Investors Are Shunning Profits for 'Hypergrowth' Models. Here's Why You Should Avoid Them at All Costs
Funding is a necessity for any startup, however, entering the wrong investment model could lead your business to fail. The Softbank scandal offers a valuable insight into what can happen when investment tactics sacrifice profits and stability for hypergrowth, hit a wall and are forced to backpedal. But Softbank isn’t an anomaly - these tactics are far more common than you might think.
As business owners and founders, we need to realize that venture capitalists are investors and money makers, not business owners. They see your company as a calculated risk within a broader portfolio in which only a few will succeed. Why? Because their endgame is different to yours - they can keep pumping money into your business at a loss, as long as another one strikes gold. You, not them, have to ensure that your startup has a sustainable growth strategy, rather than be part of a model that makes you expendable.
Even so, far too many entrepreneurs trust that venture capitalists share their intentions and are happy to live on borrowed money indefinitely, eventually driving their startup into the ground. This is why founders need to be aware of the truth behind investment models, and understand how to get your company standing on its own two feet as soon as possible.
What Investors Want
As an early startup, you’ll have several options to choose from when it comes to financing the next leg of your journey. Venture Capital is one of the most popular choices as it tends to offer a lot of money without expecting the company to become profitable as soon as possible, and will often provide veteran mentorship for your business too.
While that sounds pretty appealing to bootstrapped startups, becoming trapped in this system has risks too.
VC firms often go for high-risk investment strategies, and nine out of 10 startups they back will probably fail. So many firms seek a dominate-the-market approach to ensure they’ll actually make money. That means flooding their startups - even competing ones - with high-value investments in the hope that even the smallest number of them will turn out to be unicorns. Because when (or if) they do get those wins, the earnings will be way higher than their losses.
Some investors do this using the hypergrowth strategy, in which investors drive startups to accelerate at breakneck speed, keeping the money flowing until as many as possible become unicorns by sheer force.
These high-risk tactics run on the premise that if startups grow aggressively enough, they and their investors will eventually corner the market. Turning a profit takes a back seat to begin with.
Softbank used the dominate-the-market investment model with its companies, hoping that with enough buffing they’d become diamonds. But by standardizing this method, they stopped it working. That’s just the point - hypergrowth is only functional for very few companies.
Mainly, companies that are unprecedented and basically create a new market where before there was nothing - Facebook, Amazon, Hubspot, Dropbox... Not all startups can or want to emulate that. So by pushing any and all businesses into this framework, you’ll break them. While I’d like to say that’s a realization Softbank is coming to terms with, that might not be the case, as they’re still spending big on investments even after the WeWork fiasco.
With that in mind, ask yourself - do you and your investors want the same things? Hypergrowth tactics are so persistent that founders are starting to believe that it’s the way the business world works. But it just makes you all the more responsible for protecting your startup from damaging growth strategies.
Remember that while investors can afford to make mistakes (repeatedly) and lose money, you can’t.
Why These ‘ All or Nothing’ Investment Models Are Bad for Your Startup
VC investors with a long-term stake in your company will likely exert a huge amount of influence over your growth strategy. Some will only part with their cash if they can bring in their team or board members, and with time may aim to edge your original founders out completely. While I’m not here to tell you whether or not market domination is a reasonable goal, I do know that under the hypergrowth model businesses are more likely to run on empty, without sustainable funds or a particularly inspiring purpose driving them. Many if not most startups will break under the pressure of “toxic” VCs demanding greater and faster results.
If you survive the first period, such fast expansion + continued investment means the valuation of your company may be wildly off, creating a smoke and mirrors effect. That will shatter if your investors choose to turn the tap off - because they can - or when you move to create an IPO, and people start to look under the hood. When WeWork tried to take that step, they realized that their valuation was not $47 billion, as expected, but actually $8 billion.
The repercussions are severe, even for the most high-profile ventures. Companies in hypergrowth may have to shut their doors or scale way back, not to mention how much this harms morale and the trust your employees and customers have in the business. Right now, WeWork and Softbank’s major investments are having to radically reform their strategy and cut staff just to do damage control. Uber lost billions after going public last year and had to slash expenses.
People in the business world are talking more openly about these downsides. Recently, 50 founders met up to discuss the dangers of current VC investment strategies. Startup advocate and founder Frank Denbow said that VC investors' push for rapid growth sees startups "accelerate straight into the ground.
It’s the classic Icarus trap. Reaching that one in a million status doesn’t need to be your founding goal, or it will probably end up becoming your crutch. Your main aim should be to become profitable and stand on your own two feet as soon as possible. That way even if you do decide that more investment is needed, you are negotiating from a position of strength.
How to Avoid Investment Dependence and Become Profitable ASAP
Not relying on investment indefinitely means acquiring customers and making each of them generate profits in the short-term.
It’s not a bad thing for bootstrapped startups to acquire clients at some loss, as long as you retain them and ensure their lifetime value exceeds your expenses. It may cost you $50 to acquire a customer paying $30 on their first subscription, but if you keep them on board for even a couple of months for you’ll have bridged the gap and made that customer profitable.
You can increase LTV by encouraging repeat purchases, multi-month subscriptions, or long-term contracts as soon as possible.
The difference between this and say, the Uber model, is that you’re not forecasting gains years into the future, after you’ve built up infrastructure the world over. You’re gradually growing a loyal customer base and turning them into today’s profits.
You’ll have to accept that your growth may be slower as a result of limited cash flow. It’s a hard lesson of being a bootstrapped company, but profits will eventually pick up and allow for even greater growth, without the attached risk.
Take the energy you would’ve put into winning over investors and put it into getting mentors, securing business, social and political partnerships, and improving the expertise of your team. Rather than trying to corner a market, define and refine what makes your company unique, and what values will make you stand out.
And when you are fundraising, always be what the investors want from you, and how you plan on using the investment. Remember that options exist other than VCs that will take less of a stake in your company and have a shorter involvement, like crowdfunding, microfinancing and grants.
Why This is Better for Your Startup
Profits, as small as they might be, at least show that your company meets the first criteria of business - it works. That makes you more attractive and trustworthy to stakeholders, business partners, potential customers, event organizers and yes, other investors who will want to take your company to the next level.
So if you’re still not profitable, forget about hypergrowth and becoming a unicorn just yet. Even though you might have money in your account, that money’s not yours. Your business is still strapped to a bigger company - and by consequence, there are strings attached.
I believe that success is measured in profits, impact, realistic years-long projections, and revolutionizing the market rather than dominating it; rather than the speed of growth, market share, and popularity. What metrics are you using?