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Jon Bradshaw & Peter Harris

Do VCs care about profitability? And is it any different in 2022 and moving forward?

Do VCs Care About Profitability?

Much has changed in the last few years, and in 2022 we want do know if profitability still matters to VCs.

Over the past few years, VCs have pounded on the drum of growth at almost any cost. Startups have been flooded with billions of dollars to fuel growth.

Now in light of the current recession and financial situation join us as we discuss if and how this approach has changed.

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Episode Transcript

Jon: All right, Peter, are you ready for this? This very. You see, very easy question.
Peter: All right, hit me. Let's make me look even worse than I have on the other podcast.
Jon: You're good. You were good. So here's the question. Do VCs care about profitability?
Jon: There was a TechCrunch article that we saw. You're like, This would make a great podcast.
Peter: When we.
Jon: Were when this post came.
Peter: Out. No, no, no, no, no, no, no.
Jon: When? When?
Peter: When what? So your question is, do VC care about profitability? And my answer is.
Jon: when did they care? In January this year about profitability.
Peter: Look, if VCs have to choose between profitability and growth, they're going to choose growth. Okay. I'm going to choose profitability. In an ideal world, they're going to choose profitable growth. Now, that doesn't mean that you're generating profits. It means that you're unique and economic Rates are positive.
Jon: Okay. What are you looking at for unit out unit economics, primarily cost of goods sold.
Peter: It's going to depend on the business. Ultimately, though, it's going to be like I always look for contribution margin. So I'm looking at revenue minus costs, like cost of goods sold, minus cost to acquire customers, essentially. Okay. Right. Like basically like give me all the variable expenses and all the variable revenues and subtract the two and then let me see what's left.
Peter: Right. And if it's positive, then you can cover all your fixed expenses as you scale. And if it's not, then you can't. Right now, though, that doesn't mean that there aren't certain circumstances where it doesn't like. Let me rephrase this. There are certain circumstances where it makes sense to fund businesses that are contribution margin negative, which means that they lose money on every dollar of revenue they generate.
Peter: Right. At on a variable basis. And that is that's okay. If you have to change customer behavior and you have a high degree of confidence that you can change customer behavior and that once you've changed behavior, you can start increasing prices because they're essentially hooked. Right. And make the economics work. But that's a big bet and a risky one.
Peter: So in general, as a VC, you look for companies that are contribution margin positive, even if they're losing money on like a holistic basis. I think the challenges right now is that every VC is like, Hey, there's a recession on the horizon. Like, even if revenues don't decline, cost to generate revenue is going to go up. It's going to be harder, right?
Peter: And we want to invest in businesses that can survive that time period. And so the more capital efficient you are, the less money you're burning. Like, let's say you even get to profitability, which is great. That means you have runway to survive. But I would bet most VCs would look at that. And as soon as you may get to the other side of a recession, they'd be like, we don't we don't care so much about profitability, especially if it's at the expense of growth.
Peter: Because what we want to invest in, it's they're not always willing to admit, but what we want to invest in is monopolies. Okay. Monopolies like has a dirty connotation on a lot of people's minds, but the reality is.
Jon: That it can do all duopolies.
Peter: And monopolies into our place. But if you look at every great massive homerun venture deal that's ever been done right, they are 100% monopolies. Google Monopoly. Facebook monopoly. Apple monopoly. Amazon monopoly. Right. Like Uber monopoly, right? Boom. Like every single successful venture deal has strong monopolistic power. And part of the reason they have that monopolistic power is because they grew super fast.
Peter: They acquired a ton of market share. They leveraged network effects or whatever it might be to build up strong barriers. And then it becomes really hard for somebody else to come in and compete. And once you've established yourself as a monopoly, then you can start increasing prices and generate massive, massive profits. And that's what VCs care about. We're looking like even if in our whole period, the company never generates profit, we're looking for businesses that are going to generate insane profits over the long run.
Peter: Right. So you look at like Facebook, how much is Facebook even right now where they're kind of going through like kind of some lumpy times? They are still generating billions and billions and billions of dollars in profits. Right. That is a VC is what you care about, even if Facebook burned an insane amount of money and never generated a dollar in revenue during your whole period, you knew that like once they got scale, right, they would be such as in such a strong monopolistic position that they could charge almost whatever they wanted price wise and generate huge, huge profits.
Jon: What are the next industries that you see is having the ability to to to anoint a monopoly monopolistic actor?
Peter: that is a great question. I think one of the challenges is that it's not always obvious what that next really big potential business is going to be.
Jon: Okay.
Peter: and I was talking to a friend of mine recently, and we were we were kind of talking about how that doesn't feel like there are any big companies that where it's, like, obvious that they're going to be the next big company, if that makes sense. It's like you looked at like Uber and Lyft and you could kind of like, like, yeah, even though Uber is not worth 100 billion today, it's on that trajectory to get there, right?
Peter: If you looked at like Airbnb, it was the same, same type of story. It's like they're not there yet, but you could see it, see it going. And maybe that's because these are consumer driven apps. And I think what you're seeing a lot more of today is, you know, maybe more enterprise type apps that are growing. But I don't know.
Peter: It's a great question. I think I don't know. I wouldn't be surprised that we've had a lot of crypto companies really stumble over the last year as we head into this crypto winter. But I won't be surprised if the next kind of wave of crypto when it comes along, we start seeing companies that have really, really strong, what's the word I'm looking for?
Peter: Like staying power At the end of the day that are worth that 100 $200 billion and don't get slammed too hard by, you know, by another cyclical another. Another cycle with crypto.
Jon: Okay, what about. Yeah. Could I be that next monopoly potentially.
Peter: I mean there are different views on AI. Some people view AI as like maybe like power, right? There will be like AI engines and we tap in and we kind of rent time on those AI engines to do different tasks for us. My impression is that a AI, at least in its current state, is more something that everybody kind of has to have a little bit of.
Peter: And they're they're building their own engines that.
Jon: Will be run by the person who also is sitting on top of the most.
Peter: Data. Yeah, but but data is becoming even more and more fungible and so and easier and easier to build and get, especially like enough data to drive your models. Whereas before I would have agreed with you, I'm not certain that that's necessarily the case because we just generate as a society so much data so quickly. Now that I don't know that like data actually plays that that big of an advantage over the long run.
Jon: Okay. What about CRISPR? Could CRISPR be the next monopoly?
Peter: I mean, there are a lot of companies that are playing around with CRISPR, but it's also technology's been out for quite a while now and you haven't seen any of that, any big, big, big companies that have capitalized on it.
Jon: Still kind of early, though.
Peter: It is still kind of early. And honestly, it's not my area of expertise. Like I know enough there to be dangerous, but we don't invest in those types of companies, so it's not something I follow too closely. Yeah, I think I do think that there are interesting opportunities around the intersection of software and fintech and I think software, fintech and AI, and I think we're just starting to scratch the surface on some of that.
Peter: I think that there could be opportunities for more super apps similar to what you have in in China that don't really exist here in the US, where you have the ability to start controlling more and more and more centralized apps instead of having, you know, 30 apps to it to do, you know, 30 different things, you have one to do all of those things.
Jon: Why is that not happened here?
Peter: It's a good question. I think part of it is that you know, we were a little bit like the Wild West. Everybody wants their own, like specialized solution. Yeah. And we the U.S. is not as homogeneous of a culture as other cultures, like in Asia. but I think the flipside is that there are a lot of gains that can be had in super apps.
Peter: And so I don't know, part of me kind of wishes that there were some because the like better interoperability and performance would be really interesting.
Jon: Yeah, I've never played with one of these Chinese super apps. I've just heard about them.
Peter: Yeah. I mean, they're kind of cool because you can it's like your dating profile, your social profile, your payments, your savings, your retirement, your coupons, your daily deals, your, you know, it's like all in one, right? It's kind of cool, but also maybe a little dystopian as well.
Jon: Okay. Any other monopolies that we've got a long way from profitability, But you're saying monopolies are the most profitable.
Peter: So what what other monopolies? So I think.
Jon: Any other trends where you could say a monopoly could come out of this space.
Peter: Like I don't know if anyone's going to figure out air and VR.
Jon: Okay. Yeah.
Peter: I would like to think that we will make some point.
Jon: What Microsoft figured out.
Peter: Don't know. Microsoft Facebook matter. Right.
Jon: I think the real play with Apple VR is with the work environment is where it will become most profitable, the fastest is the best use case.
Peter: Yeah, people have been saying that for years, but it hasn't it hasn't really translated either.
Jon: Because it you know, with with Facebooks Gen two or the newest.
Peter: Yeah.
Jon: I guess it's their third.
Peter: Oculus pro.
Jon: Like Hasbro.
Peter: Which is really expensive.
Jon: It's really expensive but it's not a 4K. Yeah. Interface, correct me if I'm wrong.
Peter: I think yeah, I think that part of the issue is we've got to get the technology to the point where it's simultaneously affordable and also powerful enough to replace our phones.
Jon: And light enough.
Peter: And light enough. Yeah, yeah, yeah. It's got to be something that's like a superior user experience at an affordable price point to beat the phone. And until you can do that, it's always going to be kind of a gimmicky, you know, nice to have.
Jon: So 20 years out, ten years out.
Peter: I don't know, like tech development happens exponentially. So it could be five years out. And, you know, it's hard to know, right?
Jon: Okay.
Peter: It's the thing is, like our brains don't think about exponential growth. We don't comprehend it very well as humans. And so what seems like it's going to take ten, 20 years shocks us when it takes like three. Right. But it's also hard for us to be able to like, rationally say, it's going to be three years.
Peter: I mean, look at, like, electric vehicles today, right? Like, every car company now is, like, forced to pump out electric vehicles. And if Tesla hadn't come along, we still nobody would be talking about electric vehicles, most likely. Right? So but that has just accelerated incredibly fast.
Jon: In the salty battery space. Will be interesting.
Peter: Solid state batteries will be interesting. But ultimately, hardware is hard and it's hard to build a monopoly in hardware, especially if you don't own the full value chain. So one of the things that's interesting about Apple is that they own the full value chain effectively. Right? And the full user experience, what you don't want to be is like a supplier to Apple because, like, maybe you have the best battery today for their laptops or their phones, but then somebody else comes out with a better battery and they switch.
Peter: Right. But what they control is that user experience and the customer. And that's, you know, that's really hard to get that to replace.
Jon: Got it. So we got we have our answers on profitability and monopolistic behaviors when it comes to VCs.
Peter: So what do you think is my answer then?
Jon: I think you and probably other pieces are curious where the next next space will be.
Peter: Because you're always curious, right? And you're always trying to like, you know, figure it out. Invest in the next big thing.
Jon: Do you see? So when I used to run with you to angels, you would see people coming up with this similar idea all around the same time. Yeah. You see that with your investing?
Peter: To an extent, Yeah.
Jon: It wasn't like. It was like, kind of. But it was. It was.
Peter: It's very common, though. And the reason for that is, you know, as a VCU is you have to ask yourself, like, why now? And oftentimes what happens is like the stars kind of align, right? Technology reaches a point. Adoption reaches a point, that people that have a need to that hasn't been solvable before all of a sudden, because of technology and adoption, all the things that need is now solvable.
Peter: And other people see that. And so they start building products to solve that need. And it kind of all happens at the same time. Yeah. but, you know, as a VC, you're, you're combating like that side of things where it's like, yeah, now's the right time. And that's why there are all these companies popping up with also like saying, Hey, we want to invest in something that's more disruptive.
Peter: Right. We want to invest in that that pain point before anybody else figures it out. Right. Or or a pain point that other people don't see. Right. That now is, like, solvable. That wasn't solvable before. So you think like Airbnb is a good example of that, like, totally disruptive idea. And and so it's challenging, though, because, you know, you get wrong a lot.

Jon: Are you seeing trends right now?
Peter: You know, as I look across our portfolio, you know, I think one of the big trends, like I mentioned earlier, is this intersection of fintech software and A.I., where it's like software today, it's not enough just to have like a software that does a task. It's like, how can you bleed and like, take the data that you're collecting on the software side and create financial products on it.
Peter: And then that requires as well, like this AI input. And if you don't have kind of those three things, you're probably not going to be successful in the long run because your competitors do.
Jon: Okay. Interesting. What's the laugh for?
Peter: Nothing.
Jon: All right. Well, anything you'd like to add on this podcast over here? Wrap it up here.
Peter: No, I mean, so if you're running an entrepreneur sorry, if you are an entrepreneur and you're running a company right now, my advice is to drive towards capital efficiency, to do the layoffs, whatever it is. Drag, drag out the timeline, your runway as much as you can, But know that, like at the other end of this recession, like, VCs are going to come back and they're going to want to see growth because like I said earlier, what VCs care about is can you establish a monopoly that can generate massive profits?
Peter: And if you can generate massive profits, then you'll be valued super highly and then VCs will make a ton of money. So part of it is just surviving the recession. There's going to be a ton of companies that don't survive. And so if you can just survive, you're going to be in a really good position at the end of this to create a monopoly.
Peter: And then you raise a bunch of money to grow really aggressively and take advantage of the lack of competition. And that can put you up, puts you in a really good, really strong place.
Jon: Okay. Well, awesome. Well, thanks, guys. Go to venture capitalist and if you want to learn more, you can subscribe to all of our socials, Google socials. Sure. All right. And we'll see you guys on the next episode. Thanks, guys.
Peter: But thanks.