Just as there are heroes and villains in the Avengers universe, the startup universe is made up of growth and profitability, the former being the heroes and the latter the villains. Uber, Tesla and Spotify are the clear example of the heroes of the film that have grown tremendously in recent years, ousting traditional companies from the firmament.
Over the years these companies have raised an exorbitant amount of capital (Uber USD$25.2bn in 32 rounds, Tesla USD$20.2bn in 35 rounds, Spotify USD$2.1bn in 18 rounds) that has allowed them to position themselves in multiple markets, capturing participation and growing aggressively. The opposite case is the traditional companies, who to raise capital must demonstrate that they are generating profitability for investors. In addition, traditional companies, especially if they are listed on the stock market, have to demonstrate that profitability on a quarterly basis to preserve and increase the value of their shares.
Tesla in 2004 raised a Series A round of USD$7.5mm, at an estimated valuation of between USD$30mm and USD$70mm. In these 16 years the company has raised a total of USD$20.2bn in 35 fundraising rounds. Today it has a market capitalization of close to USD$700bn, which represents a compound annual growth in its valuation of 85%. If we compare the profitability of Tesla against the profitability of companies like General Motors, Volkswagen or Toyota, it does not turn out to be much higher.
However, the market values Tesla with an EV / EBITDA multiple of 122.2x and P / E of 373x against the 8.49x and 6.26x multiples of General Motors, 7.28x, 5.83x of Volkswagen and 3.89x, 9.47x of Toyota.
The Tesla case is not unique in the startup world. The common thing for these types of companies, especially in their first years of operation, is to sacrifice profitability for aggressive and accelerated growth. The objective of an approach to growth is to have a significant share of the market that leads you to have a relevant size to be able to defend yourself from potential competitors and compete against traditional companies. Furthermore, this strength places you in a privileged position to access economies of scale and focus.
A clear example is Rappi, founded in 2015 in Colombia, which has raised USD$2.2bn. Only in its last round in July 2021 the company raised USD$500mm from T. Rowe Price that led them to a post-money valuation of USD$5.3bn. This capital has allowed Rappi to grow rapidly in Latam, positioning itself as one of the greats in express delivery through gig economy messengers and products and inventory managed by convenience stores. According to market information, Rappi has not been a profitable company to date. In addition, there are new innovations in superior business models where they have inventory possession and deliver in less than 15 minutes through their own distributors, such as Gorillas, GoPuff, JOKR, Flink, among others.
Arising from the pandemic, and through large capital raises (ie. JOKR with its recent Series A round of USD$170mm), these companies are positioning themselves in the market with growth and profitability in a business model superior to the one that initially had Rappi. This has led Rappi to launch a new business model called RappiTurbo, which consists of having the inventory in multiple dark warehouses and dark stores and delivering it directly to the consumer in less than 15 minutes. However, this new model is still being tested, and its profitability remains to be seen.
This market dynamics has led to investors focused on growth strategies, and others on profitability. The former are mostly Venture Capital funds, which only seek to invest in early-stage startups. These investors tend to be less risk-averse and are in constant search of returns far superior to those of the capital market.
However, perhaps the great unknown is to understand how long a company is considered as “growth” by investors. Perhaps part of the answer can be found in the case of WeWork. Investors contributed more than USD$9.8bn of capital to WeWork to grow it. At the time of seeking its IPO, the market did not buy the profitability of the company and from an estimated value of USD$40bn they went down to only USD$8bn.
Every entrepreneur should keep in mind that growth is phenomenal to reach size and position in the market. However, as they access different pools of capital, they will face the reality of showing profitability, in addition to continuing to grow at a slower rate than in the early stages.
“Market leadership can translate directly to higher revenue, higher profitability, greater capital velocity, and correspondingly stronger returns on invested capital.” — Jeff Bezos
Hector Shibata. Director of Investments & Portfolio at ACV a global Corporate Venture Capital (CVC) fund and Adjunct Professor for Entrepreneurial Finance.
Gonzalo Soriano. VC Investor at ACV.
ACV is an international Corporate Venture Capital (CVC) fund investing globally in Startups & VC funds.
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