Growth can't wait

Venture investors are changing their tune. While some venture shops are proudly “open for business” on Twitter, the data tells us a different story. It’s important to remember this data only shows a slight decrease in funding so far, but it includes firms stuffing their portfolio companies with 24 months worth of cash to keep them afloat. The rate of new investments is slowing down (rightfully so). VCs are taking a step back — to develop fresh theses in a post-pandemic world, manage LPs, and to help their existing portfolio companies weather the coming storm.

If you run a startup, it’s imperative to manage cash effectively. If you can miraculously get lean, reach profitability, and sustain positive cashflow you’re in a great place. But, if you don’t think it’s possible to be independently profitable (not just community-adjusted EBITDA) and your startup will rely on VC dollars in the next 24 months, then it’s important to find ways to keep growing. Yes. Unfortunately, growth can’t wait— even in this environment.

Growth is the defining characteristic of the successful, venture backed startup. Paul Graham has written about it. For founders operating during this pandemic, it can be hard to swallow. Especially when VC twitter is now excited about value strategies and cash conversion and balance sheets. The thing that hasn’t changed is that VCs are on the very end of the institutional risk curve. They can’t really be value investors because they’re not structurally setup to be. They will never earn their fees by buying stakes in small, but profitable companies. They bet on the Babe Ruth Effect. They bet on the possibility of disproportionate and outsized returns.

Come time for your next financing, your top line metric (be it MAUs or revenue) still needs to be headed up and to the right. Margin and/or business model leverage are the secondary indicators of a good venture-backed business.

In corporate finance there’s a classic tradeoff between ROIC and growth. A management team can either focus on growing their company’s share of the market or increasing the efficiency of their value capture machine (margin). Depending on the stage of the business, an incremental dollar of revenue or incremental dollar of margin will increase the enterprise value more than the other. For early stage startups, valuation (hell, ability to raise in the first place) is based almost entirely on top line metrics and not margin.

I'm not saying margin isn't important. Margin grants the company runway. But for an early stage venture investor, the likelihood of future margin will suffice. Top line growth is a must.

As you look to the future, it’s important to remember that some venture funds will get wiped out too. Others will have their LPs withdraw some capital. While there will be fewer startups, there will also be less cash in the system to back them. Growth is imperative.