At Kinfolk, we highlight articles from people worldwide whose perspectives we find important and valuable. Our goal is to simplify the process of building long-lasting technology businesses for African founders and leaders.
This blog post by Fred Wilson explores the importance of responsible growth and profitability in the startup and venture capital sectors. It highlights the misconception that every business can follow the playbook of successful companies like Google or Uber, leading many startups to consume excessive capital without creating value. The post emphasizes the need for growth with positive unit economics and a clear path to profitability. While some companies in portfolios may meet these criteria, the majority burn through money without a solid plan for profitability. The author suggests that the profit motive and valuing future cash flows should be given more importance in the tech and startup ecosystems.
Value is created when the capital required to get a business to sustainability is meaningfully less than what the company is worth when sustainability is achieved.
As the capital requirements go up because of sustained losses year after year, the business needs to become worth even more money.
The mistake we make in the startup/tech/VC sector is that we look at things like Google/Amazon/Facebook/Twitter, Uber, Uber/Airbnb/Slack, and we think every business can execute the same playbook. The sad truth is that only some companies can run that playbook, and, as a result, many startups consume way too much capital on the way to sustainability, and value is lost, not created.
The never-ending question that founders, management teams, and boards face is whether to invest for growth (aka lose a ton of money) or work towards profitability (but constrain the development of the business). Every board and every company in a portfolio is always asking this question.
What comes out on this issue, and always has, is that the growth has to be responsible (positive unit economics on development spend) and that the path to profitability needs to be well in sight. I would add to those two constraints that a management team ought to be able to make a business profitable in a pinch without killing the industry, if necessary. These “rules” should not apply to very early-stage companies. They become relevant and possible once a business has a growing customer base and revenue stream.
Very few companies in our portfolio or any VC firm’s portfolio will pass these tests. Some do, but not many. We have a few companies in our portfolio that are operating profitably. We have a few more that are working with profitability well in sight and could get there in a pinch without hurting the business too much. But the vast majority are burning money like water, and there is plenty more where it came from.
It may be true that there will always be money to burn. Or maybe it isn’t. But even if there is endless capital, many founders and teams will wake up one day and realize that the burn they accumulated is now a hurdle they must overcome. And many won’t overcome it.
The profit motive makes capitalism work and values businesses as a discounted set of future cash flows. Positive cash flows. If you can’t generate profits in the future, your business will not be worth anything. So profits are critical, and yet we don’t seem to value them very much in the tech/VC/startup worlds. Maybe we should.