Just in case people are going to mentally summarize this as startups need to choose one or the other...the most important idea from Fred here comes at the end: Great companies can do both. Don't let investors (or anyone for that matter) say there's only one way to play the game. Reminds me of one of my favorite quotes from Charles Eames. And while it pertains to making products, I think it fits:
"Never delegate understanding."
We followed this strategy (the never delegating and balancing growth and profitability) at Wufoo and I can tell you that it was the best decision we ever made.
Not being in YC, I can only imagine that it's different strokes for different folks.
For example, if you're doing a land-grab in a newly discovered market, such as Uber, you have to prioritize growth above all.
On the other hand, if your market is well-established and your plan to win by superior polish of your offering, you're better off growing slowly, using revenue both as a funding source and as a guide for making a superior product.
In any case, the competitive situation will dictate if you have to grow fast at all costs (by raising large rounds), or if you can grow slowly by using your own revenue.
Is Uber an example of a land-grab? Regulation arbitrage and long term domination of a market are not really compatible outcomes. Sure they need to focus on growth over all to beat their competition, but the end result will just mean that they end up as regulated as the current taxi industry once they actually achieve domination.
Yes but once they reach a certain size they will need to transition from regulator arbitrage to a model similar to the one the current taxi system. Once this happen they will be as vulnerable to the next scrappy upstart as the taxi industry is. Either domination or regulatory arbitrage has to give.
They'll change from arbitrage on the current regulation, to having a say in the next regulation and living cosily in it.
Side question: why do the new regulations have to be similar to the current taxi system? Uber doesn't need eg a medallion system, they'd be happy with onerous legal (eg reporting) requirements to keep upstarts out.
Sure Uber might be able to help write the new regulations to their advantage, but at that point they will be open to attack from upstarts who choose to ignore the regulations. They need not only write the regulations and then be able to get them enforced to keep the upstarts out.
The new system does not need to the same as the current medallion system, but unless the new system is providing them with a competitive a means of keeping upstarts out the market will become one of perfect competition where profits all end up with the consumer.
Our outcome is much larger than you might think. Definitely more than what the average startup founder (who might have tried to raise more funding to chase growth over profits) under a similar exit, because the founders maintained a large portion of our equity to the end.
Now, I still have equity in SurveyMonkey and their amazing story is still in progress (one that also balances growth vs profits in a very similar way), but our outcome could be the equivalent to a traditional exit 3-4 times our size when all is said and done.
Also, a startup feels completely different when it's profitable and we were profitable 9 months after launch. Running a company on the edge is incredibly stressful and I'm glad I didn't have to do so for 4 years. I'm not saying I couldn't have done it, but I'm glad I wasn't forced.
This is not to say I believe every startup should run like ours, because sometimes you don't get the luxury or choice to do so. We were lucky to get to choose to grow the company the way we wanted at Wufoo. Sometimes growth comes to a startup and they have to do everything they can to hang on including raise money. If that's the right path, I won't be afraid to recommend that route.
The reason I'm at YC is because we don't try to slap a one plan fits all model for the startups. There are many paths to success and I'm delighted to be a testament to that.
The one plan that YC can't really slap on is the one that is most advantages to founders in many cases - the bootstrap model where no outside funding is required. If you were able to achieve profitability after 9 months do you think you could have got there (maybe a bit slower) without raising external capital at all?
When we applied to YC, the three of us only had enough money saved up for two of us to quit our jobs. So two of us quit and Chris kept working in a cubicle and split his paycheck 3 ways. Even that plan didn't give us enough money to work on Wufoo full time because we needed all 3 of us. So that 2 of out 3 plan resulted in 2 of us making a web development magazine that we'd sell and hopefully make enough money for the 3rd one to quit.
The idea behind the magazine was that I calculated we could run it in a way that half the month could be spent on that and the other half on working on the software we wanted to build. I'm pretty sure that play would have taken forever to execute.
So we actually really needed that $18K that YC gave us AND the 3 dedicated months to blow everything off and only work on the software. Very different times back then.
Couldn't you have gotten ~$18K as a personal loan from a bank? Even if everything failed, working off that level of depth would have been easy in a silicon valley corporate job afterwards.
That $18K only covered our expenses up till Demo Day. The $100K we raised after that allowed us to get to launch and then profitability. Also, it's not like we could predict that it was all going to work out. From our perspective everything was a risk up until it wasn't.
Having the choice to not take on debt and work with people who'd done it before made way more sense especially considering we hadn't written a line of code when we got into YC and had no idea what we were doing. YC paid us to start our company and gave us amazing advice that kept us from making a lot of bad decisions. The loan option isn't exactly a great deal by comparison.
Plus, we were not from Silicon Valley at the time. We quit our jobs because we hated working in a fucking cubicle. It was probably irrational, but easy for some people was completely unacceptable to us.
Certainly was. I kind of fell into my startup without really intending to start a business (I gave a pitch and someone literally wrote out a check on the spot and said go get to work), but I wonder if more founders would be better waiting and building up more capital before starting? If you only need 18K and three months full time then this should be within the reach of almost all founders especially if you are building a business where profitability is within relatively easy reach.
"But I’m a bit sick and tired of the objective of every operating plan I see is to get the business to a point where it can raise money at a much higher price."
Don't worry, the capital markets will enforce discipline sooner or later. With Fed hikes inbound, it'll be sooner rather than later. Even without the hikes, the stock market has stopped going up without QE (hasn't moved in seven months), which is increasingly crushing the ability for high valuation private companies to accomplish the big exits they require (which is why the IPO market has gone dry). I get the impression Fred is more or less warning his portfolio, and leading future would be pitchees.
I was recently at a festival in downtown Athens, GA. The college messaging site YikYak (raised $70m+) had 2 full size buses and a motorized bull to ride. They had 20+ reps handing out all kinds of free stuff.
There couldn't have been more than a few thousand attendees at this event.
To me this is exactly what Fred is talking about. A company so overfunded they can spend money on marketing efforts that don't really make sense...
FYI, I looked them up and YikYak is local to Atlanta, so that might have something to do with their large presence. Your point still stands, though—the two busses and the motorized bull...
I'm really not trying to bash YikYak, I have a lot of respect for them actually. My point is maybe they are so well funded it's clouding their judgement. I have to think there are more effective growth channels.
I'm no big investor or VC or anything, but trying to at least come close to a positive cash flow also helps proof the business against turning out to be selling dollar bills for 95 cents. Scaling a business that's selling dollars for 95 cents is really, really easy (in relative terms), and also a really bad plan.
I remember people discussing whether Groupon boiled down to that. I see it's not dead, but I see it's not exactly living up to promises either: http://finance.yahoo.com/echarts?s=GRPN+Interactive#{%22rang... (and have a look at the "news" section there, too...)
The profit motive can also keep firms from blowing money and attention on stupid things. (Example: Team A and Team B have a 50% overlap in code they're writing. The profit motive will shut this down. An overfunded company will preserve harmony, waste money and push the problems down field)
Yep. The cost of delayed profitability is extremely high for founders. Remember for the VC's you are just one of many plays and if things turn out bad then it is "oh well" for them. For a founder "oh well" is a disaster.
I think the basic problem is it is more fun to run a startup that is focused on growth than one that is focused on profitability. Smart people are very good at coming up with justifications for doing what they would like to do.
it's really good to see Fred Wilson writing about the important of profits, but i'm a little surprised as it seems like his firm USV focuses on investing in network effects businesses (ex: etsy), which to me almost always focus on growth over profit (which is probably the right choice for these types of startups, at least in the beginning).
The simple truth is that the public markets place a premium on growth. For example, plot a graph of growth rate on the x-axis and revenue multiple on the y-axis for all public enterprise cloud companies. You will see a direct correlation - higher growth leads to higher trading multiples. That's why startups prioritize growth over profitability. Now this only applies to startups which scale to the point of going public. I think Fred's points are valid and apply to the vast majority of startups (that won't go public). Food for thought.
In general, I still think growth trumps revenues/profits for most growing companies. The fact is, making money off a delighted user base is easier than building a delighted user base. However, I do think making money is important as a demonstration that this team can make money on this product/service. Also, I think zero revenue works a lot better if there is at least a view to how this thing is going to make money (surprisingly, this isn't always the case)(and if "advertising" is the answer, needs to be better thought out).
I think the fact that a suggestion that maybe, for some companies, being profitable is OK needs to be couched with "I don’t want to come off as a positive cash flow freak" is really demonstrative of just how extreme the focus on growth to the exception of all else is.
For most people unfamiliar with the VC world, the statement "Companies should try to be profitable" is nearly a tautology. In tech VC world, it's practically heresy.
Startups are a signaling game. A large part of the reason why growth is important is because you're building a story for future investors to believe in, that you're trying hard to become the Next Big Thing. A lapse in focusing on growth signals that you might be satisfied with a smaller outcome, making it harder to attract VC money ever again, unless one has a plausible story otherwise.
Commenter: haven't most (maybe close to all) the returns in VC over the last, say, decade, come from exits of companies that never achieved real positive cash flows?
Fred: yeah. but i am celebrating that ones that did today.
So weird that for every piece of advice Fred gives on his blog, he says in the comments that he's not really giving advice, and just trying to balance out the people at the opposite extreme.
Difference in agendas. A typical founder might be pretty happy getting moderatly rich whereas that's a pretty bad outcome for a VC. Since we eat up the success stories it becomes our culture without allways reflecting enough on these very different world views. My 5 cents.
"Never delegate understanding."
We followed this strategy (the never delegating and balancing growth and profitability) at Wufoo and I can tell you that it was the best decision we ever made.