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2019-09-19 16:41:04

If it weren't for venture capital, founders would have to rely on profits from their business to finance growth. But with billions of dollars flowing into small, money-losing companies. founders feel pressure to grow fast -- often by using the venture capital to keep the company going as it charges very low prices that make their product an irresistible value to customers.

Does that mean that ignoring profit is the key to startup success? Judging by the way money-losing companies like WeWork, Uber and Lyft are struggling, my view is that founders ignore profitability at their peril. What's more, the most successful companies that have gone public have mastered the ability to grow quickly and make a profit.

What ails these failed IPOs.

Too many companies grow rapidly without ever figuring out how to make a profit. It's worth examining how this has played out with WeWork's parent company The We Company, Uber and Lyft.

The We Company-- whose mission is to elevate the world's consciousness -- is losing huge amounts of money (in 2018 it lost $1.61 billion on $1.82 billion in revenue, noted the Wall Street Journal). Part of the problem is that there is nothing about its business of renting out desks to people in offices with nice amenities that other commercial real estate companies could not copy.

We's more basic problem of burning through about $200 million in cash a month is that it spent huge amounts of expansion capital before making sure that its business model was scalable.

What is a Scalable Business Model?

A scalable business model (which I wrote about in Scaling Your Startup) throws off cash because its key business processes-- such as selling and customer service-- get much more efficient as the company grows very rapidly.

Companies should do this after they win their first customers rather than sprinting to liquidity by pouring gasoline on a cash-burning business model to expand into new locations.

In case you're thinking that all startups skip the scalable business model stage, think about Zoom Video Communications. For the six months ending July 2019, Zoom's revenues nearly doubled to $268 million while it made a profit of $5 million and threw off $53 million in cash from operations, according to its latest quarterly statement.

Since Zoom's IPO the shares are up 37 percent to about $85. A key to its scalable business model is that Zoom cares about customers more than its CEO thinks rivals like Cisco's WebEx do. 

If you fail to scale correctly, you'll pay the price.

We, Uber and Lyft lack scalable business models. Uber and Lyft also participate in an industry in which too much capital funds the operation of a service in which costs keep going up even as competitors cut their prices to gain market share. If that's not bad enough, Uber's reputation has been tarnished by reports of drivers mistreating customers.

So Uber and Lyft are punishing investors. To wit, Uber's stock is down 21 percent since its May 2019 IPO while Lyft shares have plunged 50 percent since it went public in March. Both companies are growing more slowly, losing money, and burning through cash. For the first half of 2019, Uber's revenues grew a modest 19 percent to $5.4 billion while it posted a whopping $6.2 billion loss and burned through $450 million in cash from operations.

During the same period, Lyft's revenues grew-- up 82 percent to over $1.6 billion-- while its net loss popped a whopping 331 percent to $1.78 billion as its operations consumed $70 million in cash.

If your ambition is to take your company public, don't make the same mistake as We, Uber, and Lyft. Build a scalable business model before you accept a huge slug of venture capital to supercharge your company's growth as it sprints to an IPO.

As I describe in my book, to make your business model scalable, you should simplify your business processes -- such as sales, marketing, customer service, and product development -- so they are faster, better and less costly. To do that, hire executives who've done this successfully in previous jobs. If the changes make your business cash flow positive, it will be scalable. 

If so, you, your customers, your employers and your investors will be better off.

The opinions expressed here by Inc.com columnists are their own, not those of Inc.com.

inc.com @petercohan
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