Growth at all cost strategies aren’t working for startups. Here’s what is (and always has).
Written by Paul Bianco - Former VC @ ff Venture Capital, CEO @ Graphite Financial, and CPA.
The NY Times recently published a great article about the aftermath of the WeWork IPO fiasco.
For as long as I’ve been in the VC/startup community (since around 2010), the overarching narrative has been to put money into fast-growing but unprofitable companies with the hope that a “Knight in Shining Armor” swoops in to either put more money in at higher valuations, or acquire them before topline growth slows and the company begins to show its cards.
Now, the whole point of Venture Capital is supporting companies to help get them off the ground and accelerate growth way faster than a traditionally built business, which often means being unprofitable for an extended period of time. It doesn’t always work out, but when it does, it can pay off big. Some of these companies are sold for hundreds of millions or billions of dollars, so it’s easy to see how this sort of survivorship bias can occur.
And then a major event happens that startles the community.
Occasionally, a major event takes place that startles the community and forces everyone to take a hard look at what they’re doing. WeWork is likely to be that event and will have a healthy ripple effect through the startup ecosystem, with a shift in focus from growth at all costs to “profit-capable” business models.
Yes, there will be a shift in thinking. However, I believe a 180-degree change in narrative from “top-line growth at all costs” to “profit at all costs” is also the wrong approach.
This is an extreme oversimplification, but, at the end of the day it all boils down to a simple formula: if you are able to turn one dollar into three dollars, keep doing that. If you’re turning 1 dollar into 50 cents, stop doing that.
If you’re able to demonstrate that your company is only unprofitable today because it’s accelerating growth at healthy unit economics, then as long as capital is available at terms that are economically “worth it”, you should continue going down that path. If the answer is the company is unprofitable both on an absolute and unit economic basis, and will continue to be short of a miracle, major changes will need to be made.
This is all easier said than done. In future posts, we will dive into a specific playbook as to how to do this. It all comes down to determining if you’re a “Profit Capable” business.
Step 1: Determine if you are running a profit-capable business. Is profitability an option today? Is the company making a strategic decision to remain unprofitable as it invests in future growth? Can the company move to profitability and simply grow at a somewhat slower rate? If not, when will the company get to those levels? What revenue levels are required to make that happen? Will budget cuts to achieve profitability destroy the business at its current scale?
Step 2: Decide where adjustments need to be made and present this scenario to your Board. This requires a bottoms-up 3-statement financial model in which you can run scenarios. The calculus will be maximizing future value while minimizing risk to the business, employees, customers and stakeholders. Easier said than done. At this stage, you must have an honest conversation about if this move would just be kicking the can down the road, or if there is significant conviction still in the business.
Step 3: Determine if and when to act on these decisions. While these decisions can often be painful, there is a significant diminishing return those closer you come to your “cash-out date”. The closer you are to that date, even major cuts can immaterially extend runway.
Step 4: Moving forward. Messaging to your team, investors, and board that the company is in a much healthier position, and continuing the monitor the financials closely in the following months and quarters to ensure the business is tracking against the plan.
In future posts, we’ll cover the details of each of the above in an attempt to create a practical guide.
Shameless plug: I manage a company called Graphite. If you’re a Founder/early-stage startup that needs help with your finances/accounts, feel free to connect with me here. We’ve provided hundreds of early-stage companies a dedicated team of experienced finance professionals that serve as their complete or supporting in-house finance department.
Originally posted on Graphite’s Blog.