Even though we don't directly advise startups very often, we work with hundreds of them and so we get questions. Occasionally, a founder or other entrepreneur will ask me whether, at the startup stage, venture capital investors are more interested in seeing profit or revenue growth.
Like all complex questions, there is a simple and straight-forward answer. Which is wrong.
The answer is both.
Many investors we work with openly prefer to see revenue growth instead of profit. They know that the margin between income and profit can be carved from efficiencies that are uncovered in growth because, for example, it's cheaper per unit to buy 12 rolls or paper towels than one. Or a large jar of mustard as opposed to a single squeeze bottle. The same rules apply to things companies buy--but usually more expensive things such as labor, manufacturing, marketing, and distribution.
If a startup is losing money on every bottle of juice it makes but the juice is selling, investors know it's possible to make the product cheaper by making more of it. It's cheaper per bottle, for example, to fill a whole truck with boxes of juice than to add a single box to someone else's truck. Once scale and efficiency drive the price down, profit appears.
"Companies benefit from economies of scale as they grow," Shachar Gilad, founder and CEO of SoundBetter told me. "So it's OK to put off optimizing for profit and focusing on growth early on. But demonstrating you can turn a profit or having a clear path to profit on the road map is a good idea."
And the ability to make profit appear is what appeals to most investors I know.
That usually beats a profit model which makes 50 percent profit on each item sold but isn't selling many units. Even if scaling that product makes the profit margin jump, what good is a higher margin if no one is buying it?
But the other side of the coin can be just as bad--high growth with no path to profit. Anyone call sell new cars for five dollars. If you have enough cars, people will line up to buy and you'll show great revenue. But that business model will never show profit at any scale. It's not a good investment--even with efficiency--if your company is spending a dollar to make a dime. Companies that do that just lose more and more and more money.
That's the Groupon lesson.
Fellow Chicagoan Jason Fried, co-founder of Chicago software firm 37Signals, served on Groupon's board for about a year, leaving in January 2011. After he left, he said Groupon was, "more successful in growth than probably any other company that has ever been in that short period of time. But for me," he continued, "that is not a measure of success for a business. My measure of success is, 'Are they profitable?' Currently, Groupon doesn't fit that mold, but they might."
It hasn't been. That's why focusing just on growth or income--without any regard for where the profit comes--is a mistake. Between revenue and profit, the answer is likely yes.
An ideal situation is the ability to show good revenue growth and a path to profit. And ideally, that path to profit comes through efficiencies of scale. That's the holy grail of startup investing.
If you can pull that off, chances are you'll get the attention of investors. And maybe more--you may find yourself with a successful startup.