Should Your Startup Prioritize Profits or Growth?
Paul Graham, Mark Suster, Jason Fried, and Paul Graham share their thoughts on the debate of profits vs. growth.
As programming languages become simpler and distribution becomes cheaper, starting up a company on the internet continues to become cheaper and cheaper. Until recently it was unfeasible to bootstrap a company, but nowadays more and more bootstrap companies are finding success.
This seems to go against high-growth strategies that companies like Uber, Slack, and Facebook have used to become market leaders. High-growth startups fund their growth with lots of outside capital that they pay back after saturating their respective markets and pivoting to a profit model.
We’ve stitched together essential excerpts from articles written by Paul Graham, Mark Suster, Fred Wilson, and Jason Fried that give their thoughts on this growth vs. profits debate. The full articles are linked to at the bottom of each section.
President of Y Combinator // Follow on Playbook
In the past, a startup would usually become profitable only after raising and spending quite a lot of money.
Ramen profitability is the other extreme: a startup that becomes profitable after 2 months, even though its revenues are only $3000 a month, because the only employees are a couple 25 year old founders who can live on practically nothing.
The main significance of this type of profitability is that you’re no longer at the mercy of investors. If you’re still losing money, then eventually you’ll either have to raise more or shut down. Once you’re ramen profitable this painful choice goes away. You can still raise money, but you don’t have to do it now.
The most obvious advantage of not needing money is that you can get better terms. If investors know you need money, they’ll sometimes take advantage of you. Some may even deliberately stall, because they know that as you run out of money you’ll become increasingly pliable.
But there are also three less obvious advantages of ramen profitability.
- You’re more attractive to investors. If you’re already profitable, on however small a scale, it shows that (a) you can get at least someone to pay you, (b) you’re serious about building things people want, and © you’re disciplined enough to keep expenses low.
- Ramen profitability is good for morale. A company tends to feel rather theoretical when you first start it. When people start to pay you significant amounts, the company starts to feel real.
- A startup that reaches ramen profitability may be more likely to succeed than not. Which is pretty exciting, considering the bi-modal distribution of outcomes in startups: you either fail or make a lot of money.
- If you don’t need to raise money, you don’t have to interrupt working on the company to do it. Raising money is terribly distracting. You’re lucky if your productivity is a third of what it was before. And it can last for months.
Ramen profitable means no more than the definition implies. It does not, for example, imply that you’re “bootstrapping” the startup — that you’re never going to take money from investors. Empirically that doesn’t seem to work very well. Few startups succeed without taking investment. Maybe as startups get cheaper it will become more common. On the other hand, the money is there, waiting to be invested. If startups need it less, they’ll be able to get it on better terms, which will make them more inclined to take it. That will tend to produce an equilibrium.
Is there a downside to ramen profitability? Probably the biggest danger is that it might turn you into a consulting firm. Startups have to be product companies, in the sense of making a single thing that everyone uses. The defining quality of startups is that they grow fast, and consulting just can’t scale the way a product can. But it’s pretty easy to make $3000 a month consulting; in fact, that would be a low rate for contract programming. So there could be a temptation to slide into consulting, and telling yourselves you’re a ramen profitable startup, when in fact you’re not a startup at all.
A startup’s destination is to grow really big; ramen profitability is a trick for not dying en route.
July 2009 Now that the term “ramen profitable” has become widespread, I ought to explain precisely what the idea…www.paulgraham.com
Fred Wilson (AVC)
Venture capitalist since 1987 // Follow on Playbook
If you have the ability to lose money because of the availability of outside investment, then you can and should lose money in the first three stages of your company’s development which are; 1) building the product, 2) shipping the product, 3) scaling the revenues. But once you have achieved those three objectives, I believe you should move on to #4 — getting profitable.
There is this idea that you can’t grow really fast and be profitable at the same time. There is also this idea that you have to keep adding engineering and product resources as you scale your business. And there is this idea that more salespeople equals more sales. I have found that all three of those ideas are wrong to some extent. And I have found that really strong execution in product, engineering, and sales, based on doing less, not more, and based on having a high performing team without a lot of baggage, will allow your company to grow fast and be profitable at the same time.
We have a number of portfolio companies that are now seven, eight, nine, and ten years old that for most of their lives have been unprofitable and focused on growing users, revenues, and the team. I have been working closely with a few of them in the last year or two to help them to change their mindset to get profitable.
It has been enlightening to watch what has happened with this cohort of companies. They have kept growing, sometimes at a higher growth rate than before the belt tightening. They are better places to work, more stable, more focused, and more successful. They are better companies and they are more valuable companies. They are easier to finance and they are easier to exit.
I would encourage all entrepreneurs and leaders out there to embrace the idea of getting profitable sooner than you might think you can or should. It’s good for your companies and it is good for you.
Mark Suster just put up a long post on this topic. His message is “it depends” and he explains the rationale for…avc.com
2x entrepreneur turned VC // Follow on Playbook
In any tech startup there is a healthy tension between profits & growth. To grow faster businesses need resources today to fund growth that may not come for 6 months to a year.
70–80% of the costs of most startups are employee costs so what you’re really talking about when a company is unprofitable is that they are growing their staff ahead of their revenue. If you don’t have a strong balance sheet and can’t hire more people that’s fine — but understand this may lead to slower growth. Thus the trade off between profits & growth.
Venture capital isn’t right for many business but if you do want to raise from a VC at some point you need to understand that often investors care more about growth than profits. They don’t want high burn rates but they will never fund slow growth.
If there was strong market demand for their product then this investment might pay off handsomely.
A company can increase its growth rate to attract more capital, innovate more on its products, do more marketing, capture more customers, lure away employees and often drive down profits for its competitors over time.
The next time somebody wants to slam Amazon for not being more profitable please explain this. Amazon is continuing to grow at such a rapid pace that of course it should take some of today’s profits and reinvest them in growth (or acquisitions).
If there is a company that can’t grow fast enough then they should do other things with their profits, like return it to shareholders.
There are certain topics that even some of the smartest people I talk with who aren’t startup oriented can’t fully grok…bothsidesofthetable.com
Founder & CEO at Basecamp // Follow on Playbook
So I thought I’d detail some of the reasons why we designed Basecamp, our company, to be profitable as quickly and consistently as possible.
No one ever went broke taking a profit
Unlike companies that reinvest all or most of the money back into the company every year, we take money (profit) out every year in the form of distributions (we’re an LLC). This means every year we take risk out of the company. Companies that keep reinvesting keep adding risk to their companies.
Profit buys you time and flexibility.
Profit is the ultimate flexibility because it buys you the ultimate luxury: time. As long as you remain profitable, you can go in any direction you want and take as much time as you need. But if you can’t generate enough of your own cash through operations, and you have to go outside to borrow or sell off pieces of your company to generate the cash you need to continue, then the ones you owe are the ones who own your time. If someone else owns your time, you aren’t free. And if you aren’t free, you can’t be flexible.
Profit protects you from your ego.
One of the easiest things to do in business is get ahead of yourself. To feel so grand! To be obsessed with growth and potential and “if only…”. To hire too many people, to take on too much rent, to do one too many things, to complicate your business by tying strings around your money. The list goes on. But when you set out to be a profitable company, you watch your costs. Profit creates reasonable borders and boundaries, and that’s a very healthy thing — especially early on.
Profits provide insulation.
When tastes change, when trends shift, when the markets flutter, funding freezes up. That happens whether your particular business is unaffected or not. And you might well be caught out in the cold and freeze to death. Remember 2008? 2009? The nuclear winters of funding? Those were some of our best years! Profits insulated us from jittery investors, and our customers still kept paying for Basecamp.
Profits are just simpler.
We’re still an LLC at Basecamp. The simplest pass-through structure you can have at our size. That means fewer lawyers, fewer accountants, less paperwork, less hoop-jumping. Keeping your corporate structure this lean means making time for much more interesting things, like building a better product. Having all of the company focused on either making a better product or supporting a better product.
Profits have gotten a bad rep. They’ve gotten maligned together with “creating shareholder value”. Could there be a more uninspiring mission for a business? So it’s no wonder that profits have gotten a bad rep, but it’s unwarranted and disproportionate. Profits should sue for slander!
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