Balancing growth and profitability in tech startups
Many tech startups are only focused on growth and aim to become unicorns. Other startups aim for profitability, the cockroach approach (see “How to build a cockroach startup”). This article advocate balanced growth, a strategy that maximize growth given a certain level of profitability.
The first company I co-founded was Questback (questback.com) back in 2000. We got five angel investors to fund the company from start. The most active angels was Ørjan Hernes and Jarle Gundersen. They introduced us for the term “Balanced growth” and advocated positive cash flow in combination with rapid growth. Questback reached significant positive cash-flow already in 2003, and until sold to the private equity fund Reiten & Co i 2008 the profitability was 25–30% of revenue that allowed for yearly dividends to the shareholders. In the same period the yearly revenues growth was 50–100%.
The second company Admincontrol (admincontrol.com) I co-founded in 2005. With this company we repeated the balanced growth strategy with 20–25% profitability until the company was sold to private equity fund Herkules Capital in 2015.
In 2016 I co-founded Owners Room (ownersroom.com), and aim to achieve profitable growth from 2019 onwards.
Main owners and the board of directors can choose to prioritize between growth and profitability. Either focus on maximizing revenue, cash flow or both. Balanced growth is preferred by many companies and investors, and management is given a mandate to maximize growth given agreed level of profitability.
Many leading tech investors want to invest in companies with really big ambitions, hence profitability is not a requirement. It might even be a disadvantage and a sign that the company is not investing heavily enough in growth (e.g. see “Should startups care about profitability”)
Yes, some companies want to become a global-platform-for-this-and-that and need to capture the lions share of the market in order to provide any value. Winner takes all. But most other tech companies start delivering customer value as soon as the product is ready, and these companies can choose balanced growth after an initial (shorter) investment period.
Why balance growth and cash flow?
- Operational. Growing at lightning speed is very demanding for the organization. Slightly lower growth (could still be significant) could be more healthy and better for the long-term viability.
- Financial. Conserving cash reduces the risk of needing to raise capital at unfavourable terms.
- Habits die hard. Getting used to running a business with net cash burn over many years could make it more difficult to switch to significant profitability later.
Long-term investor perspective
- Positive cash flow allow for owners to get “a small exit every day” rather than gearing up for a big exit.
- This imply that the owners do not need an exit within a certain timeframe (like VCs would require), and the company with its investors can choose a longer journey if they want.
Agile budgeting for balanced growth
In Admincontrol we approached this by developed a simple spreadsheet that monitored key figures for next 12 months (rolling), and compared to the last 12 months. In addition we tracked an “investment backlog” with planned capital investments and new hires.
As soon as the company reached their next revenue milestone last 12 months, the board released the next batch of investments from the investment backlog. This way the actual performance rather than a yearly budget was determining when to release new investments.
The same methodology could of course be used for any strategy, but we used it to ensure balanced growth.