If you're running a startup that's growing fast, one of the most fundamental questions you should consider is whether to grow faster or get profitable. Judging by the plethora of unprofitable companies being offering to IPO investors, it seems that most CEOs are answering this question in favor of growing faster.
But that resolution is a huge mistake. And for that you need to only look at what happened to investors in the IPO of ride-sharing service, Lyft. After all, if you purchased its shares when they peaked at $88 a share on March 29 on their first day of trading, by April 11, you would be sitting on a 30 percent loss.
This sad outcome suggests that there is something wrong with taking your company public before it becomes profitable. I think this common mistake is bad for companies, their customers, their employees and their investors.
My new book, Scaling Your Startup, offers an effective solution to this problem-- making sure you have a scalable business model before you invest in growth.
Before getting into that, let's take a closer look at Lyft's IPO. The first thing to consider is that its earliest investors enjoyed a phenomenal return. After all, when the IPO offering initially set its price on March 28, Lyft was valued at $20 billion -- that's a whopping 3,333-fold increase for those who invested in Lyft's $1.2 million seed round back in 2010 when it was valued at $6 million.
Lyft also benefits from its successful consumer brand. This makes it easier for its investment bankers to attract investors in its stock from people who already know and love the company.
But all these good things about Lyft are designed to maximize the wealth of the initial investors and top executives-- and since Lyft lacks a scalable business model it is fobbing off three enormous business problems on those who buy into its publicly traded shares.
1. Lyft has no path to profitability.
Exhibit A is the plunging stock price of Snap, a popular brand with no hope of making a profit. It's an example of a company that goes public at a high valuation but tumbles thereafter. Eventually, such a company will need to raise more money to cover its losses. And that capital will be very expensive.
That's why I argued in Scaling Your Startup that it's crucial for CEOs not to skip the second stage of scaling-- Building a Scalable Business Model-- rather than jumping to the third stage-- which I call Sprinting to Liquidity-- before they accelerate their growth. That means that a company gets more efficient as it grows; developing new products, winning new customers, and providing them excellent service so they will keep buying the product.
But Lyft-- which says it controls 39 percent of the ride-sharing market-- lacks a scalable business model. According to its S-1, Lyft's 2018 net loss widened 37 percent to $911 million on revenue that doubled to $2.2 billion. Will Lyft shares ever rise above their $88 peak or will they stay below that level-- as Snap shares have done-- for years thereafter?
2. Shareholders will get trivial voting power.
Lyft's executives-- Logan Green and John Zimmer-- have not previously run a public company. But due to dual class shares, they have voting control of the company and anyone who buys into the stock today has relatively little.
According to Lyft's S-1, the dual class structure of Lyft's common stock concentrates voting power with Green and Zimmer, who will hold 29.31 percent and 19.45 percent respectively of the voting power of its capital stock. This limits investors' ability to influence the election of directors, amendments of its organizational documents and any merger, consolidation, sale of all or substantially all of Lyft's assets.
3. Lyft will struggle to beat and raise.
To be sure, now that the company has gone public, investors will react to its quarterly earnings reports in a predictable way. If Lyft reports faster than expected revenue growth and raises its forecast, the shares will rise. But if Lyft misses on either number, the shares will plunge.
Building a scalable business model could help avoid the first of Lyft's problems.
As I wrote last October, JFrog, a maker of software that boosts the productivity of software developers, did just that on its way to growing at over 500 percent.
JFrog has been cash flow positive since 2014 by creating a marketing process to efficiently filter out all but potential customers eager to buy the product. Instead of requiring field sales people, potential customers called JFrog's inside sales people who persuaded them to buy.
Don't skip from stage one to stage three.