Profitable: To Be Or Not To Be?
Mark Suster has a great post on this topic. In typical Mark fashion, it is long, with a lot of detail and substance. I highly recommend all entrepreneurs take the time to read it end to end.
For those who won't take the time to read it end to end, I'll summarize it.
Many high growth companies can be profitable. They have enough revenue to cover their essential costs and could easily decide to show a profitable income statement. But they don't make that choice. Instead they invest heavily in the business with the expectations that those investments will produce more revenue (by hiring salespeople), or additional products (by hiring engineers and product managers), or additional geographies (by hiring an international team), or any number of other value enhancing aspects of the business. The result of that decision is that the business loses money or simply breaks even (I prefer the latter approach).
There was a discussion of profits (or the lack of them) in the comments to the IPO Market blog post I wrote last week. A number of commenters pointed out that many web companies lack profits. I don't think that is actually true (certainly not for many that have gone public), but it is true that most, if not all, web companies are not optimizing for profits this year or next year. They are optimizing for the ultimate size of their businesss and the total amount of cash flow they can ultimately expect to generate when the business gets to maturity.
This is tricky stuff. If you are going to take all of your potential profits and reinvest them in the businesss in search of higher growth and greater profits in the future, you had better be right about those investments. And it is often hard for investors to see how those investments are going to pay off, so at times you can be penalized for making those choices. Right now the public markets seem to be paying companies more for long term growth than for near term profits, so it seems that public market investors (and VCs) are aligned in this respect. But that is not always the case. Markets are fickle. But the best entrepreneurs are focused on the long term vision and will invest in their businesses without paying too much mind to what investors want at any point in time.
Where is the full article?
http://www.bothsidesoftheta…it is linked to at the top of the post
Yes, taking the long view is so important. I would say that the #1 goal for a startup is growth. Nothing can happen if there is no sustainable growth. But early profitability doesn’t equal success because it could compromise growth.It’s difficult to generalize regarding when profitability becomes a necessity, but with good growth and a reasonable gross profit margin, everything is possible.
It seems like the real question here is of duration. When, as in within what time period, should a new business look to be profitable? I’d be very interested in hearing how you assess the point at which a business should be profiting and the ways you can recognize how a business is actually delaying or pushing off potential profits for (imagined) higher future profits.
a lot depends on the ultimate potential of the businessthere is no golden rule
Potential is tied to time horizon – these are great comments.How big / how soon = how much reinvestment?
Yes, it’s interesting to think about. Since when did sites such as Twitter start profiting? I remember people saying there was no way Twitter would be able to stay up without making a profit. I just started to see them advertise this year, so everyone who is saying to entrepreneurs to focus on profits. It goes to show you how one company can make it without making a lot of profits right away. What if Twitter advertised from the very start, would they be much more profitable of a company today or would its growth be stifled? Or, was building up the users more important then profiting.
i believe the latter is more important for a business like twitter
I would imagine twitter can be profitable any time they like (and probably already are).The greater challenge I see with a company like twitter is getting profitable enough to support their late stage market valuation. If you’ve got a market cap of $1B then $250M a year in revenue is great, if you’ve got a market cap of $10B it’s not.
How is Twitter making money?
The sell access to the firehose of tweets. They sell promoted tweets.
Thanks.Is this how a company like Adly fits in?
Mr. Market is erratic. Pschizofrenic even. Hard to live by his needs and his beliefs on what should be valuable. He sees the future only by looking at the past. A good example were the Yellow pages businesses. The market considered their profits to be a safe annuity and leveraged those profits up for near term gain. They should have been investing the near term profits in a new business because those safe profit streams were about to hit the buzz saw that is the Internet. But the people who were running those businesses (many buyout investors) we’re blinded by the historical steady cash flows and could not see the coming disruption and treated their cash flows as guaranteed. That ended badly. On the flip side, look at Bezos investing, heavily, in one new business area after another with great patience and persistence and success. Moral of the story? The market has no idea – Find a great entrepreneur and she’ll know what to do. Whether to harvest or grow.
If you want to learn one of the all time great entrepreneurs bullying a public market stories, read anything about Ted Rogers, Canadian business visionary.He ran a PubCo for years (over 10) that never made as much money as the analysts wanted. Then, all at once, they turned on the profit pipeline in cable & wireless phones. CASH COW!He was a character.
Any source material you can point to?
Have not read this…..http://www.amazon.ca/gp/aw/…
“They should have been investing the near term profits in a new business “Easy to say hard to do. Why? Because businesses are made up of people with specific skill sets as only one reason. You can’t expect a business that is essentially a cash cow and managed and filled by a certain type of person to have the insight and expertise to do what you are suggesting. And that’s exactly why they don’t. It’s possible but improbable. They are busy managing the day to day cash cow. They are older and have other responsibilities and other things on their mind. They are not young and aggressive. And this is exactly the reason why many family run businesses plod along for years until the new blood comes in in the form of young family members who try new things and take the business in a new direction. It rarely happens with the existing management. And of course a million other things like legacy issues that an existing business has that a startup doesn’t have that allow the startup to do things that an existing business can’t.As far as Bezos, that’s an outlier. He lost billions before becoming profitable. That strategy was no sure bet by any means. The business world is littered with business people that took chances and have failed. Many of the companies profiled in the popular 80’s book “In search of Excellence” look laughable in retrospect.http://en.wikipedia.org/wik…Companies are people. People get fat and lazy. Unless a monopoly the inevitable happens more often than not. The yellow pages, by the way, was a very profitable strong business for (as I calculate) well over 100 years. As far as this “Find a great entrepreneur and she’ll know what to do” I’d like to know your specific thoughts on finding a great entrepreneur.
Yeah, you’re right – excellent points. The turns in the road were obvious to a few but to those in the business, they were invisible and even had they seen them, they would not have been able to execute against building a new business.
Do you have examples of companies that the public markets seem interested in long term?I ask because it seems to me that public markets are extremely short sighted. Amazon tumbles after a bad quarter, Netflix gets clobbered while still maintaining growth numbers, etc. Now, I don’t understand the markets deeply enough to know that these hits aren’t really due to longer term concerns, but it does seem that way.Moreover, in the professional trading world, lots of money ends up in very short term investment (from seconds to weeks). Again, I don’t have a grasp of how significant that is, or how personal investment matches up with professional investment, but it does seem like that’s a pretty bold statement to make.That being said, I’m a 25 year old who doesn’t know anything about anything, so I’m really fishing for people smarter than me to give a bit of insight.
most of the software as a service enterprise web service companies trade at very high multiples while simply breaking even. they are reinvesting in their sales and marketing. and yet the market values them highly without much if any profit on their P&L
Thanks Fred, I appreciate the response!Part of the confusion was that I read your last post, which mentioned price to revenues, as P/E instead of P/R, and saw 6.6 as a pretty low number. Granted, I don’t yet understand how to distinguish long term investment from investing in a bubble, or where that line gets drawn.I tend to agree with your statement that a big first day pop is a bad thing, though my friends in finance disagree with me.
If you can scrap, and get to profitability before taking an investment, is that something you’d recommend? Or, would it be better to take that investment and grow immediately?
yes, i think that is very healthy. although it isn’t the profits that are most important. the revenues, revenue growth, and the coming together of the business model is the most critical thing. read suster’s post. he lays it out well.
Will do, thanks Fred.
“the coming together of the business model” is such a key statement. As you’re in development and growing your cost base, the financial model keeps changing until it reaches a certain stability.
What do you mean by “scrap”? Did you mean “scrape”, as in scrape enough money together to get to profitability? Not clear.
Or you meant scrap as in being scrappy ? 🙂
BTW, nice touch, Disqus team: For my last two comments above, the comment dialog box showed my earlier-entered values (name, email, etc.) from a few days ago – even though I haven’t logged into Disqus for a while. New(ish) feature, I guess. And cool.
I meant scrap, as an expression for hustle.
I know you can’t disclose specific numbers, but I’d love to see some ranges for how this has played out in your portfolio companies.Once a company has completed the “build a business” phase and could choose to be profitable, what types of companies go into the hole to scale up, and what types just stay at break even?
i would like to but i don’t have aggregate and anonymized data handy
Geocities comes to mind as one that you might be able to use for a future case study post…
Fred,Fortune favors the brave, the bold and the relentless… but good sense keeps you safe, employed and with a roof over your head:) The key is knowing how to balance the two sides of that scale and not be so carried away with the chase that you forget exactly what you’re chasing.I’m usually a lurker and have been for some time, but I had to comment on this post. We need to remember what the ultimate purpose of entrepreneurship should be, to create something that the community finds useful, and to make money doing so. My opinion anyway.I wish I knew how to search this blog, I’ve been trying to find a post in which you provided a tool/instructional site for learning how to program. Where / when was that posted?
Is this the one on Codecademyhttp://www.avc.com/a_vc/201… ? You can search on this blog or on google/ddg and add site:www.avc.com to your search string
Thank you William.
i hope you find the time to comment more frequently. i agree that balance is very important, and not just in business!i think this might be the blog post you are looking forhttp://www.avc.com/a_vc/201…
Thank you this is it.
First off welcomeHow do you find that balance?
Amen. It’s silly and shortsighted to focus on profits when going after a huge, greenfield opportunity.
If your company is going to take this route, you should take time to tip your hat to AMZN and Jeff Bezos. You should also tell everyone, like Bezos has done from day one, that this is your intention and why.Leaving it unsaid only leads to wild speculation. Even so the markets may still not like it. AMZN has only been rewarded, market wise, since March 09 and that could change in a heart beat.
AMZN dropped 14% after announcing that profits were down in Q3 results b/c of investment in the new line of Kindles.
Markets don’t like uncertainty.
You bring up a good point. The public or soon to IPO companies have to face this situation very differently from the private [with no imminent IPO in-sight] companies. I don’t think they can be compared though. Amazon, Pandora, Zynga, Groupon, Netflix, tech companies etc.. All have a very different kind of investor who do exactly what Mark Suster is explaining in his article. You have to look beyond the profitability. A good amount of people are investing in these companies and comparing them to a mid/large-cap stock that is already doing well and saying “Well they have profits, why don’t you?” And then they sell and buy into XOM or APPL…
They’ve been public since 1997 and seen a few moves in their stock.They have also pursued the low margin long term view from day one and have always been out front with it.
There is another advantage to not being profitable which I didn’t see discussed in Mark’s article nor here among the comments: taxes. I want to invest my money back into my company, not pay it out in taxes. There is a bit of a use-it-or-lose-it mentality that needs to go into the business, too.
great point Elia!
Not to take issue w/ your view but I have always thought that when you are managing for taxes, you are no longer really managing your business, you are managing the accountants.I hate taxes and have at times enjoyed almost insurmountable tax loss carry forwards so I am not the purest voice on this issue.Their is wisdom for all politicians in your statement — manage for success and let the damn taxes take care of themselves.
You are changing my comment pretty significantly, inserting meaning I did not make. I said nothing about managing for losses; I said it is another consideration.Given that, any company that isn’t considering tax implications to their decisions is not very well run. You are talking about paying out 40% or more of your cash profits to the government. As a start-up this can be a huge amount of cash, enough to fund additional employees, server farms, etc. You better treat this as a business expense and decide whether paying it to the government is a good use of funds.
“I said nothing about managing for losses…”Good, neither did I. Don’t know where you got that from.Your statement seems to support my experience and instincts — you can buy a lot of stuff w/ the 60% of profits you get to retain and you are not burning cash. Good things in the long run all.It is very difficult to manage to zero tax liability and to have a robust business that would otherwise generate a substantial profit.In any viable investment scheme, you never really avoid taxes, you simply delay them. The future long term profits generated by your short term tax avoidance will generate a tax liability that must be paid.
What about US companies that incorporate outside of US in order to avoid tax liabilities? Think Accenture for example. Elie, would you consider this as a viable option when considering taxes as part of your business strategy? And if yes, where?
The whole issue of tax policy pertaining to repatriation of profits and off shoring all kinds is an abomination of lobbying excess and the buying/renting of politicians.It makes me want to puke.We have created this problem with our absurdly high corporate tax rates.If you want to be listed on an American stock exchange, have American banking, have American securities laws, have American intellectual property laws and raise your family in America — then you should employ Americans and conduct your business in America.And pay your damn taxes.If you want access to the American marketplace, then you should have to employ Americans.I am as free market and capitalist as a guy can be but I am all about fair. And this is not fair.
The reality is we tax all the wrong things; why can’t we give start ups, or new companies (and the folks that invest in them) that have been in business 5 or less years, are profitable and are creating jobs tax free status for five years?The reason is because everyone would be finding loopholes or ways to benefit themselves.The reality is our tax code is written for large multi national corporations.All you hear is how “entrepreneurship” is our future and must be supported…well, the tax code would be a great place to start putting your money where your mouth is.I am currently being audited by the IRS and I sure wish I could learn to keep my mouth shut! I made a comment about “…ah, so you couldn’t crack those off shore accounts in Switzerland so you decide to come after me…” (said in a humorous way) and next thing I know the auditor is adding up all my deposits from all of my personal and business checking accounts and then claiming that I “under reported” income….Ah, so now I have my CPA and a tax attorney to pay for!Outside of the adding up of deposits and calling that “income” right now the IRS owes me money…..but after the expense of the CPA and tax attorney I will end up losing over $50,000….Imagine having to go through 3 years of deposits, one by one, and documenting what was sales, income, transfers, non tax investments, and or you wife depositing a refund check from some coupon……
Completely agree with LJM on this one. Companies that do this deserve to be barred from US businesses. It is easier said than done, of course, as I wouldn’t intend to bar, say, Toyota from doing business in the US.Keep in mind, though, that I am talking about much smaller companies than Accenture. My comment about taxes is regarding early stage companies and start-ups, not big companies. Every dollar is life blood at these stages and must be plowed back into the company or retained by the company for use in future years.Pay the government at some point, yes. You can’t avoid the tax bill forever. But early on I feel it is very important to avoid it as much as possible.
“You better treat this as a business expense and decide whether paying it to the government is a good use of funds.”How much of the profit made are you suggesting the company reinvest into the business in order to prevent the approx. 40% of the money from going to the government?
It is not a fixed thing. Taxes are unavoidable. LJM and I are to saying anything drastically different. All I am saying is that in the early days of a company life, cash is king and paying it to the government means you aren’t reinvesting it, this year or next, in the business.
Yes, yes, yes….The wonderful world of NOL and tax loss carry forwards; they can become an obsession and give all the wrong people decision making input much greater than they deserve!
You manage for shareholder value. At certain times of a firm’s life, there’s a large tax component to that strategy that’s nothing to be ashamed about. As others have mentioned, taxes have a huge influence on international strategy.
A bit of an oversimplification to be sure but not one I would find fault with or suggest is not correct.The real issue is time and timing. Shareholder value when? Today or 10 years in the future or a steady stream of “managed” improvements over a continuum of time a la GE and Jack Welch?Taxes generally do not go away and like the real estate developer of old who never paid taxes for decades by virtue of the interest and depreciation deductions and the character of his having been the “active” rather than the “passive” partner all that is accomplished is the forestalling of the eventual day of reckoning.When the day of recapture rears its ugly head, the piper must be paid and you will write a big tax check.Profits must be taxed and while it is certainly an expense which merits careful scrutiny and understanding it is not an element of the business engine which generates the profit in the first place.
“Shareholder value when?”Well played and simply stated…..so overlooked because most people are looking at today.
” forestalling of the eventual day of reckoning.”With the exception of doing a 1031 exchange of course in which you kick the can down the road even to the point where the property passes to someone else who pays the taxes.And in keeping in line with your thinking (having just done one) I didn’t do the transaction in order to avoid taxes but the avoidance of taxes was icing on the cake of an already good opportunity. And I agree 100% with your statement made in another comment ” manage for success and let the damn taxes take care of themselves”. Not that you don’t factor in taxes into a decision of course. But when you start to make a decision primary based upon a tax consideration that’s when I’ve seen many people run into problems. (Similar to people going into a store and buying things they don’t need because they are on sale).
The 1031 exchange and a spot of estate planning is an incredible way to pass wealth along to the next generation and actually cheat the tax man in the process.The 1031 exchange forestalls the tax liability while you live and the stepped up basis snuffs it out when you die.The only thing you have to worry about is to ensure that you have the right ownership entity to actually execute a 1031 exchange and to have an estate less than $5MM now.Of course, to make it really work right, you have to die in the process, so the planning aspect is quite severe. Joke.
Dear JLMI feel I should write a love letter to you. Well it could be for many things….but let’s keep it to taxes for the moment.”when you are managing for taxes, you are no longer really managing your business, you are managing the accountants.”AMENI was captured and held hostage in a family RE biz for many years. Which included subservience to the tax man via my cousin who manages business via taxes.I divorced him and my family on paper via our holdings. Divorced the husband after. Divorced many others in the process. Very happily unmarried now.53 weeks ago I quit RE, paid taxes specifically to get on with my life, doing other things. Which have now, in the past 53 weeks, brought me a quantum leap farther ahead and so much joy I might cry that I love my work so. Even the parts which flummox me, I love them too.At least 95% of this is NOT thinking about taxes. I hired a new CPA for my new life. My old life was 2 CPA’s who were great, but I needed new DNA. My new CPA said to the referring party he was scared of me (partly in jest) – the most tax informed client he ever had. And all I could say in return was what an f***ing waste of my brain knowing tax code rather than creating content.Make money. Pay taxes. Feel Lucky. Continue.We pay way less than Europe. Are we so cheap?? And still we lust their lifestyle?? Drink wine at lunch and take fast trains and have x weeks vacation, blah blah blah….Anyways, thanks JLM for calling out the tax thing. Man, does it go up my ass like a rocket. Could send you a GREAT picture of that image too. But I really sense a certain affinity to you on this point, and its a really important one.
Amen! Totally agree with ‘Make money. Pay taxes. Feel Lucky. Continue.’ That is the spirit!
I feel like my comment is being mis-construed. I am not anti-tax (nor anti-American to go with it). I understand it takes taxes to make a country go and give us the benefits we enjoy to make a company happen here.Given that, in an early stage company, cash needs to go back into the company to make it grow, whether that is cash this year or next. I would assume that the company you were involved with was way passed the early stage growth phase. My argument doesn’t apply to that situation
I will wait for JLM to chime in and agree or disagree with me on this…..but my feeling is that he and I are talking about a mentality whereby taxes are treated as an additional, avoidable, burden rather than the price of doing business, and the price of living in that place you do business.I just completed an exit on a 1031 series of exchanges that went on for decades and I had a ballistic tax bill. My cousin decided to stay in RE and right now he’s getting clobbered, which is too bad, but I feel inevitable due to his tax stance.I would call my exit a ‘reverse pay window experience’ in terms of cash, but it was the rainbow and the pot of gold in my life that allowed me to follow my passion.I will desperately need cash, and the reinvestment you speak of into my new business, which is chugging on after tax funds. But I will never go back to the place where I am so good at reducing my tax bill that I hit alt min all the time. I’d rather invest time in creating value than avoiding expenses.
Thank you. Good to see someone bring this up. There is an artificial disincentive to save profits, or at least report them, because Uncle Sam reams you if you do report profits at tax time. This is particularly difficult for start ups or small businesses. It’s a policy attempting to engineer new hires, employee profit sharing, or B2B spending which isn’t surprising for a consumer driven economy and political culture that discusses vague things like “job creation”. Then again, there are many other things that impede employment. So where do you go with profits? Back into the business. It’s almost like the decision has already been made for you.
I am changing my opinion about corporate taxes. I am starting to think we shouldn’t bother and, in exchange for the elimination of corporate taxes, also eliminate (somehow) treating corporations as people. I am not final on this one but something I have been kicking around in my head for a while.
If a reason for corporate personhood is to protect the personal assets and finances of its officers and employees from civil litigation, then what would the compromise for that be?
The Supreme Court gave corporations personhood status so it can enforce contracts. Many believe that a corporation is granted person status because a corporation is made up of people and therefore a corporation is just an organization acting on the will of the people running it.The compromise would be to restrict corporate personhood to enforce contracts only in exchange for tax-free status. The people working for the corporation would pay the taxes. By making this change we would potentially be able to fundamentally restrict corporate lobbying, potentially changing the way government operates. If corporations aren’t granted the rights of individuals then things like free speech don’t apply to corporations, just the people within the company.Like I said, nothing solid. Just kicking it around in my head.
Ummm… Could you elaborate?
I outlined my thinking in a quick response to Otto, who also replied to my original cryptic post 🙂 Hope that does a better job of explaining my (potential) line of thinking.
Thanks for taking this one deeper Fred…I was asking the same of Mark last week and I’m really happy to get both of your perspectives on the topic. In the end, I heard most of what I expected and got good insight to boot.I believe wholeheartedly in the fundamentals that both you and Mark present, I think it is clear however that honest discussions about profits and strategy regarding them are generally lacking in the press…this has been a refreshing give-and-take.
You are right on when you say this is tricky stuff. This decision, like so many others, comes down to how much you believe in the founders and management team.If you believe in the team, you are confident in giving them your money because you think that they are going to spend it in a way that adds value. If you are a real investor and not just a trader looking for a quick pop, you want them to spend money to grow.
I think the key to all of this is knowing what the market (in this case defined as the market you are selling into) is doing. That is something you must know. Not hope or guess. You must always be testing, watching, and adjusting.Like all things you can make mistakes to either side:If the market is growing like mad and scale means lower marginal costs worry only about growth, if you don’t invest tons of capital you will get passed by.However, I always take the Entrepreneur view: The worst lie is the lie you tell to yourself. Hope is not a strategy.So if you just blow through money hoping that will build the market, it will not. I would love an example where somebody blew through money and built a market, I’m sure somebody must have one. However, usually it is the confluence of several events or technologies that enables a market to flourish. Not just blowing money.Understand from a VC point of view, money really is only useful in the first case, because that is where you can get the returns you need for high risk capitial.But there have been contrary examples SAS comes to mind.
“hope is not a strategy”that is one of my favorite lines ever. so true it hurts.and also a great point about knowing your market. that is what differentiates the great entrepreneurs/CEOs from the rest. i think getting out of the office and talking to users/customers/etc is the best way to do that
Also a great line: ‘The worst lie is the lie you tell to yourself’. Disciplined thinking is a must.
Exactly!!! Sitting in your office building complicated forecasting spreadsheets and beautiful board packets is not going to give you knowledge about the market and your customers.
Two things -1. Suster is spot on re investing profits back into the company to fuel growth. But let’s not forget pre-revenue companies – well before there are any profits to invest in growth, I believe you’d make the same argument: focus on growth; use VC funds to grow. Point being, it’s not even all the Econ 101 that’s lost on journalists, it’s more basic than that.2. This article on Forbes has been trending and seems on-topic:”The Dumbest Idea In The World: Maximizing Shareholder Value”http://onforb.es/vRtIR2
Jim, glad you raised this article. It was one of the most provocative business reads I’ve seen in a long time – inspired me to order Roger Martin’s book.To me, one of the key considerations would be what and when the expected exit might be – assuming there needs to be a liquidity event. It seems an IPO (these days) would certainly favor high growth, whereas an acquisition by a public company might prefer profitability.Of course, there’s those who would not advocate making decisions based on potential exits – but they probably don’t have outside shareholders 😉
Paul – Your comment closes with what I think is the most appropriate realization: Start-ups need to NOT focus on the exit. “Shoot for the moon. Even if you miss, you’ll land among the stars.”
Loving the image from movie Hugo of moon for this…
Hey pinky, how goes?Actually, I think the quote goes back some time. Not sure who said that.
Hey there. All goes well on vacation with daughter seeing movies,lounging, and playing games. Some great new games, which in turn inspire my work more. Hope you enjoy the holidays…
That article really is terrific. I just downloaded the book.On a side note, my gosh Forbes.com is an awful site. What a cluttered mess.
🙂 The article was very long!! As for Forbes.com, I think the new team have done some great things over there in the last couple of years. It’s hard to balance making money/pageviews AND not getting too cluttered (just look at techcrunch!).
In most of the cases all the money are not invested upfront to start a company. So it’s completely natural and the right way of doing it, to spread the investment through the growth of the company triggered by certain prove points.The accounting model is from the old world. It needs to change. In building a web company the main assets are the users times their lifetime value. So the costs per user should be considered investment rather then expense. Only the amount you spend more on a user then his lifetime value should be considered a loss.PS. You can have intellectual property as assets, but you can’t have 200 mil users?!?
You own your intellectual property (that’s why its called ‘property’). You don’t ‘own’ your users.Facebook is trying to push the envelope on this by taking ownership of everything users foolishly upload to their FB accounts. Ignorance is bliss, and they probably deserve each other.
Ofcourse they are different and you don’t own your users. But still there must be a way to show in your accounting the value of the user base. As it is now, a company with 1 mil users can have the same balance sheet with a company with 100 mil.
Under standard accounting, intellectual property – including patents, brand value, etc – cannot be counted as an asset if it was developed internally. It can only be listed on the balance sheet if you acquire it. Even then, intellectual property is subject to write-downs, and is not generally included by investors looking to measure a company’s tangible assets. Exceptions to this rule might exist for content rights, and for mobile patents under the current patent craze. The balance sheet value of a patents depreciates each year according to the remaining life of the patent. Generally speaking it is very hard to value intellectual property, and I am not an expert in how this is done.
Accounting numbers usually lead to bad decisions. Economic numbers are what’s important. I agree with your last statement about reinvestment decisions better be right. However, if we are investing in start ups, aren’t we investing in growth? So shouldn’t the entrepreneur reinvest with some good guidance? If I wanted a dividend, I’d buy a high yield S+P company.
**I hope I’m not committing a commenting faux pas by copying and pasting the comment I just put in Mark’s blog here (if I am…I apologize!), but I hope those who don’t read both could help answer my questions here***”The profits v. growth dilemma comes down to a long-term optimization problem where we sacrifice cash flow in period ‘t’ to maximize it in ‘t+1’, ‘t+2’…’t+n’ thinking that the present value of the marginal benefits of the future period cash flows is greater than what we sacrifice today. Mark also made excellent mention of using other stats as proxies for cash flow, so there might have to be a conversion rate between something like customer growth and revenue growth causing the stat across periods to not be the same.My (admittedly oversimplified) question is does this assume that at some ‘t+i’ period we will reach some “steady-state” where we stop making sacrifices and actually realize the full profit potential in said period? Does the need to continue to make the sacrifice Mark excellently described mean we never reach the point where we are maximizing earnings in the present? This could be especially true as more players enter the space that we have proven lucrative causing us to continue to re-invest in our company. This never ending cycle could lead us to never become the ultimate cash cow investors might wish we were…or believe we should be…or thought we would be when they made their investment. (I suppose this could also be looked at as one of them good problems.)I guess the ultimate question is, at what point do we know we’ve reached the “steady-state” period and we should focus on profits instead of growth? (i.e., what symptoms will our company show!). Fred, I don’t think any of the companies you are looking to invest in face this question (again, I could be very wrong)…but it would be interesting to learn how you advise companies in which you’re already invested about this dilemma.”
That is not a faux pas. Disqus should allow you do do it with one click
I was looking at the numbers and asking the same question myself. It isn’t something writ in numbers, so how do you know when??????
The tradeoff b/w profits and growth comes down to managing liquidity vs potential. You are optimizing value over the fuzzily defined term that will keep the major stakeholders in the company happy: investors, founders, key employees, key customers (in the case of an enterprise-focused company), etc. – or at least keep them from jumping ship. If you can raise more capital, you don’t need profitability to have liquidity (I mean liquidity for the company, not the founders). This is the VC model in a nutshell. Prioritizing growth at the expense of profitability is kind of like a high-stakes game of chicken or musical chairs with the financing markets. When the music stops the companies that can’t generate cash flow internally can only hope they have enough cash in the bank to make it to the next economic cycle. This is one reason for the massive follow-on rounds we are seeing in AirBNB, DropBox, Klarna, etc. (the other being to accelerate scaling course).
Thus Conscience does make Cowards of us all,And thus the Native hue of ResolutionIs sicklied o’er, with the pale cast of Thought,And enterprises of great pitch and moment,With this regard their Currents turn awry,And lose the name of Action.
source please.beautiful prose
The Bard in full flow http://en.wikipedia.org/wik…
of course. thanks!
Volatility is a major issue here – it really depends what you are doing with what you invest. Consider the following dimensions:Client acquisition – A company with repeat revenues (maybe SaaS) and very low churn rates might defer profits more rationally than one that must “take a client for what he is worth – e.g. someone re-packaging last years Xmas gadget via this years media channel”.Product diversification – A company with high brand awareness and a wider portfolio of products (some of which are proven winners) might reasonably invest a greater proportion in diversifying market from a successful base (think Amazon and framework providers).Brand Awareness – A product that has weaker differentiation (bottled water) might need to built a position- but the investment can be very vulnerable -( think poisonous Perrier).Vertical Integration – A company building relatively superficial product as a lacquer at the end of a long value chain might want to take control of upstream production (think Apple – if you must!)On the other hand, companies that are bleeding edge tech, fashion, sports, lifestyle suffer extreme vulnerability from substitutes (which can appear from nowhere) – so they had better make their money while the making is good.This last category seems a potential money-pit for long term investment, (on the other hand this is where luck can look really prescient — Some players in the VC market ??? ) – It is VERY hard to put the polish back onto an old technology (vinyl records = good exception) and these typically re-invent themselves on a generational basis, so today’s technology is tomorrow’s old technology.Perhaps this is why a ridiculed concept can explode out of nowhere if viable but “Mocked and Misunderstood” for a while first – Everyone is chasing the fashion curve but the canny investor is out in front.This is why a VC is not as good as his last deal, or his average deal, but his next one !Happy 2012 Fred and co – hope you pick some winners.
great comment. your point about a VC only being as good as his/her next deal is what keeps me awake at night and up early every day.
I think the choice for NEW startups often depends on the entrepreneurs attitude towards risk/reward. Are you the type of person that wants to apply for 50k in credit card debt on a large potential reward? Or do you want to experiment small and grow more slowly. There is no reason both couldn’t be in the same place in 5 years. The odds are against both people for different reasons. But swinging for the fences will probably bring in larger VC dollars. 🙂 http://www.kickofflabs.com, for example, is a small bet on the grand scale. Revenue exceeds our expenses, but we could probably be growing faster… but we’re testing the markets to find the lopsided dice first. 🙂
It is a wonderful choice to have to be able to choose to not be profitable and continue to invest in the long term opportunity. It’s is also important to think about the throttle on the long term capital spending – how much is being invested for tomorrow v today and want you would do with additional capital in both upside cases (a financing offer at terms too good to turn down) or to slow down in a downside (lack of financing alternatives) case.
rick h in the house!!!thanks for the comment rick. i agree that having this choice is a blessing
it is worth considering the relationship between volatility and time here. the volatility of everything is going up in our world; it is becoming more extreme in virtually all regards. the more volatility goes up, the more expensive long-term planning is. from this perspective i think delaying profits significantly is a bad idea for most startups — worse than it has been in years, if not ever. this is not the late 90s. and of course all these people trying to build infrastructure businesses are trying to build them atop the application layer in nation-state system. i believe that view is wrong and bets made on that assumption will yield negative returns. #fs
Very good point about the “relationship between volatility and time…”
not sure i’m with you on this one Kid
i dont know about anyone else on here – but who is actually faced with this type of decision right now? I know we are beginning to. I am going to guess that william M is also? clearer path to profitability VS scale?We’ve signed a significant enterprise to a pilot for our service. I can absolutely promise you that we did not set out to solve for what it is that they are using it for (challenge number 1). They represent an “enterprise” version of what we are doing – yet we did not build for and are not configured currently to support an enterprise sale, implementation, support program. (challenge number 2). But they represent an amazing revenue opportunity, and could be an early case study in our business model – that was not frankly obvious to us that it was there (challenge number 3).So do re-focus on this opportunity all-in? or keep going with our existing strategy? I have an advisor coming in today with a strategy consulting background – to help hammer this out – any comments would be most welcome!
this post might provide some insights: ( props to chris dixon for turning me on to this via his blog at cdixon.org )Moby dick theory of big companies : http://pmarca-archive.poste…
( wow i think disqus lost my first attempt at this response …anyhow )This post by Marc Andreessen might be helpful : http://pmarca-archive.poste…( props to chris dixon for pointing to that from his blog at cdixon.org )
ive tried to respond twice now ..and my comments are being disappeared ..maybe disqus is flagging me as spam?This post by Marc Andreessen might be helpful : http://pmarca-archive.poste…( props to chris dixon for pointing to that from his blog )
I just caught them.I wish I knew why this was happening.
thanks Shana! you can delete the other two dupes if you like 🙂
tough call markyou are going to decide on your long term business model right here and nowif you go for the money (and maybe you should), you are going to be a saas companyif you turn it down and keep going with your original strategy you may end up wtih a much bigger opportunity. but you may not.i can’t tell you what to do. but i do smell a defining moment arriving on your door.
well i’ll be dropping this on several VC’s this week – hopefully it does not come out as unfocused! we shall see.
Larger companies have this issue also. I’ve often been in situations where the first 3/4s of the year is all about making profit at the expense of revenue (i.e., not competing for projects the profit margin will be low on), and then for the last quarter when we’re near the profit target the focus changes… we buy revenue by sacrificing profit because now we scramble to make our revenue number after having given up business throughout the year. It’s stupid. Business needs to focus on long-term targets. Going bankrupt if obviously bad, and there’s a need to pay employees, but like with any resources.. you invest in getting more because the more investment you do early on the greater your potential later in the game. Companies sacrifice growth all the time chasing long-term meaningless targets.
A really interesting subtext of that article is that there is no way to look at the numbers and know which company is going to do better very early on. I guess this is why they say team is important.Then you need to know what makes for a good team, beyond the “a players” baseline. There are very different management styles out there….What would you all do?
Sorry, a day or so ago at Hacker News I saw and followed a link to Suster’s post and started to read. I got to:> Most companies (98+%) in the world (even tech startups) should be very profit focused.> Being profitable allows you degrees of freedom you don’t have when you rely upon other people’s money.and agreed so strongly that I wondered just what the heck more he was going to say that wasn’t fairly obvious. His “98+%” suggested to me that the probability he would have much that would interest me would be less than 2%.But, with this post by Fred, I returned to Suster’s article, kept reading, and saw:> The characteristics of somebody who should NOT focus on profitability include those who:> Have or perceive that they have the opportunity to build an immensely scalable businesses. Internet scale.> Have easy access to capital by investors who are committed to building businesses at Interent scaleI have problems with the second point: Why: Long one of the standard remarks about venture capital is that can’t count the venture capital money until the check is in the bank and has cleared. So, spending money now assuming that more will be available on good terms, or, really, any terms, in 6-12 months seems shaky.Suster went on to say:> As I like to say,> “If you’re really on to an enormous idea then other people in the market are going to spot that and want to compete with you.> If you have a market lead then raising capital and making investments now will help you as others enter the market.> If you don’t, somebody else WILL!”For the first, sure, others will WANT to.For the last two, Suster is assuming that naturally, of course, without significant difficulty others CAN “enter the market”. Hmm. He seems to be saying that there can be no technological barrier to entry, no technological Buffett “moat”.When there is no such “moat”, then, maybe okay. However, just today I saw http://highscalability.com/…with> PlentyOfFish Update – 6 Billion Pageviews and 32 Billion Images a Month> Date Tuesday, December 27, 2011 at 11:26AMSo, it’s a romantic matchmaking site, that is, without a significant “technological barrier to entry” and continues to grow quickly with apparently only meager staff and no equity funding.So, even without a “moat”, and with many competitors, good organic growth is possible. With a good “moat”, such growth should be easier.Seems to me that one should work to get some powerful technology, difficult to duplicate or equal, and valuable for the problem being solved.Such technology, then, becomes comparable in importance to what Suster is saying, and I would suggest that Suster consider it.
Nothing is fixed, everything is fluid. More interesting than a 9-5 zombie cubicle job.
True, in general; however, there are counterexamples.One, in particular, that I have followed is Complete Genomics ($GNOM). They provide a human genome sequencing service, and their stated model is precisely to grow big and think about profits later.From the very beginning I have been public that this was not gonna work: theirs is an easy to replicate and commoditize service and not particularly attractive. Customers in that space traditionally like to own sequencing machines, rather than send samples for sequencing. That’s just the particular nature of the market: think, in NYC it may better to move around on taxi than own a car, but that’s not the case in Omaha, NE. Sequencing has always been more of a “owning a car” market than “hauling a taxi”…The market was buying their thesis for awhile; in May the stock went up to $17, and around that time I said on a public forum that it would be $2-3 by end of year, only to be widely “mocked and misunderstood”. Today’s stock price? $2.60!So, sometimes it works as Fred says, but not always. There is such thing as “bottomless pit” in technology companies. $GNOM went through an IPO, then six months later a secondary, now they have filed a $100M shelf… Meanwhile the CEO is sucking fat salary, cashing on options, while investors keep pouring money in. As Buffet once said: “in the short term the market is a voting machine, in the long-term it’s a weight balance”
love that buffet quote
@fredwilson:disqus What’s your take on Twitter? Especially given it’s a portfolio company of USV.Per Mark’s article:>>”The characteristics of somebody who should NOT focus on profitability include those who: Have or perceive that they have the opportunity to build an immensely scalable businesses. Internet scale.” … “If you had huge customer growth but just didn’t focus on revenue that’s a different story. “I’d say that Twitter has achieved “Internet scale” but has not achievable revenues, let alone profitability.Is Twitter just an anomaly? Since it’s doesn’t seem to fit into Mark’s model of Profitably vs Growth given that it’s at massive scale (growth) but not profitable.
for some reason many people think twitter doesn’t have significant revenues. that is incorrect. i don’t understand why people have that impression
To Mr. Wilsons’ point, here is an article + video about the rev model :)http://www.businessinsider….
On the one hand I see many startups view profit as not instrumental in their development strategies, and on the other extreme, I see so many established technology companies with huge cash surpluses. Surely companies like Apple (which is reported to have more cash than the U.S Treasury), Google, Cisco, Microsoft etc) must have a far different attitude to profit than what I generally hear from within the daily cut and thrust of a newbie startups? Ten years ago there was the Jim Collins debate about “Built to Flip” vs. “Built to Last”. Today it is different debate – to profit or not to profit. My inclination therefore is still “TO BE” rather than not “NOT TO BE” when it comes to profitability – otherwise it makes no sense as to how I explain the underlying nature discussed in the following articles.Apples Mountain of Cash Grows to 81.5 Billionhttp://mashable.com/2011/10…Microsoft Spent Only 0.14% of its Cash on Aquisitions in Fiscal 2011http://thenextweb.com/micro…Cash Hoards Article on WSJhttp://online.wsj.com/artic…10 Cash Rich Technology Companieshttp://www.techgig.com/know…Cashing Hoarding without Slowing Innovationhttp://www8.hp.com/us/en/hp…Maybe I have a poor understanding of startups but there must surely be a profit linkage to “grownups” like Apple and Google, that must have always been present in the financial DNA of these now vastly cash rich companies?$M.
If it’s your first startup and it has gained some traction (great word) go for the profits and cash out.You’ll have learned a huge amount through ‘on the job training’, have money to invest on your next startup, and eventually you’ll also realize just how it was that you managed to fluke the success – experience gained normally comes at a price.John Doerr said it costs $30M to train a VC. How much to train an entrepreneur? Be lucky.
A question that is obvious but often ignored – Do high growth companies need an available retreat from investment positions they take. Some strategies represent a burn that is hard to extinguish – others are a well-controlled bonfire party. Compare perhaps opening a new market (a big step that must be followed through) with a major UI version release to improve UX. Both may grow business (one widens the funnel and another reduces churn) , But one assumes a longer program, the other can be tested and rolled back (or run in parallel). It is very tricky to “un-enter” a new market with credibility, and may have backers running for the exits.So perhaps it is gravitas of an investment team, as a key criteria, that allows the risk to be taken. – How do you measure this?, you check whether you believe backers really have your back – but trust cannot be bought, it is earned, so it is a good idea to be with a backer that has shown this preparedness… This world is a country mile from perfect market assumptions…If you look at perfect markets, (obviously in a text-book where they actually exist), it should not matter if you choose to return dividends or not. So – Is this whole post by Fred mute ?In theory the only thing that matters is increasing NPV. – So ignoring transaction costs (whoaa there – finding backers is not cheap !) – a company could return dividends and then later re-raise funds for re-investment. In reality decisive or single minded management (even though it can be and often is actually mulish inflexibility) is cherished by investors. On a few notable occasions, a management team is found that is big enough to put their hands up and admit they screwed up (and still have credibility) – Think of this as a late stage pivot – bloody impressive if you can stay big and lean enough to pull it off.This reminds me of a favourite phrase and which is good shut-up bean-counters” Theory and Practice are identical – In theory. “In economic theory VC’s are simply not required, they are am imperfect substitute for a perfect market (that does not exist) , In deed they are the arbitrage of risk that makes the market. Many over-paid, many incompetent, few real risk takers (personal survival stakes) but as a whole essential to wealth generation and employment. – And a few gems amongst them. So hardly surprising that they are concerned about “team” !PS it might be interesting to hear what David Skok makes of this – any metrics ?
Acredito que deve haver um equilibrio. O lucro deve ser buscado contantemente, porém investimentos de longo prazo são necessários para melhoria contínua do negócio. @willmovimak
I believe that there must be a balance. The profit should be pursued provided, however long-term investments are needed for continuous improvement of the business. @ willmovimak
Issue I have seen with some of my investments is the founders/entrepreneurs plow the money back into the business without giving enough thought and rigor to the required returns from that cash. An angel or VC backed business requires 40-50% IRRs. And sometimes what works with one sales person doesn’t automatically scale to 15 –> when you’re small all opportunities look big (and I’ve made that one myself). Entrepreneurs need to set up a rigorous screen to ensure that they’re not just plowing profits back into a not well understood or ill-thought out opportunity.And I agree with @JLM:disqus on the taxes, 100%. As my Grandfather used to say if you’re paying taxes at least you’re making money.
I can’t argue with a break even strategy that grow’s the business. Of course the hope is that some day soon your business will begin to generate profits as it curtails growth (every business hits a wall).Agree with JLM/Elia on companies that evade taxes indefinitely. That’s just as bad as stealing from everyone else who pays their due.
I have seen a number of companies use the goal of more growth as a sticking plaster to cover the fact that they have not succeeded in making a profit on their basic business. Managers and investors can be seduced by the bigger opportunity and not make the effort to get the core business model right.Growth may be the right option to exploit a new opportunity, but there should also be as much focus on managing the initial product/market to ensure that it is profitable. You can run a rough and ready P&L for the initial business on its own. It is a great discipline to instill in any company.Successful growth is much more likely if you have proved your base model and can build on a solid base. Also as you say, markets are fickle and a profitable base provides security if you hit difficulties.
I don’t think you have to be right about all the investments you make off your own P&L, Fred. You can treat them as a portfolio the same way VCs treat their portfolios. Only one or two have to work well for the overall investment dollars to make sense.I’d also add to this dialog that I think proving you CAN be profitable is a useful exercise from time to time. Management teams and VCs definitely both get “Operating Loss Fatigue” after a while. We were in and out of profitability twice over our first 9 years before deciding to remain profitable a few years ago.
super points. thanks for stopping by and making them matt
Fred, a very theoretical question. If you read Innovator’s Solution by Clayton Chirstensen, he talks about good and bad capital — and why for disruptive businesses, good capital is one that is “patient for growth but inpatient for profit” in order to early on find the “right” market and channels and so on (I can explain more if you haven’t read the book). I wonder though whether and how the theory applies to most consumer web based startups though… many examples, 4square, Twitter.. would make no sense to be inpatient for profit early on. Thoughts?
more context on the theory:- being impatient for profit keeps the cost structure low thus enabling ventures to identify early on opportunities and market for low end/new market disruptions
why not just keep cost structure low and forget about revenues entirely?
Keeping cost structure low is a good idea nevertheless, but it will be a subjective goal. Earning profits on the other hand is easy to measure. Btw, it is chapter 9 in this book http://ow.ly/8jhzp
doesn’t seem right to me based on my experience. but if clay says it, then i need to understand it. because he is a major guru of mine
I’m with you on this Charlie.Spending a quarter ahead of profitability with signs of engagement and growth feels like an investment.Spending further out, even with growth signs, feels like gambling.Not a big believer in gambling with others or my money.
How do you know how to make your decision though….
I like your comment, Charlie because you you give the [slight] conservative approach.Perhaps you don’t need the cash reserve if you see an investment into the company bringing in a large chunk of future revenues. If you then have revenues on the rise with projections that can be agreeable to investors, they will back you with cash before you run out. That’s the “game”
if you are bootstrapping then this is certainly the right approachif you have deep pocketed investors who believe in you and will support you in thick and thin, then maybe it is notsuch investors are not that easy to findi like to think we are one of them
Of course. Seed stage and beyond.
Thanks for the insight!
Totally agree. Hiring in response to demand is the one sure way you know you are in tune with the market for your product.Hiring assuming that demand will come……well as they say assume has the words ass u and me.If you know some other way that demand will come. Spend away!
You don’t!! That is the whole point of being an entrepreneur. You need to provide answers when you don’t even know what the question is!!That is the basis of U.S. greatness. It is why I don’t care about the mean of standardized test scores. Doesn’t mean bupkis!Anybody can answer a question when they know whether the answer is right or wrong. Not knowing the question and needing to provide an answer……that is knowledge.
So Fred and Charlie, my question, as a total novice, is where is the post/response which describes cash flow metrics at 2x per 6 months etc and beyond which you and Charlie discuss above? The cash comfort level. Forgive my simplicity on this front, I make content, not BP’s, monetizations etc.
I hear a variety of metrics of how much cash to have on hand to stay afloat. Since I have to fundraise shortly I need to sort out some benchmarks.You said “I’ve always felt comfortable investing a few months ahead of profitability, but getting more aggressive than that I like to have about twice the cash needed or more.” I hear in general to have a year’s cash. I just heard to triple my R&D budget.Since I won’t get paid until orders are received in October, some idea how to project out my numbers, with 3x this or 2x that, is helpful.