Oct 12, 2022
Startups: switching from high growth to profitability in 2022
Is there a clear path to profitability in your growth plan? This is the million-dollar question that all investors are now asking early-stage tech startups, following the implosion of the stock market earlier this year.
Clearly this is a sizable shift. Even just a year ago, there was little talk of profitability being a primary focus, with more emphasis placed on high growth instead.
The present day sees the economic environment as very uncertain, with venture capital firms applying more granular due diligence when it comes to investing in startups, regardless of sector.
For the tech founder in 2022, profitability is now more than a long-term goal, but instead a key expectation investors are looking for when even deciding whether to invest in your business, – says Giorgi Alexidze, Infinity VC’s Managing Partner
The tech sector’s position in today’s stock market
For years, there have been warnings of the tech sector crashing from stock market commentators, who have claimed it is wildly overvalued.
High-growth tech stocks dominated last year’s IPO market in a record-breaking year. But this year the same cannot be said, with the facts remaining stark:
· This is the longest drought in US technology listings this century
· It’s been over 250 days without a tech IPO worth more than $50m
· The New York Nasdaq, containing a number of the world’s most valuable listed tech companies, has fallen 26% this year
In particular, tech companies are especially vulnerable during an economic downturn, as most of the early-stage enterprises aren’t profitable. Instead, they rely on venture capital investments to cover the soaring expenses needed to drive rapid growth. This is much more difficult to achieve when consumer demand slows.
So, whilst the focus before this year’s crash was on growth and having an injection of capital to fuel expansion, the present day climate sees the focus move almost entirely to profitability – with the balance of power shifting from entrepreneurs to investors,– explains Alexidze.
That shift sees companies and startups needing to make significant changes, and needing to make them now in order to become more attractive to more diligent investors.
What should early-stage tech founders do?
With investors being more cautious, and the hesitant market not expected to recover until the backend of 2023, startups are left asking some critical questions: what impact will the stock market falls have on private market funding flows, company valuation, and future IPOs?
Potentially, those questions are left without definitive answers. “Not being able to raise money as easily will leave early stage startups needing to conserve cash and scale back growth plans. The key switch in focus should then be on improving the products and growing at a more sustainable rate,” notes Alexidze.
It’s also not easy to effectively de-accelerate your growth, while at the same time make more profit, but that’s just how the market is right now. Undoubtedly, it will catch many founders flat-footed, but it’s a pivot that needs to be made quickly.
Switching focus from high growth to profitability
Across the board, founders are now switching focus from high growth to profitability, as quickly as possible. But the challenge is the time it takes for startups to prove their progress.
In high growth mode, you will have been focused on different factors, such as signing up users as quickly as possible, while being comfortable incurring high expenses with the acceptance that profits will come later. But shifting to a focus on profit doesn’t mean investors want the business to stop growing. Instead, they’ll want it to grow more sustainably, while generating profit.
Focusing on the core business model, communicating with shareholders, preserving cash, and extending the financial runway as much as possible, will give your startup the solid foundation to monetise itself in the medium to long-term,– says Alexidze.
The tech sector gets a welcome reality check
Demonstrating the pathway to profit will put start-ups in a much stronger position with investors. Having a more enhanced emphasis on sustainable success, while staying conservative in your growth plans will reassure potential investors. “Sharing a progressive yet solid sales forecast, while showcasing a more shrewd ratio of cost over revenue, will make your business a more enticing prospect,” notes Infinity VC’s Managing Partner.
This approach is not just good for investors. Longer-term it will be good for founders and their businesses too. Who could argue that the industry prior to the crash was out of balance. This correction is forcing everyone to focus on building healthy, sustainable businesses. And those that survive this new reality will ultimately be stronger for it.
Future funding focus
“Another important factor in the current financial climate is for founders to be more focused on the amount of funding coming in, rather than the price of funding. This way you can attract more capital and then play a fair game with investors,” adds Alexidze.
If funding is expensive for investors, this increases the risk of the next round needing to be a multiple of that.
The key takeaways
At the coalface, fundraising is at a level reminiscent of 2018, before the peak. Companies which, at the pinnacle, conducted early-stage fundraising are likely to find it hard to raise at similar or higher valuations in the next stages.
Yet, large amounts of cash are still sitting in existing venture funds.
Startups with proven businesses are not at an immediate risk from a weakening economy and can still look forward to raising money on favorable terms. Investors will continue with their current portfolios and will keep looking for investment opportunities in new companies,– concludes Alexidze
But the tide has turned and founders must adapt accordingly, despite it being a major pivot in the short-term.