The business life cycle, also known as the business growth cycle, is the progression of a business as it passes through various stages in its operating life. The business growth cycle follows a business from the start-up phase as it crosses the breakeven point and begins to mature, slow, and eventually decline. Understanding these phases is incredibly important to investors, whether from a valuation perspective or to comprehend the future opportunity of a business.

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What is the Business Life Cycle?

Once a company is founded, it enters a series of phases known as the “Business Lifecycle”. All public companies continuously move through various phases of this cycle. Some companies follow a linear path from start-up to decline, while others continually innovate and experience extended periods of growth after maturity.

Understanding the Business Life Cycle is an area all investors should spend time on. By understanding each of the phases, the characteristics, the red flags, the valuation options, and the financial metrics, investors are better equipped to analyse a variety of different companies across various growth cycles.

By breaking down the phases and knowing what to expect in each one, investors can understand the risks and opportunities that each phase presents. Each business phase has its own unique set of criteria that an investor can become familiar with.

Whether it’s trying to understand and value a small startup business that has no profit yet or to value a high growth opportunity without paying an excessive price, each phase often has a few defining factors to be aware of.

When operating a business, the phases are important from an operational standpoint. There are unique challenges that each stage of the business life presents. Management needs to understand the phases to be prepared to navigate each cycle.

🖼️ The cover image shows a once immaculate mansion that would have been the centre of attention, yet it now lies in ruin and dilapidation. This is reflective of the business world where former growth opportunities mature, slow down and eventually decline.

Why learn Business Growth Cycles?

Every business and opportunity has a life span. It is rare to find those multi-baggers that we all read about, where an investor held onto a stock for decades. The business life cycle is shortening. While companies used to thrive over longer time horizons, their life spans are much shorter now.

One of the most challenging tasks for an investor is to identify where a company is in its life cycle and determine how long that company can continue delivering results until it eventually declines (if it does). Even value investors may be looking for dislocated prices among mature or declining companies, with the assumption that they will return to a more favourable position on the lifecycle spectrum.

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Nothing goes in one direction forever….

Howard Marks

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Before valuing and analysing a company, it is essential to understand where it sits in the growth cycle. This is one of the first things I do when looking at a business.

What phase is it in?

This can help in many ways beyond determining which valuation model to use. The longer you invest and understand the phases of the life cycle of businesses, the better you can understand the associated risks.

Understanding the risks of a business along various phases can help prepare an investment thesis more accurately. Different phases will highlight different areas to keep an eye on when analysing worst-case scenarios.

Assessing the phase a business is operating in can be challenging, especially for larger companies. For example, a company that appears to be maturing may be entering into a new growth stage, and sometimes growth companies are in the “operating leverage” stage. Each phase requires a different set of financial metrics to use when understanding the business model and the future operations.

The relationship between revenue and profits.

The entire business growth cycle revolves around the relationship between revenue and profits. Although there are many factors in each of the phases, the key metric is how a company progresses from an operating loss, surpasses the breakeven point to become profitable, then potentially returns to losing profits.

A startup aims to increase sales as its primary focus. Selling its products and services is the most important goal for any new business. Typically, a startup loses money as it spends its reserves to grow, scale, and establish a footing in an industry.

As the business starts to generate more revenue, it converts more top-line growth into bottom-line growth and surpasses a breakeven point to become profitable. The more the company grows and earns the more it increases profits, all things being equal.

When a business starts to mature it slows down its expenditure on expansion. This leads to more profits from the same or every little bit of new revenue.

Eventually, if a company does not look to stay competitive or innovate, it can result in declining revenue, reducing profits. This is a simplified explanation of the very typical path that the large majority of companies follow, assuming they make a profit at all.

The 5 Stages of the Business Life Cycle?

The life cycle of a business typically involves 4-5 phases that a business passes through. They are the startup or launch phase, growth or hyper-growth phase, mature phase and the decline phase. In between Growth and Maturing there also lies the “Operating Leverage” phase.

Not all businesses pass through each phase, as it is determined by the nature of each business. For example, some startups never become profitable and enter a growth phase before failing. Other companies experience rapid growth but never mature and go straight into a decline.

The length of each phase varies significantly depending on the type of business, the products or services, market conditions, the unique offering of the company, and the size of the potential market. To illustrate, a tech company with a large potential global market may stay in the startup or growth phase for many years. Similarly, a mature business with a strong competitive advantage (MOAT) can prolong its mature stage compared to other companies.

If a business does not adapt to changing conditions, innovate its products or services, runs out of cash, or encounters other issues, it may enter a decline phase swiftly. If it fails to pivot and attempt to turn things around, the decline will persist.

Each phase presents various challenges to a business. Even a mature, highly profitable company still faces the challenge of mismanaging capital allocation. Understanding the metrics of each phase allows investors to focus on the strengths and weaknesses, opportunities and risks, and the areas of analysis each phase demands.

🌱 Startup or Launch Phase.

The first phase is the launch or start-up phase. This is the initial stage of a business, during which it is established and begins to take shape. During this stage, the business is typically small, with limited resources and a focus on developing its product or service.

The primary focus is on revenue. Bringing in more sales is the key to being able to bring in more cash to grow. Sales may be slow or rapid depending on the type of business and the market it is entering. A good sign of a start-up is year-on-year revenue growth. Most start-ups are not profitable. They raise capital from investors or borrow to fund operations. There is a time-lapse between sales growth and profit. Cash flow is always negative, even if there is a positive working capital cycle. This is because all operations are typically paid for from funding activity.

The company aims to increase revenue despite incurring losses, then seeks to enhance operational efficiency and achieve profitability. The cash outflows are always higher than the inflows.

Many companies in the launch phase are also pre-revenue (which is another story altogether). They are companies that may be developing a product or service or need funding for research and development. These are very high-risk businesses.

The risks and challenges are numerous in this phase. From failing to gain market share, the market not accepting the products or services, funding issues, competitive threats, and tough market conditions. Time is the enemy of a start-up. Start-ups often fail due to funding restraints.

In this phase, proving the business model is incredibly important. Market adoption can determine the future of a start-up business very fast. The business needs to be unique, have a scalable business model, have strong leadership or founders, be well-resourced, and be resilient.

🚀 Growth Phase.

As a company progresses beyond the startup stage, it enters into the growth phase. During this period, the business experiences expansion and increased sales and revenue. Its focus is on capturing a portion of the identified Total Addressable Market. The company may still be experiencing losses and negative cash flow as it allocates resources to scale.

Effective management of cash flow and working capital is crucial to sustain growth, meet financial obligations, and continue expanding. Companies in this phase have already proven their product, service, and business model viability and acceptance in the market. The primary objective at this point is to increase revenue. Investments are heavily directed toward accelerating business growth, with all generated cash flow being reinvested into the business.

Significant expenditure on marketing, sales, research and development, and capital expenditures is common among growth companies. These strategic expenditures are aimed at establishing a strong foundation, capturing market share, and maintaining it. Year-over-year revenue growth is accelerating, leading to a continuous cycle of growth.

At this stage, a business begins to approach the breakeven point, where it starts earning more revenue than it spends on growth, resulting in a profit. However, cash flow may remain negative for extended periods, as the company continues to spend significantly on operational and investment activities, leading to higher cash outflows than inflows.

As the company becomes more profitable, it can reinvest its earnings without relying on external capital. Achieving economies of scale becomes crucial in the growth phase, while improving margins is also a key focus. Starting with a high gross margin allows for greater improvement in net profit margins when operations are optimised.

📈 Operating Leverage Phase.

The self-funding phase is a short phase that occurs after the Growth phase and before the Operating Leverage and Maturity phases. During this phase, a company focuses on generating profits from the revenue it has been bringing in. Once a company reaches the breakeven point, expanding that profit becomes crucial. Maximising profit is essential for every business in the long term.

Not all companies enter the operating leverage phase. In this phase, a company focuses on efficiency, prudent capital allocation, and reinvestment into core areas while reducing heavy investments in marketing, research and development, and other areas that were required to scale.

Fixed costs stabilise, resulting in the overall costs starting to taper off. As a result, more of the top-line revenue flows through to the bottom line. Revenue at this stage slows down as the company has established a foothold in its market. This is the stage where a company begins to convert all that revenue into bottom line profit, which can grow very fast as a result.

This is the real turning point for a company, and identifying companies at the beginning of this phase is quite challenging but very rewarding for investors. The Operating Leverage phase usually follows a company that has had years of consistent growth, a track record of making the right decisions at the right time, and the metrics to match it.

Typically, a company in the early growth phase has a strong gross margin. This gross margin however does not flow down the income statement. It is reduced as the company spends a lot on all the operational activities outside of the core activity (i.e., costs of goods sold).

Over time, as a business stabilises costs more of that gross margin is retained and flows to the net profit margin.

👴 Maturity Phase.

In the maturity phase (capital return phase), a company has stabilised and reached its peak. This is evidenced by having an established and loyal customer base, a strong reputation, and a solid market position. Revenue is recurring but may be slowing down.

This turning point is reflected in the cash flow statement, where operational activity starts to turn positive and investing activity slows down. This happens when the net profit margin on the income statement increases and begins to convert into cash. A mature company can still grow but at a much slower rate.

Profit margins may also begin to shrink, and cash flow can either remain strong or stagnate. A mature business can enter the Free Cash Flow phase, with the option of distributing earnings back to shareholders through dividends, share buybacks, or paying down debt.

If the company has further growth prospects, it can continue to reinvest in new opportunities, or through the acquisition of other companies. Capital allocation is incredibly important at this stage and can either extend the life of the business or lead to decline.

A mature company does not need to spend a lot to continue earning cash flow. Sometimes, mature companies that reinvent and create innovative business segments or products can reignite another growth phase.

From a financial perspective, companies in the mature phase can usually self-fund, don’t require a lot of debt, and are stable companies that have been around for a while. Understanding this phase is incredibly important for investors. Evaluating whether a company can remain a cash flow machine, spark a new growth cycle, or whether the business will be disrupted and decline is key.

The maturity phase can last for long time horizons without growth prospects, especially for strong companies generating a lot of free cash flow.

📉 Decline or Rebirth Phase.

The decline phase can be detrimental to a company, and some businesses might not even reach the maturity phase. Instead of advancing through a natural growth cycle, companies can start declining due to various reasons. In this final stage, a business begins to falter and eventually cease operations

It may struggle to retain customers leading to declines in sales, profits, and cash flow. In an attempt to prolong its lifespan, a business may try to make a turnaround. Some businesses may also experience a Renewal/Rebirth stage, where they are able to revitalise themselves and regain their momentum.

There are several reasons why a business might experience decline, including loss of competitive edge, market saturation, mismanagement, poor capital allocation, lack of innovation, or failure to adapt to changing consumer preferences. Businesses that fail to keep up with evolving market dynamics often meet their downfall.

Signs of a declining business typically include consistent year-on-year sales decline, shrinking margins, and an overall reduction in available cash flow. Excessive debt can also prove to be burdensome for once-stable companies. A high debt load combined with changing market conditions can create unforeseen pressure on the business.

A strong balance sheet is crucial for a successful turnaround. Identifying areas for improving margins, cash flow, and potentially discontinuing underperforming business segments is the next step. Sometimes, expansion into new regions or strategic pivots may backfire, leading to business setbacks.

This can be the hunting ground for the disciplined Value Investor sifting out the most compelling opportunities and avoiding the value traps and companies that respectfully deserve to perish.

Valuation of different phases.

📖 Prior Reading: How to Value a business?

It’s important for investors to understand the valuation techniques required for each phase of a business. Different valuation models are more suitable for different business models and stages. Knowing which model to use for each phase is the first step in valuation and analysis.

To help understand the best valuation techniques for each phase, I have organized them into a table. There is no one-size-fits-all approach to valuation. Each phase has different characteristics and financial metrics to evaluate. Once you understand the phases, you will be better equipped with the right tools for the job.

Phase	Valuation Models	Why?
Start-up Phase	Total Addressable Market	It’s hard to value pre-revenue or early-stage revenue companies so we can only determine a hypothetical analysis to value the “IF” it pulls this off what is a likely value. No earnings makes other multiples pointless.
Growth Phase	Price-to-sale ratio or Multiples Valuation Analysis or Forward Price-to-Earnings ratio.	Growth companies with sales are primarily valued through multiples analysis, which is the best approach for valuation when comparing opportunities, in addition to TAM analysis. If there are earnings than a P/E can also be used.
Maturity Phase	Price-to-Earnings Ratio or DCF Model or Reverse DCF Model or Dividend Discount Model	A variety of valuation models can be applied here, including FCF ratio and standard DCF models. This is due to the availability of earnings and often FCF or dividends, allowing for consistent figures for valuation and projection.
Decline Phase	Reverse DCF Model or Trailing Price-to-Earnings Ratio	Declining companies need to be valued with caution. It is best to use a reverse DCF because we can see what value the market has placed on the company and how that stacks up with reality.

How to invest along the Business Life Cycle?

Investing across each of the phases is important. Startup and high-growth companies can offer great long-term growth opportunities. Mature, free cash flow machines offer stability and potential dividends. Companies transitioning from growth to operating leverage phases may present great long-term quality compounders.

In a portfolio, having a diverse mixture of companies at different phases is another diversification tactic, just like industry, geographical selection, and asset class selection. Even owning declining companies that are significantly undervalued with solid underlying companies can potentially turn back into mature, stable businesses.

Investing alongside each of the phases is not an easy question to answer. One of the best ways to approach the business life cycle concept, aside from valuation and analysing the characteristics, is portfolio construction.

Each phase has its risks and rewards associated with it. A startup and growth phase business are riskier but provides a lot more upside for capital growth. A company in the operating leverage phase entering a maturing phase may be a great quality business to hold long-term.

A mature, stable free cash flow machine may be a solid core for a portfolio that can provide dividends or consistent long-term returns. Declining companies have their place under various circumstances.

So, from a diversification perspective, holding companies across different phases is a good way to spread capital with various hedges. Even from a core-satellite portfolio structure, you may hold most of your core in operating leverage or mature companies, with a portion allocated to growth companies, and a smaller portion allocated to “Turnaround Situations” or higher-risk startup companies.

Whilst not an exact science any of this, it just provides a different perspective to how I think about the Business Life Cycle and how I integrate it into my philosophy.

Business Life Cycle and Market Cap Size.

While there may be a correlation between phases and market cap size, it’s not always the case. During the launch and startup phase, you often find micro-cap and small-cap stocks. In the growth phase, you find a lot of small-caps, all the way to mid-caps and large caps, and at the top end of the maturity phase are large to mega caps.

In my experience, each phase can also be found within a particular market cap segment. For example, in the small-cap space that I work in, I’ve found that this segment can offer companies in various phases. There may be a small startup with no revenue, or a rapidly growing small-cap, and even a maturing small-cap that is returning dividends as it continues to gradually grow.

The key lies in the underlying fundamentals that drive the business. A small-cap may be a quality growth company already generating FCF and highly profitable. Therefore, while all this may sound confusing, the phase a company is in will be determined by the relationship between revenue, profit, and cash flow more so than the market cap size.

In Summary…

The business life cycle can be expanded on in many ways, which we will explore over time. However, this should give you an initial understanding how companies fit into a specific cycle.

I always prioritise checking the life cycle phase when considering a new idea. Analysing the financial statements, business history, model, market, and theme helps me estimate where a business stands. This information guides me in choosing the most suitable valuation model.

Determining the duration a business has been in its current phase is crucial. For instance, a startup that has been in a pre-revenue phase for 10 years signals a red flag. Similarly, a growing company that has been boosting its revenue for years without making a profit may indicate inefficient operations and potential future funding needs. Even with a mature company, I aim to understand its sustainability and potential for future growth, as well as any threats that could disrupt its stability.

Understanding the life cycle phase allows investors to focus on specific areas and make more informed investment decisions. It’s not just about refining skills such as valuation; it’s about efficiently evaluating companies that fit your investment criteria. I find that the business life cycle provides a valuable framework for organising ideas and improving the investment process.

🔑 The key takeaway is to identify the current position of a business. Then the best way to evaluate its value, and the characteristics and traits associated with each phase. Finally, assess the potential for the business to transition from one phase to another or even start a new cycle. One important question to ask after identifying a business at a specific phase is what it would take to move into a new phase?