Source: Alison Coleman, Forbes
It’s a question that most entrepreneurs will have asked: should you keep your profits or reinvest them in growth? Ploughing every cent back into production has traditionally been a golden rule of survival for fledgling startups. Yet there will be times when it is better for the business to focus on one rather than the other, and success will depend on finding a balance between the two.
“Ninety per cent of the time a founder should reinvest their profits back into their business, because it helps them grow and means they won’t stagnate,” says Matt Jonns, founder of ucreate, a co-creator of software startups. “However, the unpredictability of startup life can make the use of profits to shore up cash flow a smart decision. Keeping this money aside for a rainy day is often just as important as reinvesting and could be the difference between survival and extinction when times are at their hardest.”
Since its launch in 2012 ideas portal 7billionideas has put 100% of its profit back into the company. “A pound in my back pocket, will still be a pound in a year’s time, but a pound invested into our business, will significantly grow,” says group CEO David Harkin. “It is imperative to invest in our clients, our services and our staff. Diving into the profits, particularly in the early years of a company, could be a risky strategy.”
Varun Bhanot, head of business development at flexible office marketplace Hubble, shares a similar view in prioritising growth over pocketing profits. “This enables us to grow faster than our competitors,” he says. “By ploughing everything back into the business, it also means the pie is overall bigger in the end. When profits are eventually returned, they are much bigger and substantial than if dividends were given to shareholders in the earlier stages.”
However entrepreneurs also have to look after themselves. Starting up is incredibly stressful, and financial hardship only adds to the pressure. Matt Jonns advocates founders paying themselves a small minimum wage and using excess profits to support their lifestyle when needed.
“As long as you don’t put your cash flow at risk, spending profits in moderation is essential for your own wellbeing,” he says. “It’s something many founders struggle with, but not something they should feel guilty about.”
Entrepreneur Adam Bradford, one of the Queen’s Young Leaders, who works with social enterprises and charities on campaigns, echoes that sentiment. When he started his business, Adam Bradford Private Consulting, he took 50% of the profits for himself.
He says: “There is nothing wrong with this. Even though the business was a social enterprise, I felt as though there was a taboo that needed to be broken around making an impact and making money.
“Heading down the slippery slope of constantly reinvesting into the business I worried that I would be lured into a false illusion that the business was okay, when in fact this would have meant it could not sustain itself. Constantly pouring the money back into the business does not help the economy and can demoralize founders.”
The decision to focus on boosting profitability or investing in growth also depends on the nature of the business and the market.
Trailblazer brands like Amazon and Facebook weren’t profitable for years because they had focused all their resources into growing into new markets. Today they are highly profitable. For businesses that are less unique in their market sector, organic growth, i.e., not investing excessive amounts, may be a smarter move.
But as Sami Benchekroun, founder and CEO of Berlin-based SaaS science and research platform Morressier, points out, growth and profit go hand in hand, even for smaller businesses or startups. He launched Morressier in 2014 and bootstrapped it to profitability by bringing over 250 conferences on board before raising $1.7million in seed funding in 2017.
“Making money from day one provides a proof of concept and market along with a steep learning curve, as selling a product is incredibly challenging,” he says. “Ideally, your business model allows you to generate revenue in a way that fuels the growth of your company.”
From a fundraising perspective, however, he says that focusing on profits can be detrimental to a company.
“If you have classic hockey stick growth without making any revenue, that’s more likely to impress VCs than generating some profits while growing more slowly,” he adds. “Hopefully this will change in the future as investors start to see more value in startups that have a bootstrapping approach and the first signs of a successful business model.”
The answer to the question ‘is it better to focus on growth or profitability?’ is not always clear. It may not even be the right question to ask. According to Steven Hess a trustee and program lead at global entrepreneur network The Startup Leadership Program the question is not growth or profit, but how long to profit points out?
He says: “I’ve recently noticed an increase in financial gearing to make money where investors come in and out at different rounds, taking their profit as capital. But for a business to be sustainable it must ultimately make a profit at the operating level, otherwise it’s just a house of cards. Maybe you need a critical mass of customers to achieve supply side economics, but it’s still a path to profit that increasingly is growing in importance.”
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