What is better: growing up Making money fast or big?
The answer, in the opening words, is both. But because there’s an inherent tension between growth (which often comes with additional expenses, often ahead of new revenue) and profitability (which allows revenue to outpace operating expenses), most startups lean more toward growth equity. .
It is not difficult to understand why. Venture investors often provide capital in excess of a startup’s revenue base, allowing the company to hire and trade—and build, we hasten to add—at the cost of future large-scale near-term profitability.
The trade-off between growth and profitability is detailed in what is often referred to as the Rule of 40. Of course, it measures growth (measured in year-over-year terms) and profitability (measured in terms of percentage-of-revenue). ) have created benchmarks for companies of a certain age or class, with the hope of an aggregate meeting or more than 40.
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Naturally, the Rule of 40 doesn’t apply to pre-revenue startups hoping to raise a pre-seed round. It’s a metric that applies to startups that are generating enough revenue to make the numbers reasonable. Nobody cares if you can meet the Rule of 40 while tripling your income from $1 to $3 a year, but if you’re growing your income from $1 million to $3 million a year, the rule might be something to measure.
Now that venture markets are in retreat and public markets are undervalued, there’s been some pressure for startups to reverse their positions, now trading some growth for small losses. To a quality flight, some call it.
We call it a rebalancing from rapid growth and dramatic losses to rapid growth and less cash burn.
Battery Ventures recently released a new report (“The State of OpenCloud 2022”) that includes some interesting data on the profitability/growth landscape. It’s something we’ve touched on repeatedly here at TechCrunch as both investors and their public market counterparts shake up their valuation models.