What happens when the high beta, growth stage model fails?
We’ve all seen wildly unprofitable venture backed businesses command multi-billion-dollar valuations. For every unicorn, however, there are hundreds, if not thousands, of businesses that fail spectacularly. These businesses frequently end up in this position out of a necessity to be constantly doubling in size year after year in order to raise the next round of capital. Founders, leaders, and board members are all singularly focused on value creation through growth at any cost. But what happens when topline expectations are not achieved? Do you double down on unprofitable activities, assuming it was simply poor sales execution, or do you look in the mirror and honestly ask yourself how repeatable this business model really is? The sooner you identify that you are not scaling in a cost-effective manner, the easier it is to adjust course and protect the core value that you worked so hard to build.
How did the business model become so wildly unprofitable?
It is important to start by asking how you got here in the first place. You have a real business, solving a real pain point in the market and a handful of salespeople hitting achievable quotas. You gain confidence and think it might be time to raise outside capital to grow faster. However, in order to attract additional capital and perhaps to minimize dilution to your ownership stake in the business, you begin stretching your growth projections and lock yourself into an aggressive growth plan. Working backwards from that plan, your sales leader looks at the number of salespeople, the associated quota, and what they’ve historically achieved, and starts adding sales heads into the financial model to hit the targets in the coming year. What is forgotten (or perhaps deliberately overlooked) in pursuit of an aggressive growth plan are the additional infrastructure needs for a sales team to be successful. In other words, it’s not enough to add sales people; additional investments to support those hires must be made.
Sales teams will immediately tell you:
● We need better collateral from the Marketing department;
● We need technical support for pre-sales activity from the Professional Services team;
● We need the Product team to drive more differentiation to be competitive;
● We need Engineering to deliver on the roadmap faster;
● We need more flexibility and support from the Finance department;
● We didn’t receive the proper training / onboarding from the Company;
Even if you have early success scaling through aggressive sales headcount additions, if the product isn’t one that delights the customer through timely and effective delivery and followed by high quality customer success engagement, over-hiring in sales often leads to organizational inefficiencies, a lot of internal finger pointing, and dissatisfied customers that ultimately churn.
Where to go from here: Hypothetical value creation vs. Realizable value creation
Ask yourself a simple question: Which is more valuable, a $20 million business growing 30% that has burned $10 million a year in each of the past 2-3 years or a $15 million business growing 15% and operating profitably? While the faster growing business may command a hypothetically higher forward-looking multiple valuation in a comparative public comps analysis, if there’s no real tangible evidence that the incremental growth is becoming more profitable over time, then few potential acquirers will take the leap of faith that they can somehow fix your broken model. In fact, the more likely outcome is that they’ll tell you to come back when it’s fixed. Furthermore, with the M&A market increasingly dominated by profitability-minded private equity firms, the higher-probability path to realizable value is through the execution of a sound business model that’s focused on profitable activities.
How to transition from “growth at any cost” to a “profitable growth” model
While every situation is unique, the opportunities for improvement are often similar and easy to identify if you remove the near-term requirement to accelerate growth. Focus on the unit economics of each activity and make it as productive and profitable as possible. Identify unprofitable customer relationships and evaluate remediation strategies, such as pricing increases where appropriate. Re-evaluate all your customer acquisition channels to truly understand the fully loaded cost of acquiring and supporting them and rebalance your efforts into the most cost effective and repeatable areas of the business. Place a maniacal focus on churn and customer satisfaction from the initial product delivery through the ongoing maintenance cycles. Happy customers are the easiest to reference and can serve as the foundation for the future growth of the business.
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Brian Peters is a Partner at HighBar Partners, a private investment firm focused on enterprise and infrastructure software companies undergoing change or transition. HighBar provides patient, long-term capital and resources to fund profitable growth and assist management teams with financial, strategic and operational execution.