Profits in Venture Capital and Startups

Profits in Venture Capital and Startups

Peter Drucker, the founder of American Management, said this about profits, "profit is not the purpose of a business, but rather the test of its validity." In Silicon Valley venture capital culture, an Entrepreneur "not caring" about profits seems to be the current chic trend these days and a badge of honor for the Entrepreneur who gets funding. Let's blame it on Jeff Bezos for the Profits Later Movement. In Bezos's quest to build an empire, he didn't think about profits but more on how he could scale and capture market share.

Examples and case studies are plenty of this crazy culture of Profits Later Movement. Jawbone and Uber are great examples of this craziness. Jawbone, a tech company with all the resources and capital at its disposal, still went bankrupt in the end. Almost a billion dollars of investor money wasted with nothing to show for it for anyone. Uber's loss was $4.5 billion in 2017 and $2.8 billion in 2016. This loss may decrease with a new CEO at the helm and cash reserves are being offset by Softbank's cash infusion of $1.25 billion. But an investor subsidy for Uber passengers is not a sustainable long-term strategy especially when the passengers were only paying 41% with the other 59% subsidized by investor cash.

The Twitterverse goes crazy on this topic. Marc with the Twitter handle @marckohlbrugge gives his opinion, "I just realised I'd rather buy from a 1-year old bootstrapped company than a 1-year old funded company. The bootstrapped company is more likely to have found a sustainable business model and will still exist in a year's time." This statement is direct from an end user and customer regarding quality and sustainability.

Many supporters point out that Uber is just following the Amazon strategy. Even though Jeff Bezos rarely focused on profits, Amazon's cash flow is king and may be what is kept Amazon afloat which may be the big differentiator from Uber. Several Wharton professors completed a very detailed Uber analysis in 2017 examining the sustainability of their strategy. The concern we pose is if the capital allocation is effective and efficient in these companies that don't worry about profits. The allocation issues is that this capital could be invested in other startups that have an executable plan for profits.

What do you think about profits and Venture Capital?  Profits are the dirty word of the Silicon Valley VC culture and many of these investments don't pass Drucker's "test of validity."  Let us know your comments below or post them on our forum.

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