The Ingredients of Profitability for Socially Conscious Startups
I applaud the resurgence of a focus by new ventures on saving the environment and having a positive social impact. Yet, when you are pitching to investors, this has to be balanced by generating enough profit to keep the venture thriving, growing, and providing a healthy return-on-investment (ROI) to investors. Founders who avoid using the word “profit” had better have deep pockets of their own.
Zappos, impressively, has given away 26 million pairs of shoes to needy people in 127 countries and all 50 states. However, that wasn’t the main reason they were acquired by Amazon for $1.2 billion a few years ago. It probably had more to do with the fact that they had doubled their sales annually for several years, and still managed to squeeze out a profit of $11M in their year of acquisition.
Without profit, there is no longevity to any business, so I’m always surprised when sincere young entrepreneurs avoid using the term, as if “profit” is a bad word. At the other extreme, I don’t condone greedy and unethical business practices to shake down customers and employees alike unjustly. As an investor myself, I look for a balanced story focused on the primary ingredients that drive profitability, including the following:
- A 5-year financial forecast achieving a positive cash flow early. Every entrepreneur and investor needs targets and a conviction that your business will be sustainable, and will provide a return-on-investment (ROI) to all constituents. If you have not done the work to derive rational numbers, or you are unwilling to commit, no investor will help you.
- Shows positive value for both the customer and the business. Customers and investors are looking for quantifiable specifics, not just social value or “eco-friendly.” They are looking for solutions that will reduce their costs by 20%, or double productivity, or cut traffic accidents by a third. Evidence in the form of data is essential here.
- Targets a significant demographic segment with money. Solving social problems, like feeding the hungry, is excellent and may heighten your brand credibility, but customers with money to spend are the key to the survival of your business. Tiny markets may excite your passion but won’t sustain a business or leave you with a long-term positive legacy.
- Highlights a sustainable competitive advantage. Social value alone is not usually a sustainable advantage for a startup with limited resources since big players can jump in with more money to replicate your social value and add more innovation. The best advantage includes intellectual property to provide a barrier to entry or incent acquisition.
- Introduces a team with the balanced competencies to deliver. Investors look for a team with business, financial, marketing, and operational skills, as well as a social passion. A solo entrepreneur rarely has this range of talents. For this reason, you often hear investors talk more about investing in the team, rather than the idea.
- Employs a profitable business model with customer traction. A winning business model, like Zappos, often benefits social needs as well as business needs. But business models need to be validated by paying customers (beyond free trials) before they are credible. Before customers, traction can also include letters of intent and testimonials.
- Includes balanced and hard-hitting marketing and sales. Good deeds and word-of-mouth alone will not get your solution the growth levels you need in this world of information overload and 14K new websites published every day. You need some innovative new approaches, including digital marketing, as well as metrics to measure effectiveness.
- Ends with a winning legacy for customers and investors. Constituents look for a long-term strategy of continuing return, generally including an initial public offering (IPO) or merger/acquisition, to on-going value or option to cash out. A huge user base may also be a source of profitability if it results in a multi-billion dollar valuation.
Some entrepreneurs argue that recent business successes through free product and user growth alone, pioneered by Facebook, show that revenue and profit are no longer needed. Such an approach is possible, but still relatively rare, and it requires more cash than most investors are willing to risk. Facebook, for example, had to raise over $340 million before finally turning cash-flow positive in 2009.
Therefore, I recommend that a plan for profitability be part of your new venture story — and that positive social and environmental impacts be part of your marketing plan to get there — rather than a substitute for profit. Overall, you need a balanced and complete story to attract customers, as well as investors. It’s hard to leave a lasting legacy if you never get out of the starting blocks.