Whether startups should pursue profitability or high valuations

Editor's note: This article is from the United States very famous investor Frede Wilson (Fred Wilson) personal blog AVC, the Chinese version by Heaven Zhuhai Branch rudder to compile. The full text of the practice of blindly pursuing the rapid growth of the enterprise in order to obtain a higher valuation and ignoring the importance of profitability in today's investment and entrepreneurial circles, raised its own doubts and made a deep analysis ...

As a VC to invest in high-tech enterprises, one of the problems that often bothers me is whether we need to pay more attention to the profitability of the companies we invest in, or whether we should focus on the rapid growth of startups.

"Growth is more important than profitability, and once you invest in a company that ' captures ' the market, you can always focus on profitability."

This statement has gradually become the credo of the high-tech enterprise investment community (whether in the open market or private equity market). And the millet pattern here should be a good example.

This leads to a large amount of money being put into the marketing of startups so that companies can quickly occupy the market faster than normal growth.

40% Law

A few months ago, I wrote the 40% law describing:
Your year-on-year growth rate plus your pre-tax operating profit rate should reach 40 percentage points.

What do you mean? For example, if you increase your growth rate by 100% per cent a year, and your operating profit is owed, then your profit ratio must be equal to or greater than 60%, or 20% of the growth rate will require more than 20% of the profit ratio, or there is no growth and the operating profit rate is 40%. How to get these 40 percentages does not have a certain formula to apply, but here I would like to say is the relationship between acceptable profitability and growth rate.

I've seen too many companies that are just growing for growth and desperately investing in corporate growth without any rational restraint or scrutiny of the costs and losses of those investments.

The tradeoff between growth and profitability

Over the past decade, we have worked with a number of outstanding tech startups and tried to invest in them. These companies have never had a compromise to give up or cut profit opportunities in order to grow.

These companies have already started making profits early on, and then invested their profits in the re-inventing of their businesses, while maintaining a high-speed annual growth rate, so they didn't burn money ( because their money was renewable, not burnt out ), There is no need to introduce us to these VCs.

These experiences have made me question the industry's so-called Orthodoxy about high-tech companies ' investments:

"If you do not invest heavily in the growth of your business now (at the expense of losing money), then you cannot maximize the potential future valuation of your business."

In fact, I feel that there is really no need to do so. What you need is to create a company that has a structured competitive edge in the market competition to avoid this tradeoff, or you just need a very sharp and experienced business person to help you avoid this tradeoff (indeed.com Paul and Rony are a good example ).

Profitable drivers will effectively constrain the team

At the same time, I agree that profit-driven production of more annual returns than your investment will be a valuable constraint on your management team .

This will force people to think and weigh creatively and logically before investing in some aspect of their capital. Avoid making unwise investments in people, products, sales, markets, and other aspects of your business, while still keeping your business in an "elite", efficient operating structure.

10,000 step back said, even if you now have a large amount of money to compensate for your losses, you really want to "invest in growth", then you should not and do not need to completely abandon the drive of profit. This way you can devote more attention to the growth of your team and ensure that the team members contribute their strength with high quality.

Sustainable profitability vs. Annual growth rate

I don't want to act like a freak who insists on cash flow. But what we do as investors is really to allow the companies we invest to launch their products into the market even if they lose money, and to grow the business and the team so that they can earn more for their founders and their stakeholders.

Many of the portfolios that our company invests in are in fact losing money, and what we often do is look down at the deficit-filled earnings reports they provide, and look up to see when the existing funds will burn down to make the next (financing) plan.
But I'm a little bit fed up. The goal of every start-up business plan seen is to aim at this direction:

"How can we push our business to a certain height so that we can finance it with a higher valuation?"

While it's a game like this for vc/startups, I'd like to see a start-up business plan as a way to target sustainable profitability in a way that I'm talking about sustainable profitability.

As mentioned before, we can see that the outstanding companies that we have worked with before have already started making profits early, and can still have a 100% annual growth rate while maintaining profitability.

So, this is entirely possible. The reason why many start-up founders disagree is that no one has ever told him that this is entirely feasible, so they are chasing high growth and abandoning profits. And that's why I wrote this article.

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Whether startups should pursue profitability or high valuations