As an early-stage company, do not focus on company profitability
As a director of a start-up, you likely have ambitious goals, and you're aware that growth is the lifeblood of any budding company. At the pre-seed stage, where a company might be generating around $20,000 per month with a small team of three employees, achieving profitability is relatively simple. That revenue may be enough to cover salaries and server costs, but it doesn’t indicate long-term viability or scalability. What startups at this stage should focus on is unit economic profitability - not overall corporate profitability. Why Corporate Profitability Isn’t the Goal 1. Growth Over Profitability Early profitability often comes at the cost of growth. To scale rapidly, significant upfront investment is required. Expenses tend to lead revenue in fast-growing companies, meaning revenue might take time to catch up with rising costs. For example, hiring new team members and expanding operations means a delay before those hires contribute meaningfully to the bottom line. In many startups, the team grows from a few co-founders to 10-15 people within a year. This rapid hiring creates a lag between costs and revenue generation, making profitability hard to sustain. Therefore, focusing on profitability too soon can stifle the growth potential of your business. 2. Early Profitability Can Be Misleading Profitability at such an early stage is often misleading. It usually stems from unsustainable cuts in expenses rather than significant revenue growth. Founders might be taking low salaries or cutting corners just to stay in the black, but this isn’t scalable. The moment you hire more people or increase your marketing spend; profitability can evaporate quickly. A startup that’s “profitable” on $20,000 a month isn’t necessarily setting itself up for long-term success. 3. Chasing the Wrong Metrics Focusing too much on profitability can make founders chase unsustainable customer acquisition strategies. Some startups achieve rapid growth by pouring money into acquiring customers without considering long-term customer retention or profitability per customer. This approach often leads to a fragile customer base that’s expensive to maintain. Founders should instead focus on sustainable growth and building a solid customer base that’s both loyal and profitable on a per-unit basis. 4. It’s Not a Measure of Long-Term Success Early profitability doesn’t tell you much about long-term sustainability. It’s easy to break even when the company is small and lean, but as you scale, the dynamics change dramatically. Your ability to sustain profitability on a much larger scale is what really matters, and early profitability on a small amount of revenue doesn’t provide any meaningful indicators of future success. The Importance of Unit Economic Profitability 1. What Is Unit Economic Profitability? Unit economic profitability measures the profit you generate per customer or per unit of product sold, after accounting for costs such as goods sold and customer acquisition costs (CAC). It's a much more accurate indicator of the health of your business than corporate profitability at this stage. Revenues, cost of goods sold, and marketing expenses all contribute to understanding this metric. The key here is to include all costs associated with acquiring a customer, not just the direct ones like paid ads. This means factoring in sales salaries, commissions, and other less obvious expenses. 2. Why Unit Economic Profitability Matters More Venture capital investors want to know if your product or service is profitable on a per-customer basis, not whether your entire company is breaking even. If you’re losing money on each customer acquisition, it will be difficult to achieve sustainable growth. Unit economic profitability can be achieved early on and is a strong sign of a healthy business model. It shows that you’ve found demand for your product and are making money on every sale, which is a solid foundation for scaling. What early-stage investors want to see If you’ve proven that your product has demand and you can profit on a per-unit basis, venture capital investors know that your business has the potential to scale. After that, it’s a matter of increasing marketing efforts to bring in more customers without dramatically increasing costs. As you scale, your focus should shift to acquiring “healthy” customers who provide long-term value and don’t just respond to short-term discounts or promotions. Another key factor in long-term success for a start-up is the ratio of Lifetime Value (LTV) to Customer Acquisition Cost (CAC). Venture capital investors like to see a ratio of at least 3:1. This means that for every dollar you spend in customer lifetime value, you are receiving three dollars back in lifetime value. A 1:1 ratio is a bare minimum for any business aiming for profitability. How to Build a Scalable Business To build a fast-growing, scalable company, focus on building a robust, sticky customer base that is profitable on a per-unit basis. The most valuable customers are often the cheapest to maintain, and you’ll find that customers acquired through strong product-market fit will stick around longer and contribute more revenue over time, at a lower acquisition cost. Cheap customers acquired through discounts or unsustainable acquisition strategies often have high churn rates and cost more to retain in the long run. Instead of focusing purely on top-line growth, build a sustainable base of customers who genuinely love your product. Final Thoughts As a founder, you may be proud of your early profitability—and that’s a good thing—but it's not what venture capital investors want to see. Show them how you’ve built a healthy, scalable business with strong unit economic profitability. Demonstrate that you understand how to acquire and retain customers in a cost-effective way. That’s what sets companies apart and builds unicorns.
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October 2024
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