Have you ever been in a conversation that has gone something like this?
"Damn, Uber is growing so quickly. What a great business idea!" - Susan
Only to be met with a response like this…
"Yeah but they aren't even profitable" - Fred (The weird cousin no one likes.)
You can find this everywhere. Twitter. Airbnb. Facebook. Or with pretty much any growing tech company. You have the people that are admiring the product and growth, and then there are the people criticizing the fact that they haven't reached profitability yet. I need to be honest, those people kinda bug me. It wasn't until a few weeks ago that I put my finger on what annoyed me about them. Now, it's clear. I've made a discovery that will help me look at fundraising and startups very differently. The discovery is simple.
For startups, profitability doesn't matter, and here's why. To start, let's get into the basics of startup land.
A Basic Startup Funding Landscape
A startup is a quickly growing company. 99% of the time, outside investment (Angel investors or venture capitalists) help fund this massive growth. The investors that invest in these startups are investing in the hopes of a massive exit, so they can get an ROI on their investment. Once the startup exits, investors cash out, or allows them to pay back their limited partners, which increases their chances of raising another fund.
An exit generally can happen in two ways. A bigger company can acquire a startup, or a startup can go public. The former is much more common than the latter.
So to make this clear, once a startup raises outside funding, the startup has an obligation to pay those investors back through an exit. It doesn't matter what the founding team wants. If their "vision" for the company doesn't involve an exit, there are going to be issues.
Are we clear on the startup funding landscape? Ok, now let's get into why a startup would take on funding in the first place.
From the sound of it, it seems like raising money isn't a good idea. You need to give up a percentage of your company, and you even lose control over business decisions. Raising money puts you on a path that you can't get off. Exit or fail. There is no middle. Sure, an exit can take 20 years and there have been instances when companies have raised but haven't ever had an exit. Still, if you're like 99.99% of startups, your future is plotted out….it means having an exit. If raising money means relinquishing so much control, then why raise?
It's Needed To Start
Some founders can't hire the team to build their product until they can pay them. So, they raise money so they can get started. Usually only repeat founders can do this. It's challenging to raise money on an idea/prototype (at least outside of the bay, it is).
It Accelerates Growth
What makes a startup a startup is growth. What makes a successful startup a success is the speed at which it grows. The reason Uber took down the Taxi Industry is because it moved very quickly. What allowed it to grow so quickly was funding. Outside funding ultimately just increases a startup's growth percentage. Uber would never have accomplished its goal without funding. This leads me to the next point.
It's needed to take down incumbents
Google wouldn't have been able to take on Yahoo alone. Same with Netflix taking down Blockbuster. In Google's case, Larry and Sergey had the recipe (their algorithm) but a small team vs. a giant company isn't a fair match. In order to compete, Google raised money to level the playing field and increase their growth percentage. Most big tech platforms you interact with every day raised money. Why? To get to the scale they got to, the needed to take down their competition along the way. Funding helps with that.
So that's why founders raise. On the flip side of the coin, let's look into the world of profitability.
Profit Over Growth
Most of the companies in the world care more about profit than growth. Restaurants, agencies, bookstores, etc. The need to make more than they spend, or else they are out of business. Their business is considered healthy and they have the full freedom to spend their profits as they wish. There are several benefits to choosing profit over growth.
Full Control of Company
Business owners that focus on profit own all of their business. They can do whatever they want with it, and the can change their mind anytime and its fine. There are no investors to repay.
It Forces Sound Business Decisions
Business used to be just profit. Make money. Spend some of it. Keep the rest as profit. Basing off of this mindset, it keeps business owners focus on what matters. You won't find many lavish offices with ping pong tables in this camp. They have a budget to stick to and don't have any money coming in from elsewhere. it forced the owners to make more logical business decisions. This leads to long-lasting businesses, sometimes for generations. Whereas with startups, most of them fail.
Most profit over growth companies wouldn't be considered tech companies, but there are a few tech giants that got to where they got without raising a dime. Basecamp comes to mind first, which has tens of millions in profits a year. An earlier stage but promising one is Hotjar as well. So, it CAN be done. A tech company can be built at scale without raising money. Still, what the missing link here is the founder mindset.
What Is The Founder Mindset?
What many miss over the "profit vs. growth" argument is that most founders got started to solve a problem, not to start a business. It just turns out that starting a business is the best way to solve the problem. Usually, if many people have that problem, founders want to solve it for all of them.
Founders never got in the game to build a "profitable business". They got in it to solve a problem. Travis wanted an alternative to taxi's because the taxi system was broken. He wanted to solve that problem. To solve that problem, he needed to raise 11 billion dollars to beat the incumbents…the Taxi industry, ad all the other ride sharing companies. Do you see what i'm getting at?
Founders are focussed on the problem, and they'll do whatever it takes to solve it. Profitability doesn't matter to them.
But What About Building a Sustainable Business?
Yes, at some point, all businesses should be sustainable and profitable. But for a startup, their goal is to grow grow grow grow, and exit. Founders just want to solve their problem. They need to delight their customers. They also need to pay back their investors.
In terms of the customers, If they love a product, that's all that matters. I bet you're not thinking about how Medium isn't profitable as you use their product at this very second. No, you just get the benefit of being able to read all the amazing sotries on here. You don't care that they aren't profitable yet. If a customer likes a product, the financial aspect of a company doesn't matter to them.
When it comes to investors and getting an exit, how often does a startup get acquired because it was profitable? Rarely, if not never. Startups get acquired because of the technology, product, team, or combination of the three. No startup gets a big win for their investors by "being profitable". They get a win by building a kickass product, that solves a real-world problem, being executed by a world-class team. That takes cash.
Note, I'm not saying be irresponsible with your money. If you are, you'll end up like Homejoy. I'm just saying, if profitability doesn't matter to the founder…doesn't matter to the investor…doesn't matter to the customer…then why does it matter to anyone? I have no idea.