By Paul Morin
Is profitability what business is all about? Going through all the various waves and cycles of rational and irrational exuberance, you begin to wonder.
Let’s get back to the basics. When you start a business, why do you do it? Is it because you want something to do with your spare time? That may be part of what you’re looking for, but if that was the whole reason, it would be called a hobby, not a business. Is it because you want to help people? That too may be part of the story, but if that were the only motivation, it would be a non-profit organization, not a business. Is it because you want fame? That may be some of what you’re looking for, but if that were all you wanted, there’d be more direct routes. Is it because you want to “do what you love?” Again, that could (and should) be part of the picture, but if it were all you were trying to do, again, we’d just be talking about a hobby, not a business. I think you’re starting to get the point. When you start a business, the vast majority of the time, the motivation is (and should be) to make a profit.
I will grant you that there are some great businesses that are started by founders who know that the company will likely never “see a profit” while they are still in control of it. The businesses are started with the main objective being to grow (in revenue terms) to a size where big competitors can no longer ignore them and rather than have to compete against them, just acquire the company, hopefully at a “handsome profit” to the founders and investors. Granted, this strategy exists and it has worked spectacularly in certain cases. For most entrepreneurs and most businesses, though, this strategy is very risky and makes almost no sense.
Even for those companies that aren’t built to be acquired, there may be a logical reason why they need to go through the early stages of their lifecycle “bleeding red ink” and only reach profitability several years down the road. In certain cases, this makes a lot of sense. There may be a great deal of necessary early investment in building a market presence and reaching a scale where profitability is possible. This is true in some cases, but even when it is, it is not an excuse to lose money without any sense of when profitability will arrive.
It is important as an entrepreneur that you don’t deceive yourself into thinking, “Sure, it’s a lousy business now, but we’ll make it up in volume.” As absurd as that sounds, you’d be shocked how many times I’ve heard and seen variations on that theme during my career. Don’t fall into that trap. Understand your break-even point. Understand your cost structure and whether your gross margins at the outset and certainly at some foreseeable point in the future, will be sufficiently high to justify the risk you are taking by starting and running your business. If you have investors who have any common sense and experience, they will require such analysis and forecasts from you. If you don’t have investors, do yourself a favor and be very realistic about the business you’re in or you’re thinking about entering. Don’t rationalize. Make sure your assumptions about costs and revenues are realistic and don’t deceive yourself into thinking that if the business model is lousy in the beginning that it will somehow magically get better with time. Typically, it won’t.
Time is precious. Make sure you are spending it on business opportunities and potential deals that have a realistic chance for a level of success that justifies the risk involved. Remember that, in the end, if a business is not profitable, unless you’re working some financial alchemy, there’s no way it can provide you with the economic benefits that justify the risks you are taking and the time you are investing. Make sure the fundamentals of the business look good from the beginning, or that you can at least reasonably project a point on the horizon where it all “comes together”. If not, you are likely to dump a bunch of money and time, among other resources, into a venture that had no chance from the get-go.
I look forward to your thoughts and questions. Please leave a comment (“response”) below or in the upper right corner of this post.
Paul Morin is the founder of CompanyFounder.com. Morin has worked with various entrepreneurial companies in senior management roles and has led the development, review and selective implementation of several hundred start-up and corporate venture business plans, financial models, and feasibility analyses. You can e-mail Morin at firstname.lastname@example.org.
Originally published: Sep 25, 2011