I’ve always been a big fundamentals guy. Unlike Silicon Valley, I’ve always preferred smart growth to dumb hypergrowth.
So what I’m about to tell you might shock you…
Silicon Valley investors have gone too far in trying to make up for their sins. They want to see profits NOW. And they’re not investing if they don’t.
In what world do venture capitalists (VCs) refuse to fund early-stage companies growing 30% every month? It’s happening right now in the San Francisco Bay Area.
Companies in the midst of Series A or Series B raises had better be profitable or anticipating profitability. Otherwise, the VCs won’t be interested.
This emphasis on profitability isn’t exactly new. It’s been building for months. Uber, WeWork and Peloton (among many others) have incurred huge losses. Wall Street is giving their revenue growth a big thumbs-down. And share prices have plunged for most of these companies.
Wall Street’s reaction to these startups stunned the venture capital community. I’m not sure why though. Bottom-line growth has always been the king of metrics on Wall Street.
Now VCs are changing their approach. With Wall Street’s rebuke still fresh in their minds, and the spreading fear of a coronavirus-induced economic slowdown, VCs are preaching the importance of profits over growth.
And I can’t believe I’m saying this… but they’ve gone too far.
Most founders would love to make a profit right away. That’s not the way it works though.
Startups spend a great deal on product development. As they grow, they hire more employees. That’s not cheap. Startups have to pay for one-time intellectual property costs, for building a sales team, for digital advertising… the list goes on.
Economies of scale don’t enter the equation until late in a company’s growth journey.
It takes money to grow. And for most early-stage startups, revenues lag behind costs.
That’s why Silicon Valley has always preached growth first. Then figure out profits. But now, it’s singing a completely different tune. It wants startups to achieve profits as soon as possible, and only then ratchet up growth.
Seriously? Can this really be the new mantra? If so, it flies in the face of reality. Sure, founders can try to save on the margins. But these expenses are very real and, for the most part, unavoidable.
Silicon Valley knows this! Yet it’s having an irrational moment.
It’s wildly overreacting and making it harder to access capital.
Meanwhile, most founders are behaving reasonably. They have already come to the realization that 2020 is different from 2019. They have rejiggered their expectations. They have adjusted downward how much they can raise… and spend.
I believe that many of these startups will turn to crowdfunding because VCs have lost their minds.
That doesn’t mean you should invest in every startup that comes along. And you should be more careful and more critical of big-spending companies.
But you should NOT follow the example of VCs and avoid ALL startups that can’t show a profit.
Instead, take a hard look at what founders are doing to manage their cash flow and create a pathway to profitability. And remember that founders aren’t dumb. They’re as eager as you are to turn a profit as quickly as possible.
Startups that require big budgets should justifiably fall to the bottom of your list. But some of them will be worth the risk. And you don’t want to miss out on those.