Growth vs Profitability: The key to startup longevity

Venture-funded startups, unlike lifestyle businesses, are expected to innovate, venture into an unknown territory, and develop products that have never been tested in the market.

By Pearl Agarwal

In the dynamic world of startups, the debate between prioritising growth and focusing on profitability has long been a topic of contention. Recently, this debate has intensified, driven by shifts in the startup ecosystem, changes in funding patterns, and evolving investor expectations. On one hand, rapid growth is seen as the ultimate marker of success; on the other, a sustainable business model grounded in profitability is considered as the true path to longevity.

The truth, however, lies somewhere in between. The question isn’t whether to prioritise growth or profitability, but rather how to balance the two effectively. This balance is not just about numbers; it’s about understanding the nature of the product, the market, and the long-term vision of the company.

The 2021 Funding Frenzy 

In 2021, the Indian startup ecosystem experienced a remarkable surge in funding, with over $42 billion invested and 45 new unicorns emerging. This period was marked by a "growth-at-all-costs" mentality, driven by abundant capital and low interest rates. Investors were eager to fund rapid expansion, often placing profitability on the back burner with the assumption that it would eventually follow.

However, as global economic conditions shifted, with rising inflation and increased cost of capital, the focus began to pivot towards profitability. This sudden change in investor sentiment created significant challenges, particularly for younger startups. After years of being encouraged to prioritise growth, these companies were now expected to demonstrate a clear path to profitability, often within unrealistic time frames.

The Balancing Act 

The core objective of setting up venture funds in the 1960s was to support innovation that otherwise would not have been sustainable with cash flows and debt. Venture-funded startups, unlike lifestyle businesses, are expected to innovate, venture into an unknown territory, and develop products that have never been tested in the market. Expecting profitability from the outset in such scenarios is unreasonable. However, both growth and profitability are crucial for long-term success. The key lies in finding the right balance, which often depends on the startup's stage, industry, and product type.

For startups bringing innovative products to market or creating entirely new markets, initial losses are often a necessary investment. Take Zomato, for example, it operated at a loss for a decade to establish itself as a household name in food delivery. Only after creating a strong habit among consumers did it manage to turn profitable.

On the other hand, startups operating in established markets or offering incremental innovations might need to focus on profitability earlier. For instance, SaaS companies in established verticals can often achieve profitability more quickly compared to startups in winner-takes-all markets like e-commerce.

The key is to ensure that the core business model has high operating leverage, meaning that while fixed costs might be high initially, the company should be able to achieve profitability as volumes increase. Losses in the early stages should stem primarily from marketing and brand-building efforts, not from the fundamental cost of delivering the product or service.

The Path to Sustainable Growth 

While short-term losses can be strategic, startups must have a clear roadmap to profitability. After the initial phase of heavy investment in growth and market penetration (typically three to four years), companies should start generating profits. This transition is crucial, not just for the startup's sustainability, but also for creating value for shareholders through dividends and increasing share value.

To conclude, the growth versus profitability debate isn’t about choosing one over the other; it’s about finding the right balance at each stage of the company’s journey. While rapid growth can create market opportunities and establish a brand presence, profitability ensures long-term sustainability and shareholder value. 

Successful startups understand that this balance is dynamic. They strategically invest in growth during their early stages, creating strong value propositions and customer habits. However, they also maintain a clear vision of their path to profitability, ensuring that their business models have the potential for high operating leverage and eventual profitability. These founders understand the business levers deep enough to be able to turn profitable, if required, but choose to aggressively spend to capture market share.

In the end, the most successful startups are those who can navigate this delicate balance, adapting their strategies to changing market conditions while building sustainable, profitable businesses that create value for both customers and shareholders.

(The author is the Founder and Managing Partner of Eximius Ventures.)

Views are personal, and do not represent the stand of this publication.