Should Founders Focus On Profit or Growth

At the foundation of the Venture Capital world, is the Power Law, which stipulates that the majority of the returns will be borne from one or two massively successful investments out of a massive pool over the life time of a fund. 

What this means for companies that receive VC investment is that they need to be growing at a rate that takes into account how VC’s see return on their investment. If a VC invests $100 into 10 companies for 10% of each company, for a total of $1000 over the cohort, and had promised to return 2x return to its LPs (i.e. $2000); and we assume that only one company becomes successful, that one company doesn’t just need to grow 100% to get their VCs $100 to $200, instead the VC would be expecting the company to grow enough that all $2000 (thousand, not hundred) is covered by that one company, that means that $100 is now $2000 at 10% when means that despite the company starting at $1000 valuation, its needs to be worth $20,000, or 20x larger within the timeframe the VC is expecting the fund to close. So for this reason, companies that take this kind of investment and the reason the industry puts so much pressure on growth exists.

That doesn’t mean that founders should only accept this kind of investment, neither does it mean that founder should ignore profitability, in reality, whilst related, growth and profitability are two different issues, and founders need to consider each separately and understand the impact of each on the other.

Ultimately revenues need to grow as the company grows, revenue growth should strive to mitigate the burn rate of the business over time, and as revenue grows the deadline for burn down extends, in simple terms as the company increases in revenues and gets more profitable, the impact of costs on the cashflow diminishes, more revenue over time and fixed costs means the company would get profitable quicker, or have more months lifeline, i.e. cashflow. 

In theory you could use investment case for cashflow, but thats reckless, ultimately thats like buying a house on a credit card. VC money is designed for scaling growth, given the multiples of growth expected, any VC money not spent on growth is like using a credit card to pay off another credit card, so it makes logical sense that you ideally want to have profitability in place and a clear idea of burn rates and run rates before you take VC money, then when you take that VC money you want to concrete it on growth. It’s important to remember that growth doesn’t mean profitability, we’ve encountered several companies who invest heavily only for their business to exist treading water running in a hamster wheel, the level of customer churn means that they’re simply filling a leaky bucket, considering the needs for growth of VC money, again this is not an ideal position to be in. 

In summary, focus on profitability first, specifically focus on the scalability of profitability first, then when you know you have a relatively repeatable model, concentrate on growth.

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