the Sustainable Growth Rate (SGR). Understand this formula and you’ll appreciate the power of intellectual property.
The SGR is your return on equity minus dividends. For example; let’s say you invest $100,000 to start a business, and you make $20,000 net profit after you’ve paid the taxman and your shareholders. Your sustainable growth rate is 20%. That means your business can grow 20% without borrowing more or issuing new shares.
Now for the fine print. There are actually other ways to improve your growth rate. However, they involve really tough decisions that may have nasty consequences. For example you could:
- get your customers to pay you faster
- take longer to pay your suppliers
- raise your prices
- lower your costs
- reduce your inventory.
Alternatively, you could sell your intellectual property. IP has no inventory costs. It doesn’t require warehousing or raw materials. Once it’s created, infinite copies can be sold or licensed at zero marginal cost. Last night the team from Headvert suggested the value in their business lay in a licensing model – they would allow other companies to manufacture and sell their patented paper hat.
Let’s look at the example of franchising. Many small business owners are happy with a 33% return on equity. Every three or four years they could afford to start a new business. However, by adopting a franchise business model and licensing their IP, they can grow much faster. That’s why successful franchises seem to spring up out of nowhere. All of a sudden, there’s a Boost Juice on every street corner.
Similarly, products like the Scrubba Washbag leverage the power of IP to create a highly scalable business. The raw materials, labour and overheads may only cost a fraction of the retail price. The remainder is usually the value-add of IP protection, and that has huge implications for attracting venture capital. Why would anyone risk money on a start-up that can only grow 20% per year, when another start-up (for the same risk) can grow 200%?
Shark Tank airs 9pm Sunday 17 May 2015 on TEN.
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