In October of 2009, exactly 10 years ago, Mark Zuckerberg introduced the world to Facebook’s motto, “move fast and break things.” It was a breakout year for a startup with unprecedented growth, so the entire tech industry was paying close attention. As a result, “move fast and break things” was a concept that spread like gospel. Looking back today, I don’t think there’s any phrase that better captures the ethos of the tech industry over the last decade.
But as that motto was passed down from startup to startup, year after year, the message became more distorted. “move fast” ushered in an era that rewarded growth at all costs, even when it meant a company spending more than it makes on each customer. It has reached a point that this year only 24% of companies that filed to go public reported positive net income. That’s the lowest rate in the 20 years since the dot com bubble era. Equally mismanaged was the “break things” part, which now seems to include laws, social contracts, and customer trust.
As this decade comes to a close, it appears we’re finally awakening to how unsustainable that behavior really is. But why are we all of a sudden paying attention? And more importantly, what comes next?
Impossible Public Offerings
For the last several years near-term profitability fell low on the list of startup priorities (or was outright discouraged). Instead, startups prioritized growing the market and their market share before creating any economic value. However, if a company sells dollar bills for 75 cents each it is not creating economic value. This still holds true even if it does this a few billion times over and has people lining up to buy them.
Negative earnings in the early years of a startup has long been a part of venture capital, but its actually negative gross margins that have been driving a lot of the growth across the industry in the last decade.
Venture investors put a premium on growth, with the implicit assumption that its presence is an indication things are going well with the business. This used to be true, but over the last decade growth has become entirely decoupled from value creation. Growth is treated as a manufactured commodity, a skill you can hire for, or a team you can spin up. In tech, growth is viewed as something to master rather than the result of increasing supply at a fair market price to meet increased demand.
In the last few months, however, there’s been an unmistakable shift in perspective towards profitability by tech founders and venture capitalists. Investors and founders are waking up to the reality of what it takes to build a long lasting, high performing company. Weak market performance from several high profile tech IPOs has made investors begin to more closely scrutinize the feasibility of each company’s free cash flow, gross margins, and ultimate path to profitability.
The benefits of this scrutiny extend beyond just improving investor returns. When companies begin to pursue sustainable models it benefits employees, who would like to keep their jobs and have the value of their stock options reflect their contributions. It benefits the customers, who are beyond tired of seeing the prices of services they use every day consistently creep up once the company decides it needs to turn a profit. It benefits a variety of stakeholders that executives and investors seemed to have ignored over the last few decades.
From Shareholders to Stakeholders
Since the 90s the Business Roundtable has published the Statement of Purpose of a Corporation, which stated that companies “primarily exist to serve shareholders.” That all changed this August when the association adjusted the language to acknowledge the changing scope of executive responsibility.
Nearly 200 CEOs from companies like Apple, Amazon, American Express, and AT&T each signed a new directive stating their companies now have “a fundamental commitment to all stakeholders” including customers, employees, suppliers, communities, and shareholders.
These business leaders had a message for the investment community as well, “we urge leading investors to support companies that build long-term value by investing in their employees and communities.” Given these company’s leaders represent many of the largest acquirers of emerging companies, investors would be wise to listen.
2020 and Beyond
Early stage VCs will continue to provide capital to ambitious founders that require a lot of risk-tolerant capital upfront. That’s our job. However, the days are numbered for companies rapidly scaling without a viable business model or consideration for its impact on all stakeholders. It’s time to let go of the companies whose primary product is their stock. The good news is the founders who are creating the companies of tomorrow already hold this perspective today.
Some believe this combination will result in suboptimal returns for shareholders. Counterintuitively, we believe the most value created for shareholders will be by founders that sustainably balance the interests of all their stakeholders. It’s about time we all wake up to this new reality and become intentional about the way we deploy capital.