What’s better: growing quickly or making lots of money?
The answer, in startup terms, is both. But because there is a natural tension between growth (which usually comes with incremental costs, often in advance of new revenues) and profitability (allowing revenue to further extend its coverage of operating costs), most startups lean more on the growth side of the equation.
It’s not hard to understand why. Venture investors provide capital that often greatly exceeds a startup’s revenue base, allowing the company to hire and market aggressively — and build, we hasten to add — in hopes of far-larger future scale at the cost of near-term profitability.
The tradeoff between growth and profitability is often detailed in the so-called Rule of 40. Indeed, the rubric that combines a growth metric (measured in year-over-year terms) and a profitability result (measured in percent-of-revenue terms) in hopes of the sum meeting or exceeding 40 has generated derivative metrics for companies of a particular age or segment.
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Naturally, the Rule of 40 is not something that applies to, say, pre-revenue startups hoping to raise a pre-seed round. It’s a metric that applies to startups that are generating revenues at a sufficient scale to make the numbers reasonable; no one cares if you can meet the Rule of 40 while tripling your revenue from $1 to $3 per year, but if you are expanding your revenues from $1 million to $3 million per year, the rule is likely something you’ll be measured against.
Now that venture markets are in retreat and public markets have been revalued, there’s been some push for startups to change their posture, trading some growth now for smaller deficits. A flight to quality, some call it.
We’d call it a rebalancing away from quicker growth and staggering losses toward merely rapid growth and less cash burn.
Battery Ventures recently dropped a new report (the “State of the OpenCloud 2022”) that includes some fascinating data on the profit/growth conversation. It’s something that we’ve touched on repeatedly here at TechCrunch as both venture investors and their public-market cognates have shaken up their valuation models.