“I hate high margin businesses,” "Donald", the billionaire VC head of Donald Ventures, said to me.
I ignored him, and continued on with my pitch knowing he would never fund us. I mean, after all, how do you respond to an idiotic comment like that?
A couple year of years later I was meeting with the same VC (yes, he actually funded us which is a much longer story). Before the meeting I was talking with one of Donald’s partners, "Raul", and I asked him why Donald had this belief system about high margin startups.
Raul's answer was insightful. He said, “Donald only cares about revenue growth, not the profitability of the business.
“Donald believes that if your business keeps growing at a fast rate then you can always find another investor who will put more money in at a much higher valuation.”
In other words, Donald is saying, “Profitability? Who cares? We just need to find another fool that will get excited by the high growth. Then we can eventually sell the company or dump the company on an unsuspecting public in an IPO."
The strategy is the classic Ponzi Scheme strategy that too many VCs follow.
Once upon a time it used to matter if you built a profitable company. However, with VCs like Donald, does it really matter any more?
The answer is profitability always matters, and here’s why it should matter to you.
The funding environment for startups is constantly changing, and you want to manage each round of funding like it’s the last round of funding you will ever get.
I get the fact that you might need multiple rounds of funding, and I also get the fact that you are going to be under a lot of pressure to grow at all costs. However, if you have an appropriately frugal mindset about your funding, then your funding will last longer than you need it to.
An appropriately frugal mindset means you spend money on the things that matter such as paying your employees at the market rate. An appropriately frugal mindset also means saving money every chance you get:
- So don’t spend money on that expensive office furniture, and…
- Maybe that expensive management system you’ve been eying can wait when Quickbooks and Excel will do, and…
- I hope it goes without saying, but you’re flying coach
You get the idea. Money is the only thing you have complete control of when you’re running a company.
You don’t know when that extra amount of cash you’ve saved will be the difference between you having enough cash to make it to the next round.
So, when should your startup get to cash flow positive?
If you’re bootstrapping, you really don’t have a choice. You have to get to cash flow positive or you’re out of business.
Think of your funding like gravity. Eventually, just like gravity, you will come back to earth and not be able to get more funding.
This is especially true if you're in a hot space. Funding is plentiful as VCs place their bets. However, as the space, inevitably, gets overfunded, or the funding environment turns, it gets increasingly difficult, if not impossible to raise that next round of funding.
It happens to everyone. And when it happens you, you’ll have nowhere to go. You’ll either have to sell your company or shutdown the company, or you will raise money at very unfavorable terms.
That’s why, despite what you might have heard, you need to be cash flow positive as fast as is practical. You’ll want to balance growing to a level where you can keep growing organically without constant cash infusions versus your ability to continually raise money.
Here’s what I used to tell my team:
“Getting to cash flow positive equals freedom.”
You don’t need more money from your investors when you get to cash flow positive. When you don’t need more money, you are immune to changes in the funding market.
And, not needing more funding is a beautiful thing.
For more read:
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