Steering a course through market turbulence

For a whole host of reasons, the global economic picture isn’t looking especially healthy right now. This is affecting everybody, from individuals and families dealing with the cost of living crisis, to governments re-examining public finances. 

It’s also having a profound effect on the investment landscape, too. Instead of making longer-term, pragmatic investments more focused around growth, investors are focusing solely on profitability and what they’ll get out in exchange for what they put in.

Of course, there is a close relationship between profitability and growth, but this change of priorities among prospective investors does mean that startups have to change their approach to suit. This blog takes a close look at the current state of play, why it’s occurring, and what startups can do about it.

Navigating a turbulent market

The substantial fall in tech stocks earlier this year is just one of the factors that has affected investment. Rapidly rising rates of inflation and interest have also put investors on the defensive, and led to an investment environment that is far more risk-averse than it was as recently as last year.

At the same time, ambitious startups are still dreaming of pursuing twin goals of growth and profitability at the same time. This is by no means impossible, but can be fraught with hazard for companies starting from scratch: in many cases, startup leaders and owners have failed in this endeavour because they haven’t had the right knowledge, or have made the wrong decisions.

The relationship between growth and profitability from an investor’s perspective has always been an interesting one. Historically, growth was generally valued more than profitability, because it meant that success would come in the long-term. However, this was only possible if a clear path to profitability existed: i.e. there was definitely a pot of gold at the end of the rainbow. However, to adjust to the demands of today’s market, investors have naturally become more selective and cautious.

What has changed for investors and what does this mean for startups?

Investors are right to prioritise profitability in the current marketplace, because those businesses who can’t get there in the short term will find it much more difficult over the next few years. 

The current and upcoming economic turbulence means many businesses need money coming in so that they can weather the storm, which means long-term growth ambitions have to be put to one side for the time being. As a result, startups should present themselves with profit as a primary goal, and growth the happy consequence that follows later on, once they’ve got beyond their initial start-up phase. 

One area that investors will investigate when assessing startups is their current cashflow position. Companies that have more money coming in than going out at present (i.e. are cashflow positive) can approach investors from a much stronger position, because they don’t need the investment to plug gaps and survive in the short term. Instead, they can demonstrate how they are already doing well in difficult financial times, and how investment can help them maximise opportunities for profitability.

Startups who are cashflow negative will need to adopt a different approach, and formulate a detailed roadmap that explains how they intend to reach profitability over a defined period of time.

How should startups change their approach?

Regardless of the cashflow situation of any startup, it’s important to find that balancing act between profitability and growth. One cannot be completely sacrificed in favour of the other.

This is why a business plan should now lean further towards shorter-term profitability, and demonstrate the total investment required from an investor in order to get there. This plan should encompass costs, timelines and revenue projections, so that investors can make a commitment with their eyes open and with their expectations managed.

Of course, how long it will take to get to profitability depends on the industry and the nature of the business. For tech startups, this timespan will be especially short because of the incredibly fast-paced nature of the sector and how quickly new ideas and innovations come on stream. Any tech or Internet-enabled business will most likely need to demonstrate how they will get to profitability within 18-24 months.

Many in the business world advocate the ‘Rule of 40’, where the total of a company’s growth rate and its profitability should add up to at least 40%. This represents a good target for ambitious start-ups to aim at, and getting there is generally built on four guiding principles. According to McKinsey, these are setting realistic growth targets, prioritising retention of existing customers, optimising go-to-market spend through data and analytics, and building new business rapidly.

In summary

Every good business adjusts its plans and strategies as market conditions change. The current economic situation makes this especially important for startups, who have to re-evaluate their priorities around growth and profitability. Those who can get this rebalancing right, and explain it to prospective investors in the right way, will be better placed to get the financial boost they’re looking for.

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