Startup Profitability Myth Busted: Key Insights for Entrepreneurs

Why do some startups thrive while others struggle?

The startup world is filled with legends of bold entrepreneurs, yet myths about profitability persist.

For instance, many believe that startups don't need to be profitable to succeed.

However, comparing companies like Deliveroo and Adyen challenges this myth, especially today's economic climate.

Deliveroo has never been profitable, and Adyen reached profitability from the beginning.

Despite these differences, both companies now generate equal revenue. Deliveroo relies on venture capital funds, while Adyen focuses on profitability.

This raises a crucial question: does similar turnover equate to success?

It's high time we redefine our notion of a successful startup, placing profitability at the forefront, not mere revenue generation.

In that spirit, we'll bust the top 5 profitability myths for you in today's article.

Let's begin!

What Is Going on with the Startups?

Yes, we all listened to the growth over profitability story, but now it is obvious that was wrong.

With the global decline of capital, choosing organic profit growth before overgrowth sounds quite reasonable.

Furthermore, investments are in general decline.

Cash and capital are shrinking with the rocketing price of using.

This leads to the conclusion that Startups need to be profitable over the growth paradigm.

In 2024 and further, we expect VC and other investors to fund only profitable Startups.

What Makes a Startup Profitable?

By embracing this new profitability mantra, we assert that numbers are inherently severe and sharp.

According to statistics, only 10% of new Startups succeed!

Owners of first-time startups have only an 18% success rate.

Here are some of the profitable Startups:
✅  Clockify
✅  Mollie
✅  Ahrefs
✅  Netflix

And, surprisingly, unprofitable Startups are:
❌Airbnb (2008-2022)
❌ Uber (2009-2023)
❌WeWork (2010-?)
❌ Deliveroo (2013-?)
❌ Discord (2015-?)

How a Business Model Affects VC Investor Expectations

The way that late-stage funders and the general market respond to a company's rate of development and profitability can also be influenced by its business strategy.
Investors may place greater value on user growth and participation in the marketplace and social networks than on income.

Particularly with:

👉 social networks,

👉 time spent on the site by each user and

👉 visitor growth (number of daily active users) can take precedence over revenue.

Investors often overlook significant losses due to the hyper-growth (blitzscaling) of social networks and marketplaces.

However, this is about to change, as we'll cover in a moment.

But remember that your company still needs to have a low percentage of employee turnover.

Abundant Capital Lowers Profit & Efficiency Incentive

We think that having too much capital might be a significant concern, especially for mid- to late-stage enterprises.

Frequently, having too much capital obscures inefficiencies that could be closely examined if money was restricted and postpones the discipline needed for profitability.

While finance can be a useful tool in a strategic market share acquisition, solid control over the effectiveness of marketing and sales efforts is essential.

When you're well-funded, it's simple to fall into unhealthy habits while pursuing expansion and lose the productivity that got you here in the very first place.

Effects of Networks and Blitzscaling (Hyper-Growth)

Startups with network effects adopted extraordinarily aggressive expansion techniques known as "blitzscaling"—a term coined by LinkedIn founder Reid Hoffman—in an environment of plentiful financing.

Historically, network effects organizations have sought to quickly build scale in order to feed their network effects, as network effects tend to create winner-take-most dynamics.

Investors have previously demonstrated a greater tolerance for loss-making endeavors for even extremely large organizations with network effects because they understand that there is a taking-all option with growing returns to scale.‍

Aggressive expansion is the ideal strategy when there are strong network effects, flexible acquisition channels, and good cohort profitability.

Few organizations have enough capital or a lucrative business model to continue blitzscaling even in an economic slump.

The balance of power is moving again to an attention to profitability.

On the other hand, sustainability is pressuring businesses to prioritize efficiency and innovation over pure growth.

Debunking the Top 5 Profitability Myths—Everything You Need to Know

There are so many myths around Startups profitability.

The solution to frequently raised myths is not as simple as one might assume.

While some startups are successful and profitable, others barely make it by.

Let’s start with our myth #1!

Profitability Myth #1: Startups and Small Enterprises Can't Easily Turn a Profit

The idea that Startups and small companies lack the same assets or economy of magnitude as larger enterprises gives rise to this misconception.

It's a common understanding that tiny firms are intrinsically dangerous and susceptible to changes in the market, rivalry, and other outside variables.

Yet, there are numerous small startups that turn out to be profitable!

Explanation of Profitability Myth No.1

The truth is that new Startups and tiny companies don't have to struggle to turn a profit or be destined to fail.

There are plenty of tiny firms that succeed and turn a profit despite the fact that many of them deal with difficulties including:

• scarce resources,
• heightened competition, and
• legal restrictions.

With wise and structured guidance and help, they can reach profitability!

Profitability Myth #2: Profit Is the Only Measure of a Startup’s Success

A common misconception among Startup owners is that they are failing if they aren't making a big profit.

This false belief frequently causes small business owners to concentrate only on making a big profit, ignoring other crucial elements that are crucial to their company's success.

It is ok to make even a small profit in the beginning!

Explanation of Profitability Myth No.2

Additional aspects that influence the success of small businesses are:

• customer happiness,
• recession,
• high cost of capital,
• high rates,
• employee involvement and satisfaction,
• economic growth and sustainability, and
• total community impact.

While profit tracking is vital, it's also necessary to monitor additional important performance metrics (KPIs) that reflect your company’s well-being.

Profit alone can lead to shortsightedness and an inability to see the wider view of long-term success.

Tips for Evaluating Startup Performance:
‍
🚀 Create KPIs beyond financial gain.
🚀 Use surveys and reviews for customer satisfaction.
🚀 Assess staff feedback and retention for employee engagement.
🚀 Track revenue growth and new customer acquisition.

Profitability Myth #3: Founders Must Sacrifice Personal Income for Startup Success

The notion that Startup owners must forgo their own earnings to support their enterprise originates from the presumption that a company's ability to succeed exclusively relies on the amount of capital invested in it.

A common misconception among the public is that entrepreneurs must invest every dollar they possess in their company in order to maintain operations and turn a profit.

This style of thinking gives rise to the notion that startup owners will constantly struggle to make ends meet and that the needs of their companies will always come before their own personal income.

Explanation of Profitability Myth No.3

As often happens, startup owners who risk their own earnings during the early stages of their venture are not able to maintain their business in the long run.

Startup’s founders must strike a balance between financing their ventures and giving themselves a respectable wage.

Since they are usually the main power behind their companies, startup owners ought to be paid appropriately.

Paying yourself decently guarantees that your business will continue to run smoothly and that you will be able to pay your personal bills.

It's crucial to bear in mind that receiving just compensation encourages you to keep up the good work and expand your company.

Besides, giving up personal income to support the company looks like the right thing to do, but in the long run, it may affect your company negatively.

👉 Firstly, it may result in burnout and a drop in output.

👉 Furthermore, it may be challenging to draw in and keep workers who are seeking stability and just remuneration if you're not paying them a fair wage.

Tips for Balancing Personal and Business Budgets:
‍
🚀 Create a budget for both business and personal expenses.
🚀 Set a reasonable salary based on your company's financial health and industry standards.
🚀 Invest strategically for long-term profitability and growth.
🚀 Regularly review and adjust finances to meet personal and business goals. 

Profitability Myth No. 4: Cost-Cutting Is the Key to a Startup’s Profitability

Many people think that the startup’s owner must minimize expenses in order to boost income if they want to see an increase in profitability.

But that's only a small portion of the picture, and it frequently has unfavorable long-term effects.

Examination of Profitability Myth No 4:

While reducing expenses is crucial for every company to effectively handle its finances, a startup may suffer long-term effects if it concentrates just on cost-cutting strategies.

Severe cost-cutting may result in a drop in the caliber of the goods or services, which may have a detrimental effect on client retention.

Furthermore, cutting costs on marketing and advertising may result in a drop in brand recognition, which will make it more difficult for small firms to draw in new clients.

Startup’s success is not just about cutting expenses but also about growing revenue.

👉 Identifying fresh sources of income is one method to achieve this.

For example, a boutique may start selling goods online, or a bakery may start selling cakes to neighborhood cafes.

The bottom line of small enterprises can be greatly increased by looking into additional revenue streams.

👉 Another strategy to enhance income is to improve client loyalty.

Loyal consumers are more inclined to recommend and spend more, which broadens a company's customer base and boosts earnings.

Businesses need to give exceptional customer service, loyalty programs, and distinctive goods and services in order to develop client loyalty.

Tips for Boosting Startup Income:

🚀 Expand service and product offerings.
🚀 Grow your customer base with targeted marketing.
🚀 Simplify processes to reduce costs and increase efficiency.
🚀 Leverage technology to improve customer service and streamline operations.
🚀 Explore joint ventures and partnerships with other companies.

Profitability Myth #5: Only Certain Industries or Business Types Can Have Profitable Startups

There is a common understanding that some industries are naturally more lucrative than others and that startups are more likely to succeed than others because of things like:

• geography,
• economic conditions, or
• the experience of the entrepreneur.

The idea that some kinds of startups, like tech or financing startups, are more profitable than others feeds this misconception.

It is further supported by the notion that prosperous business people possess a certain set of abilities or character attributes, such as:

• the ability to take calculated risks, 
• think creatively, or
• be excellent salespeople.

In actuality, a startup's profitability is determined by a number of variables, such as:

👉 the viability of the business concept,

👉 the entrepreneur's capacity to carry out a solid business strategy and

👉 the degree of customer demand for the good or service.

The value of the business plan and strategy is ultimately what determines a startup's success, even though some businesses may be more lucrative than others.

A strong business plan and strategy are essential for any profitable startup, regardless of the industry.

This comprises determining the target market, evaluating the competitors, establishing reasonable budgetary targets, and developing a marketing strategy to attract possible clients.

A thorough awareness of the expenses associated with starting, maintaining, and managing a startup is also necessary for its success.

Tips for Creating Successful Startups in Any Sector:

🚀 Conduct market research to identify potential markets and evaluate the competition.
🚀 Develop an operational plan outlining objectives, tactics, and costs for launching and running the business.
🚀 Focus on delivering high-quality products or services that meet the target market's needs.
🚀 Create a unique brand identity to attract customers and differentiate from competitors.
🚀 Regularly monitor and adjust the business plan based on financial performance, market trends, and customer feedback.

Warning Example of Dot.com Bubble Crash

During the 1995–2000 bull market, extremely risky investments in internet-based enterprises drove the dot-com bubble, a stock market bubble.

The equities markets had a sharp increase in value over that time, and the Nasdaq index, which is dominated by technology, increased five times.

Tech stocks increased far faster than their real sector equivalents and rose well beyond their fundamental value.

Many investors still anticipated Internet-based companies to prosper since the Internet was an innovation.

Because of this, investors eager to discover the next major dot-com were more than happy to put their faith in technical improvements and ignore fundamental firm analysis incorporating indicators like price-earnings (P/E) ratio.

Ultimately, the extremely speculative and expensive businesses led to a 1995 stock market boom.

In response, the Nasdaq had record capital inflows in 1997, which resulted in 39% of venture capital investments flowing to Internet startups by 1999.

Internet firms accounted for the majority of that year's 457 IPOs, with 91 of them occurring in only the initial quarter of 2000.

As a result, the Nasdaq Composite, which is a stock market index, increased 400% between 1995 and 2000.

Why Did the Internet Bubble Pop?

And after rocketing data, everything crashed in a few minutes.

Nobody could predict, and yet it was a logical outcome with such high speculations.

The following causes contributed to the dot-com bubble's eventual collapse:

1. Irrational Overestimation of Dot-Coms 📢 

Due diligence was a major factor in the dot-com bubble for investors.

The majority of online businesses that held initial public offerings (IPOs) before the dot-com era were wildly overvalued due to high demand and a dearth of reliable valuation models.

To put it briefly, investors tended to overlook traditional fundamentals, and companies were valued based on revenue and profit that would not materialize for a while, supposing that their business model actually functioned.

Because these high-tech companies lacked reliable profitability measures like P/E ratios that were based on facts and reasoning, investments in them were extremely speculative.

Clearly, investors were ignorant of the warning signals that finally indicated the burst of the bubble because of this ill-advised investing technique, which produced unrealistic and too-optimistic values.

2. The Extravagant Expenditures of Dot-Coms 📢 

VC lavished so much money on marketing and advertising to gain as much market share or awareness as quickly as possible the majority of Internet companies experienced net operational losses.

Furthermore, these businesses would typically provide their goods or services for free or at a reduced price in order to build enough brand recognition to charge profitable prices later on.

And that was a big trap!

Too many expenses to grow in the future without an eye on profit destroyed many firms.

3. An Abundance of Venture Money 📢 

The main cause of the bubble was the money that venture capitalists and other investors were pouring into dot-coms.

Furthermore, the capital was freely accessible because of the cheap money made available by extremely low interest rates.

In addition, the Taxpayers Relief Act of 1997 increased the willingness of Americans to undertake speculative investments by lowering the highest percent capital gains tax in the country.

This, together with lower finance barriers for computer and internet businesses, caused the industry to see tremendous investment, which blew up the financial crisis even further.

4. Support from the Media 📢 

Media organizations pushed unduly optimistic projections of future returns to the public, encouraging them to make investments in risky tech stocks.

Similar to this, business journals took use of the public's desire to participate in the stock market to further increase demand.

Examples of these publications include Wall Street Journal, Forbes magazine, Bloomberg News, and several investment analysis periodicals.

They all created strong FOMO (Fear of missing out), and that was an intro into disaster.

What Does the dot.com Bubble Have in Common with the Startups Myths?

And if you’re wondering what the dot.com bubble has in common with the startup myths, here is the answer: exactly the same is happening with the withdrawal of VC:

👉 nobody wishes for high-risk investment and

👉 everybody wants to secure their money.

There are so many sad stories around the world about a failing economy.

Capital, in general becomes expensive and continues with high rates all over the World.

In the US, the standard interest rate is 5.50 percent.

As the US Economy influences worldwide, this has a huge long-term impact!

Moments from the January FOMC meeting revealed that FED policymakers believed the policy rate was likely at its peak for this cycle.

However, they generally stated they would not lower it until they had more assurance that price growth would rise sustainably toward 2%.

Participants also emphasized how unclear it would be to sustain a tightening monetary stance for an extended period of time.

While some officials emphasized the dangers of proceeding too rapidly, only two emphasized the possible disadvantages of maintaining a restrictive position for an extended period.

Too many remember the Crisis after 2008, and yes, the numbers look the same again!

VCs with this memory and linking with other bubbles in the investment history are reasonably cautious.

What New Startups Need to Understand to Survive?

To gain VC investment and to grow, Startups need to gain profitability as soon as possible.

This means avoiding at any cost above mentioned mistakes with the dot.com bubble.

Yes, there are always bubbles created in the economy.

But, we need to navigate wisely within.

To achieve financial stability, consider the 40-70 rule and the EBITDA rule while managing expenses tightly but sufficiently.

👉 40-70 Rule:

• Decision-making should happen when you have 40-70% of the information needed.
• Waiting for more can lead to missed opportunities; acting too soon can result in poor decisions.

👉 EBITDA Rule:

• Aim for a healthy EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) margin.
• A good EBITDA margin varies by industry but generally falls between 10-20%.

👉 Expense Management:

• Keep expenses tight to avoid unnecessary costs but ensure they are sufficient to maintain operational efficiency and support growth.

Remember, growth is necessary, but profitability is crucial.

How Should We Proceed?

Some necessary improvements are well known, as misaligned incentives partially contribute to the low market demand for new technologies and the lack of startup revenues.

👉 A lot of venture capitalists (VCs) charge 1-2 percent of investor funds as fees thus, they have an incentive to support businesses even if they don't have a lucrative exit 

They raise capital and return invested capital.

👉 Then there are the proceeds of selling their startups to the general public, ideally before the general public discovers that the startups won't turn a profit at the degree of profitability that the prospectus claims.

Some refer to it as "pumps and dumps."

But there are much more serious issues.

👉 Prior to anything else, it is imperative that we all have a deeper understanding of value creation, its origins, and the processes by which new technologies arise and generate profits.

To do this, we must ask more insightful questions regarding the advantages and disadvantages of emerging technology

We require:

• new approaches to the development of science-based technologies, 
• approaches that incorporate new players,
• new policies and incentives for higher education, and
• new systemic objectives.

For this, we need academics, experts, and policymakers to take the lead in proposing new ideas and organizing a means of discussion.

Essential Tips for the Startups Founders

✔️ Avoid running out of money during downturns; give yourself time to adjust before the market rebounds.

✔️ Focus on survival first.

✔️ Aim to succeed by creating a company that redefines its category.

✔️ Strengthen your position and gain market share during downturns.

✔️ Maintain strong cash flow and operational efficiency.

✔️ Prioritize profitability but remain open to expansion and new opportunities.

To Conclude 

In conclusion, while profitability plays a significant role, success is a result of several factors.

Investors and entrepreneurs should consider a wider range of factors, including: 

• market share potential, 
• timeliness, 
• innovation, and 
• strategic growth in order to assess a startup's true potential.

By keeping costs down and focusing on product development, you may:

👍 attract investors,

👍 boost your startup's gross profit margin and

👍 position yourself for long-term success.

Schedule a 30-minute call with us to discover how we can help your startup grow organically while maintaining profitability.

Let's take your business to the next level!