What Is More Important: Growth or Profitability? The Answer Is Changing Fast
Should you run your business for growth or profitability? The answer depends on why you created the business in the first place. If you want your business to go public or be acquired for billions of dollars, pursue growth.
But if your top concern is preserving the jobs of your employees, keep the company profitable and make growth a secondary concern. A profitable business can often generate enough cash to keep you in control of your destiny. Borrowing money or swapping cash for stock from others will give those capital providers a powerful seat at the table.
To get there, you must at least double your revenues every year. How? By offering a good product at a price way below what rivals charge and expanding quickly into new geographic markets. Doing that means burning through so much cash that, to sustain your growth, you must raise much more outside funding.
Up until October of this year, those capital suppliers that pour money into venture capital–the insurance companies, mutual funds, pension funds, and government investment funds–were happy to oblige. The reason is simple: They expected that the VC investments would offer them higher returns than more prosaic investments like S&P 500 stock index funds.
But supplying hundreds of millions or more in venture capital to finance breakneck startup growth has abruptly gone from being the coolest way to make money to a gigantic embarrassment devoutly to be avoided.
This looks like very bad news for SoftBank which could end the year having extended a grand total of $18.5 billion in debt and equity to WeWork to keep it afloat. And the only hope SoftBank has to salvage its investment in WeWork–which generated $1.5 billion in revenue in the second quarter while burning through $1.4 billion in cash–is to make it into a profitable business.
But that could be extremely difficult because WeWork’s business model is broken. It signs long-term leases with commercial real estate owners and then rents desks at much shorter terms to aspiring entrepreneurs who could easily switch to another desk renter if a better deal came along.
As I learned from an interview last month with a bankruptcy expert–Stephen B. Selbst, chair of the restructuring and bankruptcy group at Herrick, Feinstein–some of WeWork’s leases could be profitable. But significant investigation would be required to ferret out the small number of profitable leases, and lots of cash would be required to terminate WeWork’s many unprofitable leases.
Investors have now turned to punishing public companies for their profitless prosperity. A case in point is Chicago-based food delivery app Grubhub, whose shares plummeted 43 percent on October 29 after reporting disappointing revenue growth and declining to supply a forecast for next year’s growth.
One reason is that Grubhub is losing market share to rivals such as DoorDash (which raised $1 billion in capital in 2019 and now controls 35 percent of the market) and Uber Eats (25 percent), according to the Wall Street Journal.
Grubhub’s fundamental problem is similar in some ways to WeWork’s–its profits are squeezed by powerful suppliers that can play its competitors off against each other for lower fees, while consumers can easily switch to the lowest priced delivery services.
The abrupt change in investor sentiment could have major implications for your company–especially if you are trying to get big fast.
Stop burning cash to double your revenues. Cut your fixed costs and trim money-losing products and regional operations. Venture capitalists may only invest now if you can generate positive cash flow.
Now you’ll get a cold shoulder from investors who this summer would have gladly poured gasoline on your cash-burning business. Build a scalable business model that makes your company more efficient as it grows.