This goes under the name of "Unit Economics" and is reasonable for small startups to use. It's VERY hard for a potentially high growth startup to cover their overhead costs. (If they were already cash flow positive, most likely they wouldn't be talking much to VCs anyway)
Companies go through stages:
1 - "Can we build something"
2 - "Will anyone pay for it?"
3 - "Can we turn a profit on each unit?"
4 - "Can we grow profitably and eventually cover our fixed costs?"
Generally you want to know #3 before tossing bags and bags of money at a company, but it's ok for startups to ask for money without having it answered. It's also ok for companies to ask for money without having covered their fixed costs yet.
To oversimplify...
Let's say my fixed costs are $10mm. Let's say each delivery I make turns a profit of a dollar, and each customer uses me for 20 deliveries over the course of 4 years. (Lifetime value of $20, which I get $5 per year) Let's say that it costs me $10 to acquire a company. (Customer acquisition cost)
Then in year 1 I'm $5 behind on each customer, but by year 4 I'm $10 ahead.
If I'm reasonably confident of these #s, then it pays for me to get as much investment money as possible to invest in customer acquisition. From a current cash flow (and potntialy from GAAP [0] earnings too) perspective I am losing money, but this will maximize the long term value of the firm.
This goes under the name of "Unit Economics" and is reasonable for small startups to use.
That's fine. But I think the meat of the article is that there are startups/businesses out there that are using so much smoke and mirrors with financial reporting that it has become a ridiculous process to read a "we are profitable!" press release.
I get it - there is an arms race out there to get funding for the "next big thing" which will require hundreds of millions of dollars to get off the ground. But whatever happened to a sound business plan, an experienced team, and a sound business idea? And the "next big thing" is now so saturated by so many players that the arms race seems to be exponentially increased for any possible idea that might have some traction. It is a race to the bottom.
Facebook and Google are such outliers that VC has resorted to throwing cash at the next 1,000 Mark Zuckerbergs, which only one or two probably exist in the next 10 years.
Capital is chasing returns that are not sustainable.
But whatever happened to a sound business plan, an experienced team, and a sound business idea?
Those exist, and they are all over the place. Ostensibly most quality startups have those things too. The majority never make big headlines - and as far as I know never really have. They generally just chug along and comprise the majority of "small businesses."
Facebook and Google are such outliers that VC has resorted to throwing cash at the next 1,000 Mark Zuckerbergs, which only one or two probably exist in the next 10 years.
Right, well that's the whole thesis of Venture Capital.
Well put. That is one of the fundamental problems with the economy of the current tech startup boom. There is too much of a winner-take-all dynamic. From the VC's perspective, it doesn't matter whether the portfolio is 10 or 1000 companies, as long as you get that home run. But to each individual founder, it's the difference between a 1/10 and 1/1000 shot at success.
Staying at Facebook/Google/etc seems to be the way to go these days...
The other alternative is to come up with an idea that doesn't require scale, that can become cashflow positive more quickly.
You can do this in software by attacking a very narrow niche, or by doing a services-heavy business. Neither creates a unicorn, but both can be stable.
But whatever happened to a sound business plan, an experienced team, and a sound business idea?
If most of the risk has been taken away, then you don't need high-risk venture capital.
In many cases, the business idea only seems Sound in hindsight. Google == "Yet another search engine with a crazy valuation run by two very arrogant prima donnas" AirBnB == "Some crazy idea contingent on strangers opening their houses to each other."
Capital is chasing returns that are not sustainable.
If this is the case, then people will lose the capital. That's the price of a free market, and the occasional Zuckerberg returns.
> If they were already cash flow positive, most likely they wouldn't be talking much to VCs anyway
Didn't you talk about high growth startups? Do be "high growth" their profit would need to be in the four digit percentage area or more. So just writing black numbers is that not enough. So yeah, even if they are profitable, they are probably still talking to VCs.
Yes - 0 through 2 can be shuffled. Sometimes you can just ask questions and get answers. Sometimes people can't visualize the need until you put something in front of them. Those first few steps are also more iterative than I showed, though 3 and 4 are more sequential.
Companies go through stages:
1 - "Can we build something"
2 - "Will anyone pay for it?"
3 - "Can we turn a profit on each unit?"
4 - "Can we grow profitably and eventually cover our fixed costs?"
Generally you want to know #3 before tossing bags and bags of money at a company, but it's ok for startups to ask for money without having it answered. It's also ok for companies to ask for money without having covered their fixed costs yet.
To oversimplify...
Let's say my fixed costs are $10mm. Let's say each delivery I make turns a profit of a dollar, and each customer uses me for 20 deliveries over the course of 4 years. (Lifetime value of $20, which I get $5 per year) Let's say that it costs me $10 to acquire a company. (Customer acquisition cost)
Then in year 1 I'm $5 behind on each customer, but by year 4 I'm $10 ahead.
If I'm reasonably confident of these #s, then it pays for me to get as much investment money as possible to invest in customer acquisition. From a current cash flow (and potntialy from GAAP [0] earnings too) perspective I am losing money, but this will maximize the long term value of the firm.
[0] https://en.wikipedia.org/wiki/Generally_accepted_accounting_...