Growth or profitability?

Key takeaway

• For entrepreneurs: Balance growth and profitability, aiming for efficient growth with a burn multiple below 1x, and shift focus towards profitability when growth rate falls below 50% year-on-year.
• For investors: Growth rates impact valuations 2-3x more than profitability for public companies, but for early-stage, cash-burning startups, growth and profitability are equally important.

Summary

Kyle Poyar's article "Growth or Profitability?" delves into the critical decision-making process for software startups regarding balancing growth and profitability. The article provides insights on burn rates, how they impact valuations, and when to prioritize growth over profitability. It emphasizes the importance of efficient capital use and offers benchmarks for typical burn rates among VC-backed startups.

Insights

• Burn Rate Definition: Burn rate measures how quickly a company uses its cash reserves to cover expenses. Burn rate is a crucial metric for measuring capital efficiency and business sustainability.
• Efficiency Metric: Burn multiple (cash burned divided by net new ARR) is a key indicator; a burn multiple below 1x is considered best-in-class for fast-growing, VC-backed startups.
• Sustainability Metric: Runway (cash on hand divided by monthly burn rate) should ideally be around 18+ months. Median burn rates have decreased significantly from 2022 to 2023, especially for companies with over $20 million ARR.
• Valuation Impact: Tech company valuations are often based on revenue multiples, influenced by growth rate and profitability.
• Trade-offs: There's usually a trade-off between growth and profitability; fast growth often requires significant investment with delayed payback. There's a significant shift towards profitability when growth rates fall below 50% year-on-year.
• Benchmarks: Typical burn rates vary by company size and growth rate; higher growth companies tend to have higher burn rates. Only 10% of fast-growth companies (>50% year-on-year) are break-even or profitable.

Implications

• For Entrepreneurs: Efficient capital use is crucial. Aim for a burn multiple below 1x and ensure a runway of at least 18 months. When growth slows below 50% YoY, focus on achieving profitability.
• For Investors: Evaluate startups based on their burn multiple and growth efficiency. High burn rates can be acceptable if they lead to substantial future returns, but monitor sustainability closely.