When Profitability Trumps Growth

Source: Jonathan Kimmel, OpenView Partners

With all of the focus today on SaaS and hyper growth companies, it’s easy to lose sight of the fact that not every business is ready for 100% growth or can even support that level of expansion. On the other hand, there are a few precious companies that are fortunate enough to sustain fairly high growth rates without having to dip (too much) into the red. If that’s the case, then in terms of next steps, perhaps raising venture capital isn’t the right decision. Instead, maybe targeting or maintaining profitability is a better option.

3 Reasons You Might Choose Profitability Over Growth

Below is a list of three factors that suggest raising a large amount of outside capital potentially isn’t the right decision:

1) “Small” Market Size

It’s no surprise to see tech blog after tech blog pointing out investors are focused primarily on market size and team when evaluating a venture capital investment. The reason is that while the technology, execution, and a range of other factors are important, if the market is big enough, it can allow for a range of mistakes before the company finally finds its way. What’s considered “big”? For most investors, it’s a market size of $1 billion or more. Note: It also depends on the stage and focus of your company, and a great vertical SaaS business can be developed in a much smaller market. Nonetheless, a market below $250mm leaves very little margin for error.

On a purely mathematical basis, if you are looking for a $50 million valuation and your investor is looking for a 5x return, then the exit must be at least $250 million. If we divide that number by public SaaS revenue multiples, that can yield annual revenue of $30 million or over 10% of the market. How reasonable is that to expect?

2) Management Team’s Aspirations Not Aligned with Potential Investors

While you might need capital to grow, what’s your definition of growth? Is it the same as what your investors want?

As mentioned before, think about the capital raise from the point of view of your partners. If they are targeting a high return multiple in a limited number of years, the growth rate must be very high and the financial profile must look very close to highly valued public comparables. To the extent you are focused on a specific distribution method or want to have a services or other component that inhibits the former goal, perhaps taking venture capital might be more trouble than it’s worth. After all, there are many sources of capital, and a good number of them will allow you to exercise much more control in how you want to run your company.

3) Barriers to Entry

Many great businesses have limited structural barriers to entry — Bloomberg, Thompson Reuturs, etc. Sure, they seem unassailable now, but at much smaller sizes, they were primarily about moving faster, creating the right relationships, and excellence in execution. While all companies have to be focused on those elements — which primarily relate to management — hanging your hat on those as an early investor is particularly hard. Similar to the market size issue, it leaves very little margin for error.

While it’s true that raising venture capital may allow your company to move faster and enhance the management team’s chance to succeed, it might also encourage rivals and force the company to move faster than is optimal.

Remember, You Don’t Have to Go for Broke on Growth

While there are definitely more, these are three of the more popular criteria to think about as you balance the decision of whether to raise capital and try for hyper growth. While the choice du jour these days may be to go for that growth, there’s nothing wrong with seeking profitability. At the end of the day, it puts you more firmly in control of your business, and sometimes the most lucrative outcomes for owners are small exits when they own the majority of the business.


About Scale Finance

Scale Finance LLC (www.scalefinance.com) provides contract CFO services, Controller solutions, and support in raising capital, or executing M&A transactions, to entrepreneurial companies. The firm specializes in cost-effective financial reporting, budgeting & forecasting, implementing controls, complex modeling, business valuations, and other financial management, and provides strategic help for companies raising growth capital or considering M&A/recapitalization opportunities. Most of the firm’s clients are growing technology, healthcare, business services, consumer, and industrial companies at various stages of development from start-up to tens of millions in annual revenue. Scale Finance LLC has offices throughout the southeast including Charlotte, Raleigh/Durham, Greensboro, Wilmington, Washington D.C. and South Florida with a team of more than 40 professionals serving more than 100 companies throughout the region.