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When Should Startups Start Caring About Profitability?

As we look back at our business classes, we recall terms such as gross profit, net profit, return on investment and all things geared towards profitability. In fact, if a business was unprofitable, then it was deemed unsuccessful.
The Startup World

The real world of business and in particular the story of startups tells an entirely different story. Some of the world’s largest (and deemed most successful businesses) are not profitable, and others took many years to even see revenue. Modern day examples of Amazon, Facebook, Google and Uber are seen by entrepreneurs, and in reality most of the world, as incredibly successful businesses, but if these businesses were focused on profitability in the early days of their existence it is unlikely that they would be the aspirational companies that we know today.

How do a VCs and Angels look at businesses?

In early startup days it is common for founders to raise Seed funding, and then a Series A. Typically this will be to assemble the founding team of employees, build out an MVP and start customer acquisition. But how do investors look at a business and decide whether to invest?

Firstly, venture capital is not right for every business. Angel’s and VCs typically will look at businesses with large scaling opportunities. To build out scale, often a lot of investment is required, and the more investment made usually means profitability is moved further away. When a VC looks at early stage investments the most important thing is growth. Admittedly startups with a high burn rate are not attractive for investors either, but they will never fund slow growth.

Why is growth more important than profitability for scaling startups?

There are 2 key reasons why growth is often more important that than profitability in the early stages of a scaling startup; the requirement for investment to increase the opportunity for higher future profitability and the need to move at speed.

The need for investment

If a business is entirely focused on profit, then the opportunity for them to invest in growth is limited to the profit margin, which of course will be very small in the earliest stages. This means that there is less money available for the company to actually invest in the likes of business development, technology and marketing. On average 70% of an early stage startup costs are made up of staffing and restricting key outlays like staffing will restrict growth. We see so many examples of incredible businesses that didn’t turn a profit for years, instead investing in growth, and go on to become incredibly profitable businesses. Facebook took 5 years to even generate revenue and was not profitable when they floated, and subsequently went on to have the most successful IPO in history and become one of the world’s most valuable businesses.

The need to move fast

In a world where startups are disrupting established businesses as well as fighting each other to release the latest innovations across industries, there is a constant need for businesses to be first to market with their products to ensure they take a notable market share. Being agile and moving quickly is something that startups can do at ease unlike established businesses, but this comes with investment, and although it may take time to turn that investment into profitability, without it, may be the difference between the businesses success and failure.

If not focused on profitability … then what should a business be focused on?

As a business looks for growth ahead of profitability, what are the KPIs a startup should be looking at to ensure they are moving in the right direction?

New Users/Clients – How many new users/clients is a business acquiring?

Cost Per Acquisition – How much did it cost to acquire a user/client?

Active Users/Clients – How many regular users/clients a business has

Gross Revenue – How much revenue is being generated?

Return on Investment – Revenue generated from a sale minus the costs of sales?

Future Profitability

You can't ignore profitability entirely. Although a business may have a high burn rate to start with, there must always be an eventual goal to achieve profitability based around potential scale. It may take 1 year or 10, but it must be a goal to eventually achieve, and focusing on growth and revenue are huge attributes to achieving this.

The Accountancy Cloud

If you run a scaling startup and need help The Accountancy Cloud can help you across the board in all areas of accounting and taxation, simply contact us.

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