Why does it seem that startups are more proud of raising investor capital than having a profit at the end of the year?
Why does it seem that startups are more proud of raising investor capital than having a profit at the end of the year? To me (a layman), a profit of any amount would indicate a working strategy and ability to make their own ends meet.
This question originally appeared on Quora, the knowledge sharing network where compelling questions are answered by people with unique insights.
Answers below are by Andreas Kitzing, Noam Kaiser and Eric Arthur.
Andreas Kitzing, Entrepreneur – Rocking the Sport Industry
Updated Dec 31, 2015
I can’t believe everyone here (except Jakub Kostecki) is arguing that profits are more important than funding. Startups have different dynamics than normal businesses. For most (early stage) startups, being profitable is bad news!
As a startup, you want to keep growing as long and as fast as possible, until reach the maximum potential size for your business. If you have cash at hand, you want to invest it into further growth. Consequently, if your balance sheet shows a profit at the end of the year, it means that you didn’t find any more opportunities to invest in further growth.
It’s easy to start a profitable business. You could start buying butter, flour, sugar, eggs, and chocolate chips for $50 and bake delicious cookies, which you can sell for $100. Bravo! You just made $50 profits. It’s much more difficult to find investors. I wouldn’t buy stakes in your cookie business, but if you had a super-high growing, innovative tech startup, I might be interested. Of course, you have to show that your startup has the potential to generate (high) profits at some point in the future. But until then, growth is more important.
Finding an investor – someone who bets his own money on your success! – is a much higher validation of your startup’s success than showing profits. Consequently, entrepreneurs are much more proud after a round of funding.
Epilogue: If you want to analyze the performance of a startup, neither profits nor funding are the ideal metrics. You might rather want to look at:
- growth rates (users / revenues)
- contribution margins
- costs of acquisition
- revenues per customer
- churn rates (i.e. how many users stop using the product/service)
- However, these numbers are often difficult to obtain. Funding and valuation might serve as a proxy, because they mirror
- what the market thinks about the startup’s performance.
Noam Kaiser, VC Biz Dev @AWS, former Principal at Gemini and Naiot VCs, Startup Founder & CEO
Updated Aug 2nd, 2017
Forgive me if I cut through the “Do it on your own” rainbow and care-bear sweet talk and lay it on you like it is:
Startups need to grow. Fast. Do you realize how long it takes for a startup, that engages in a competitive ecosystem, to hit profitability? Significant profitability at that? And by the way – does it make sense to you to expect private companies, embroiled in fierce competition, to disclose figures, and subsequently their cash burn rate, income, price tag, and so on?
A startup, by definition, is an agile, fast-growing entity, that attempts to upset a power balance set up against it, fighting an uphill battle all the way, against established giants and/or outdated methodologies, aiming to win with and through innovation.
In order to stand a chance, it needs to GROW. FAST. With the exception of an insignificant and marginal percentage, that is exceptional to the overall group, a startup leadership team that thinks it can upset a market through “organic growth,” is fooling itself, and speaks out of lack of experience and knowledge.Mainly because of one thing: If you think you will win by growing at your own pace, that means you think time is not an issue. Wrong. If you’re acting in a field that is interesting, dynamic and lucrative – then here’s a news flash: No way are you acting alone. Others are racing to the top of the hill, and most likely, you do not know everything about them, nor all of them. But one thing is clear: The first one to offer a good, sustainable, cost-effective and market fitting solution, and then proceed to deepen, widen and fortify its hold – Wins. Let’s say you manage to set up a team, develop a solution, get a few beta clients, keep it lean and mean, and even be profitable, after 2 years: Let’s say you’re up by $100,000 by the end of year 2! Don’t get me wrong, I appreciate that, heck: You’ve made the point as to why you are now investment worthy! You get shit done – Give me a call! But the thing is that meanwhile, another startup, which also started off mean and lean, got something done and used that something to raise $5M, is also active on the scene. They will now use the money to hire a remarkable R&D team that the founders know from former jobs. Not only will their product be good – It will keep getting better.
They will hire a team of 4 hungry yet experienced salespeople and a sales leader.
They will be able to hold a service and sales support team, and a decent QA team, to prevent churn, and build trust.
They will have money to spend on marketing, and they will probably have some guidance on using it well. (Not burning half of it on SEO.) So their sales funnel will grow, and their leads will grow too.
And because now it’s out there, that the money is there, everybody knows the above is what is (very likely) going to happen, and now that you too see what the money is going to enable, you can put together what it means to receive it, and why the company – and investors – want to make that known:
It’s a signal to the entire ecosystem that a credited investor, that knows how to perform due diligence, marked a company as THE horse to bet on: “Sequoia/Scale/Bessemer/Kliener Perkins/Benchmark/(and so on) invest in honeybooboo.io”. All of a sudden everyone wants to know what the honeybooboo team is up to.
It’s a signal to the entire ecosystem that says that John Smith, Partner at Bucketsofcash Venture Partners, who has invested in 20 companies in this field, 8 of which were acquired, 2 went public, and another 10 are still out there, is now going to sit on the BoD of the company and help steer it in the right direction.
It’s a signal to your clientele and potential clientele: “This company is backed, it’s financed, it’s reasonable to cooperate with it/solicit its services/adopt its solution” etc.
It’s a signal to other investors for later on down the road: “We will be interesting for you in the very near future – Keep an eye on us”.
It’s a signal to the sharpest devs, dev ops, UX/UI specialists, you name it: “There’s a new opportunity here if you had it with the big companies, and are the top of your brand”.
And yes, it’s a signal to you: “Be afraid”.
Oh, but I forgot, all this does not concern you: You made “ends meet”… good for you.
You won’t be eating their dust – Their dust will be too far ahead of you for you to catch-up with it to grab a bite. That said, if you can do all that, which I’ve listed above and not raise a dime? Go for it, you’d be nuts not to!
But don’t assume that companies that raise funds lose it: They need to mind the KPIs, the burn rate, the CAC/ASP ratio, the lead/opportunity/demo/trial/win ratio, the MAU/DAU ratio – And as mentioned, they now have experienced people to help them do that, and oversee that they do.
But since you most likely can’t keep up without an investment, and you will raise funds, keeping that a secret is both impossible – investors need to present their portfolio – and (as I hope you realize at this stage) silly:
There are good reasons why substantial investment rounds are a good indication as to who the interesting players in a certain field over the next few years will be, and there is much to gain by signaling the right signal out there. Hope this helped. Good luck.
Eric Arthur, A coder and entrepreneur who’s into Kant, Jung, Objectivism and gnosticism.
Updated Dec 29, 2015
From a startup founder who has fallen into this trap, I can tell you exactly why: because I drank the tech media Kool-Aid. I began to believe the hype that the press was selling – namely, that “funding = validation”.
To be sure, there is a kind of validation in having an investor – in other words, a 3rd party outside your startup – think that your idea is valuable enough to take the significant risk by giving you money. After all, we often ask people to “put your money where your mouth is.” And that’s exactly what investors do when they fund you.
Ayn Rand (author) once said – and I’m paraphrasing because I don’t remember the exact quote – that money is the symbol of validation for the creator. I think there’s truth in that. The real question is: Is it the money of investors or is it the money of profit that is the real validation?
Before I became acquainted with Sramana Mitra ‘s philosophy on entrepreneurship, I had bought into the “funding = success” equation, hook, line, and sinker. When I dug deeper into the roots of this belief, it really stemmed from a desperate need to feel like my startup – and therefore I myself – was valid. “If we could just get an investor – any investor – to give us money,” the reasoning goes, “then surely we must be a valid business!”
Of course, this is a recipe for poor self-esteem. Because we all know that, if you let someone else’s endorsement determine your sense of success, you’re setting yourself up for feeling badly about yourself! And, something my momma taught me: if you compare yourself to others (those who are getting funded compared to me who’s not, for example) you’ll always come up short.
At the time I began to drink the Kool-Aid, we had only a very marginal profit. Never mind the fact that we actually were in the black – that wasn’t good enough. It was a bootstrapped startup going on 3 years, and we were just growing so slowly. We were growing, but slowly. Meanwhile, we’re reading every day that this one is getting funded and that one is getting funded. I read one article about an on-demand service that hadn’t been existence for even a year, already getting $8 MM in funding!!
You read stories like this enough, and that age-old media adage starts to ring true: the media’s job is to make us feel fat, ugly, poor, scared and sucky. Read enough of these stories, and you start thinking, “Shit! My startup must suck.” Even though we had achieved a very tiny amount of profit, were growing our user base gradually, and had to pay customers, I still felt like a failure at the end of the day because “the angels weren’t shining their grace down upon us.”
Then, I started following Sramana’s tweets, blog posts, and YouTube videos. I kept hearing her say over and over again that business is about customers, revenues, and profits. Reading her work helped me refocus our efforts. It helped break the curse of, “I gotta get funded to have a valid business model.” Instead of spending so much time chasing investors, creating pitch decks, and applying to accelerators, I started focusing my time and concentration on a single question: How do we bring in more customers?
And you know what? That kind of intense, diligent focus works. The first week after familiarizing myself with Sramana’s work, we acquired 3 new customers. And we’ve acquired more since then.
And there was an added bonus. After I decided to sort of forget about chasing the angels, an angel surprised us with some unexpected seed funding, which we should be receiving in January 2016. It’s funny how that works. It’s like dating: once you just decide to do you and stop chasing the girl, now all of a sudden she starts getting really interested in you! But so long as you’re spending all your energy trying to get her to call you back, you spend a lot of sleepless nights, alone.
Moral of the story: you have to get clear on what “validation” means to you and your startup. Is it the money of investment, or the money of profit?
Read more at Quora, the knowledge sharing network where compelling questions are answered by people with unique insights.