The Corporate Life Cycle: Preface

In every discipline, practitioners search for a framework that helps them explain the whys, the why nots and the what ifs of that discipline. In corporate finance and valuation, we have seen many such attempts to build universal theories, and in our view, the structure that offers the most promise is the corporate life cycle, where companies go through the cycle of being born, growing up, growing old and eventually perishing. It is one that we find ourselves coming back to, repeatedly, as we try to understand the behavior and misbehavior of businesses, differences across investing perspectives and the allure of the next big thing.

The Corporate Life Cycle

            The place to start this journey is with an understanding of how companies age, and the transitions they go through, and we try to do that in this picture:

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A business start-up is like a baby, with a high mortality rate, despite the care and attention paid to it. If a business makes it from concept to product, it is already an exception and in young growth, it tries to find a business model that works, with all logistical challenges involved. If successful, it enters the high growth phase, with revenues accelerating, though profits usually lag, and the business will require capital infusions to keep growing. The most successful of these companies will be able to enjoy high growth, where profits start to catch up to revenues and not only will these businesses be able to self-fund, but you see the beginnings of cash flow payoffs to owners and other capital providers. While the very best of these mature businesses can extend this phase of glory, middle age eventually comes to every business, with slowing growth, but solid profits and cash flows. Being middle aged is far less exciting that being young, but after middle age comes worse, as businesses age and find their markets shrinking and profits fading, before they reach their ends. The corporate life cycle resembles the human life cycle in its arc, and just as humans try to fend off aging and death with plastic surgery and personal trainers, companies do the same, with consultants and bankers offering them expensive and fruitless ways of staying young again.

Book Structure

            In the first part of this book, we describe the corporate life cycle, with the markers to tell you where a company falls in the life cycle, and the forces that determine why the shape and timing of life cycles vary across different types of business. We also look at the transition points, as businesses transition from one stage in the life cycle to the other, and the challenges that they face in making these transitions.

            In the second part of the book, we use the corporate life cycle to explain how and why the focus of a business should change as the company ages, with young companies almost entirely centered on finding good investments, to mature companies looking at changing financing mix and type, to declining companies deciding how to return cash most efficiently. We use this framework to argue that the most destructive acts in business occur when companies refuse to act their age, by behaving in ways that are incompatible with where they are in the life cycle, often spending large sums in this endeavor.

            In part three of the book, we use the corporate life cycle to illustrate the challenges in valuing businesses, as they move through the life cycle. With young companies, the biggest barriers are the absence of information on the working of their business models, and the uncertainties about how these models will evolve in the future. With mature companies, it is an over reliance on past information, and the assumptions that what worked in the past will continue to work in the future. With declining companies, it is the unwillingness to even consider the possibility that companies can shrink over time and go out of existence. In response, analysts often concoct short cuts and turn to pricing companies, using pricing metrics, where the scalar changes from users and subscribers for young companies, to earnings for mature businesses to book value for declining firms.

            In the book’s fourth part, the corporate life cycle comes into play in explaining differences in investment philosophies, and in particular, the divides between growth and value investing. Value investing, at least in the form that it is practiced today, with an emphasis on earnings and book value, will lead its followers to mature companies, and growth investing’s focus will be on companies earlier in the life cycle. In fact, the life cycle provides caveats for each group on the risks in each of their philosophies, with growth investors overpaying for what they perceive as young, growth companies, just before they transition to middle age, and value investors pumping money into mature companies, as they shift into decline.

            In the final part of the book, we look at other insights and extensions for managers, that can come out of the corporate life cycle. We first look at what makes for a great manager and argue that the one-size-fits-all narrative does not work, since the skill sets needed to run a young, growth company are different from those needed for a mature company. We also look at the dreams of rebirth and reincarnation that excite managers at mature companies, and the lessons that can be learned from the few companies that have succeeded and the many that have failed. We finally examine how the shift away manufacturing to technology have altered and shortened corporate life cycles, and why much of what we accept as good business practice has not kept up with these changes.