We’re in this really weird era as Silicon Valley creeps out to the rest of the world, in which investors elsewhere, traditional business owners, and the like, keep advising everyone to, “focus on customers,” “it’s all about revenue,” and questions such as this.
Startups never needed to become profitable.
- Venture Capital investors fund EXITS
- Grants fund impact
- Banks and loans finance revenue
- Kickstarters pre-purchase product
The only time when a business is driven by profitability is when the company is public and shares are sold on a public stock exchange. Profitability tends to correlate to Share Holder Value and public companies are fiscally responsible to shareholders… who tend to like profit.
Bottom line, startups never needed to become profitable.
Heck, startups don’t even need to focus on revenue!
Let’s look at each of those capital sources in a startup scenario:
- As a startup seeking investors, the entity must be a Corporation (preferably a Deleware Corp).
- The Angel or VC earns equity in the startup relative to the amount invested and a bunch of other not-so-secret sauce
- Equity is ownership, akin precisely to what the founders have. The difference being that the founders, and team, have jobs whereas investors do NOT.
- Such investors don’t get anything back until the company is acquired or goes public.
- NOW… why would revenue/profitability matter? Companies get acquired for IP, customers, marketshare, patents, team, or even just to get rid of a competitor. Profitability factors in but rarely is a company acquired at the 20x ROI such investors seek merely because it’s profitable.
- Grants fund impact
- Profitability has nothing to do with businesses in this situation.
- The business has a mission to… employ, provide, teach, etc. In accomplishing that, it secures capital
- Grants don’t get paid back. Revenue and profit is often irrelevant but can be considered in the funding as most sources of such funds will expect the business isn’t just spending money.
- Banks and loans finance revenue
- Revenue. Cash flow.
- Any type of business. If you can pay back the money with 4–20% interest… here you go!
- Kickstarters pre-purchase product
- We want money to make a thing
- We make the thing
- You get the thing
Now, what’s missing from our list of capital sources? Business investors. Partners. And indeed, such people tend to want profits so that they can get their money back from the profit sharing, business ownership, or the job that they have as an investor in the business.
But such businesses aren’t startups. And such investors aren’t venture capitalists.
When you’re starting a typical business, you have a proven and established model and methodology with which to work. Venture Capital doesn’t seek such businesses and thus such businesses aren’t called startups; they’re just new businesses.
No one calls the new real estate firm in their neighborhood a startup. Why? Because it’s very well known how that works.
Such businesses tend to need to show profitability because the “Partners” or business investors coming in have every right to expect that the business knows how to make money… just like every other like-business.
Startups have never needed to be profitable.
Doesn’t mean they shouldn’t be and that’s not to say at all that they can’t be nor that they wouldn’t benefit from being so! But “startups” should be investing every hard earned dollar in creating value and new markets… most investors would question why a startup is profitable.
No, rather, most investors would question why a startup is raising capital if it is profitable; rather than first, now, NOT being profitable, to alleviate that RISK in that photo, and then substantiating the opportunity for investment.
What about bootstrapped startups? Would they fall under the traditional business model?
ALL startups are bootstrapped. I’m not a fan of the notion that bootstrap is different or better. Every founder bootstraps, until they’re not. https://seobrien.com/lets-get-something-straight-all-entrepreneurs-are-bootstrapping
But… what of them? It’s not a “traditional model,” the fact is that startups should NOT be profitable. Or put it another way, when they are profitable, they’re no longer a startup; they’re a company. Until that happens, profits should be funneled into innovation and marketing. Otherwise, they’re recognizing profits (and paying taxes on them) because…???
I agree – being profitable simply means one accumulates more money than they spend. And free cash is bad just for any business.
Whatcha talking about Willis?!? I needed to read this.
I would have written more! But I wanted to get on to my Aston Martin Bond article!!
https://mediatech.ventures/from-fleming-to-fukunaga-the-bond-of-books-to-films
Profit is not needed for a startup. but its value is generally based on the potential and eventual profit of the business model.
Dear Startup Advisors, Entrepreneur Mentors
The most crucial point at the Startup Dev Phase, is to stretch the dollar as much as possible, while deferring a meeting with the tax man lol (dependent on Nature of the business model and product offerings).
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It is my privilege to share Alvin Toffler’s afsuture Shock has been set in motion. We will prevail =)
Startups need to grow by definition. Once they start making a profit they’re no longer a startup. They become a company.
By this definition there are public companies that are still startups.
Yeah I’d concur, *profit* has nothing to do with the distinction of startup not company; it’s merely a reduction of costs so that revenues exceed them.
It’s a question of proven, competitive, and sustainable, business model, or not.
True, it’s not an black and white definition but I still say that startups do focus on rapid growth as you wouldn’t call a new local bakery a startup. That would be called a small business.
Apparently not, VCs play the numbers (of companies to fund) hoping for a Unicorn, so as long as there is one in your stable you can burn through cash…until you can’t.
Paul, I just had this subject come up elsewhere. I basically mentioned that Breaking Even is short term goal for a lot of startups. Breaking Even is not poverty, everyone gets paid, loans are paid, R&D is ongoing, reinvestment, and the company is self sustaining.
Exactly! If you have profit, use it.
I told the ‘savvy’ business person to visit one of the many incubators in San Francisco for business help. Are there still Bar Camps and such, I was heavy into that stuff in Memphis.
If you have a business that’s struggling, seek business advisors and support. The SBA, score, and SBDCs come to mind.
If you have a startup, you need to focus on startup programs, and startup experienced mentors and advisors
Not for me, I was helping and such. Memphis had a very active scene 12+ years ago. Eric Mathews was one of the folks, he runs Start Co. in Memphis and also ran other incubators etc.
Curious what your take is in businesses pivoting to layoffs / sustainability to secure VC loans since the VC market is a lot tougher than even just last year.
A startup that doesn’t succeed doesn’t help anyone. Can’t employ anyone
Being as overconfident, certain, of the business model or the solution, is as dangerous as being certain of the team.
You must pivot. You must change. You must do what it takes to make it work
But I want to add a healthy reminder too. A startup is not yet a business. And operating business is not a startup. If you’re a startup, you haven’t yet proven the business model, and if you want investors, you must keep changing what you’re doing until it works.
Sure, I mean in the context of growth vs profitability to attract VC dollars, why is sustainability suddenly a higher prirority than growth? Does profitability matter when the economy can’t sustain growth?
I think you still missed my point. Startup investors are not drawn to profit. Business investors are drawn to profit.
Startup investors are drawn to sustainability and growth. If you’re not going to survive and you can’t deliver exceptional returns, you can’t raise VC
I think I’m missing the distinction between startup and business.
When is a startup a business?
I have 5 questions about this today. Must be in the water ?
A startup is a temporary venture in search of a business model. Hoping to become a company.
If a business model is known, it already exists and is proven, what you’re doing is a new business, not a startup.
Okay, so a startup can become a company prior to an exit then it seems.
Does that mean VCs may be early seed rounds and tend to stop once it’s a company, but allow business investors to carry it to an exit?
To add to that, what if the startup starts in search of a business model, then pivots to a “new business” proven business model. What do VCs do at that point?
What do VCs do? They’ll still participate if the company can deliver exceptional returns. If not, if the proven business model warrants a typical business size, you’re looking for business investors, partners, debt, etc., as there is little reason for VC to get involved.
What’s the typical time horizon on a startup getting VC backing to any sort of return for the VC (assuming it gets there at all)?
2-3 years to VC and then 7 years to ROI is standard.
Capital before VC, in that 2 – 3 years, is out of pocket, grants, Friends & Family, revenue, and then Angels.
New businesses replicate existing businesses and models. “Do that, and it should work.”
Startups can’t do that, there is nothing to replicate proven to work for what you’re doing.