Strategic Unprofitability: Understanding How Long Your Business Can Be In The Red For Knowing the difference between acceptable unprofitability and genuine financial trouble is crucial for investors and entrepreneurs alike.

For any entrepreneur or small business owner, the question of profitability is central. There are countless examples of startups that were unprofitable for years before hitting it big, and studies have shown it's quite common for a new business to take two years to become profitable. But how should you measure it for your particular business? And what happens if those two years become three, or four, or more? Because for many, being unprofitable is not only very worrying, but it also puts a timer on how long your business will remain feasible.

So, in this article, I'll discuss how unprofitability can be workable if it's approached strategically, the warning signs to look out for when there is a genuine problem, and I'll elaborate on my view, which is that even when there are red flags, there are things you can do to mitigate it. Let's get started.

Looking out for red flags: How to know when unprofitability is okay—and when it's not

A prolonged period of unprofitability is often seen in companies even with a very strong business plan. The goal in these cases is to dominate the market, often through aggressive investment in technology, marketing, and infrastructure. For example, in 1999, even though Amazon was showing US$1.6 billion in revenue, it didn't turn a profit until 2003—nine years after it—now one of the "Big Five" American technology companies—was founded. As such, those investors and stakeholders familiar with these strategies understand that initial losses are just a part of achieving long-term gains. But here is where we need to be very careful, as the distinction between strategic unprofitability and real financial trouble is crucial.

To my mind, these are the factors to consider:

- Market positioning and growth Is your company growing its market share? Companies that manage to continually expand their user base and market presence—despite being unprofitable—are generally on the right track.

- Revenue trends Are revenues increasing year-over-year? While you still may not be profitable, consistent revenue growth indicates a demand for the company's product or service.

- Burn rate How quickly is your company spending its cash reserves? A manageable burn rate, aligned with future funding rounds or revenue milestones, can indicate a healthy business—even if it's not yet profitable.

- Path to profitability Does the company have a clear and realistic path to profitability? This is key. Investors and stakeholders need to see a strategic plan detailing how and when the company intends to turn a profit. As an entrepreneur, you also need something to aim for.

Now, let's look at the other side of the coin. While accepting long periods of unprofitability, one still need to be wary of warning signs that one's company might be in trouble. These can include a pricing strategy that isn't working, a product that isn't viable, or perhaps you're not attracting the right kind of customers, or your relationship with money is flawed.

Here's a look at a few of these key considerations in more detail:

- Stagnant or declining revenue If your company's revenue is stagnant or declining, it may indicate a lack of market fit or competitive pressure.

- High customer acquisition costs If the cost of acquiring new customers outweighs the lifetime value of those customers, your business model may be unsustainable.

- Lack of innovation Companies that fail to innovate or adapt to changing market conditions may find themselves unable to compete effectively, leading to prolonged losses.

- Poor management Ineffective leadership and a lack of strategic vision can be a real issue for any company, regardless of its market potential.

Related: Striking Out Alone: Developing Your Identity As An Entrepreneur

The profitability problem: Underlining the "staying power" of your organization

Let's take a moment now to focus on how potential investors may see your company. Any investor will look at both profitability and growth. Your job is to ensure that the red flags we have discussed are not present, and that your focus on growth and market dominance is not hampering profitability. It all comes down to what Investopedia calls the "staying power" of your organization. In short, this is how well your company can keep operating without making a profit.

The question about how much capital your business needs in order to keep going will be asked—because the longer this period, the longer it takes to become profitable. Investors will also want to assess how determined you are to make your enterprise a success. Frederick W. Smith came up with the idea of an overnight- delivery company in 1962—in fact, he drew up the idea while still a student at university. Nine years later, he founded FedEx. And it was four years after that before it made a profit. In those in-between years, Smith did everything he could to keep the business going, which included trying to gamble his way to liquidity in Las Vegas (definitely not advised for any budding entrepreneur!), before finally raising $11 million through more orthodox methods. But what he demonstrated throughout was a willingness to stick with it, and to see his idea through to the end.

That said, if you do find yourself no longer strategically unprofitable, and are slipping into red flag territory, what can you do? Let's run down a quick checklist:

- Don't rely too much on debt While debt can be a useful tool to finance your growth and innovation, it can also be a double-edged sword that can harm your financial health. Debt increases your interest expenses, reduces your cash flow, and limits your flexibility. If you borrow too much money that you cannot repay or refinance, you may end up defaulting on your obligations, and losing your assets.

- Don't ignore your competitors While unprofitable companies may have a first-mover advantage or a unique value proposition, they may also face fierce competition from other players in the market. Some of your competitors may be more profitable, more efficient, or more innovative than you. If you don't keep up with your competitors, you may lose your market share, your brand recognition, and your competitive edge.

- Don't neglect your stakeholders While unprofitable companies may have a loyal fan base or a visionary leader, they may also alienate some of their stakeholders if they don't deliver on their promises or expectations. If you don't treat them well, you may face lawsuits, boycotts, strikes, or fines. Therefore, you should always respect and engage with your stakeholders.

Sometimes, a single moment proves to be a turning point. The sports network ESPN was founded in 1979, but it wasn't until the mid-1980s that it became profitable. The turning point? Support from American brewing company Anheuser-Busch, who signed—at the time—one of the biggest advertising contracts in history. So, knowing the difference between acceptable unprofitability and genuine financial trouble is crucial for investors and entrepreneurs alike.

But even though companies like Amazon and Uber (the American ridesharing company took 15 years to get into the black) demonstrate that extended periods of unprofitability can lead to monumental success, it's vital to continually assess key business metrics and market conditions. By understanding the nuances of strategic unprofitability, what red flags to look out for, and how to mitigate them, businesses can navigate those challenging early years, and then have the potential to one day achieve long-term success.

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