
Tech Startups Come Up with Some Creative Definitions for ‘Profitable’ - chang2301
http://www.bloomberg.com/news/articles/2016-05-16/tech-startups-come-up-with-some-creative-definitions-for-profitable
======
Animats
GAAP or go home.

There are Generally Accepted Accounting Principles. Lots of startups whine
that GAAP accounting doesn't represent their coolness, disruption, clicks, and
general greatness. In hindsight, the GAAP numbers usually mean more than the
vaporware numbers used for PR purposes.

If you go public, you have to show GAAP numbers in your financial statements.
While private, you can sell to "sophisticated investors". These are like
"whales" in the gambling industry; it means they can afford to lose money, not
that they have a clue.

Most of the trouble comes not from companies that need a long period to do R&D
or build up manufacturing capacity, like Space-X. It comes from companies that
are losing money by buying market share, hoping that, in the end, they achieve
a monopoly position and can make it back. Like Uber.

Funny accounting anecdote of the past: remember AOL disks, given out in vast
quantities for free? AOL treated those as a _capital expense_ and depreciated
them. AOL was losing money for most of a decade while showing numbers that
indicated profitability.

~~~
tim333
GAAP can be deceptive. Take Amazon for example which hasn't reported much
profits, probably less than $2bn over 20 years, but is now worth $331bn.

~~~
serge2k
Why does that make GAAP deceptive?

~~~
tim333
It makes the company look like they are doing poorly when they are not
recording GAAP profits but are increasing things like their user base and
intellectual capital which are not reflected in the GAAP profits and losses.
Say you start from nothing and get a million users paying you $10 each for
some info service and you spend $10m in advertising to get there which you
expense. That will show, roughly speaking, a GAAP profit of zero but your user
base of 1m people paying $10 will be worth ~100m ($100/paying user) so you
really will be wealthier by nearer $100m than $0.

Basically change in intrinsic value of the business is often a more useful
measure than GAAP profits (or EBITA or all the other stuff). It's what counts
to a business owner. GAAP profits are what the government forces you to
declare so they can charge corporation tax on them and smart CEOs like Bezos
will often try to keep the GAAP profits down so as to pay less tax while
maximising the intrinsic value of the business which is what makes you rich.

------
mathattack
This goes under the name of "Unit Economics" and is reasonable for small
startups to use. It's VERY hard for a potentially high growth startup to cover
their overhead costs. (If they were already cash flow positive, most likely
they wouldn't be talking much to VCs anyway)

Companies go through stages:

1 - "Can we build something"

2 - "Will anyone pay for it?"

3 - "Can we turn a profit on each unit?"

4 - "Can we grow profitably and eventually cover our fixed costs?"

Generally you want to know #3 before tossing bags and bags of money at a
company, but it's ok for startups to ask for money without having it answered.
It's also ok for companies to ask for money without having covered their fixed
costs yet.

To oversimplify...

Let's say my fixed costs are $10mm. Let's say each delivery I make turns a
profit of a dollar, and each customer uses me for 20 deliveries over the
course of 4 years. (Lifetime value of $20, which I get $5 per year) Let's say
that it costs me $10 to acquire a company. (Customer acquisition cost)

Then in year 1 I'm $5 behind on each customer, but by year 4 I'm $10 ahead.

If I'm reasonably confident of these #s, then it pays for me to get as much
investment money as possible to invest in customer acquisition. From a current
cash flow (and potntialy from GAAP [0] earnings too) perspective I am losing
money, but this will maximize the long term value of the firm.

[0]
[https://en.wikipedia.org/wiki/Generally_accepted_accounting_...](https://en.wikipedia.org/wiki/Generally_accepted_accounting_principles)

~~~
blantonl
_This goes under the name of "Unit Economics" and is reasonable for small
startups to use._

That's fine. But I think the meat of the article is that there are
startups/businesses out there that are using so much smoke and mirrors with
financial reporting that it has become a ridiculous process to read a "we are
profitable!" press release.

I get it - there is an arms race out there to get funding for the "next big
thing" which will require hundreds of millions of dollars to get off the
ground. But whatever happened to a sound business plan, an experienced team,
and a sound business idea? And the "next big thing" is now so saturated by so
many players that the arms race seems to be exponentially increased for any
possible idea that might have some traction. It is a race to the bottom.

Facebook and Google are such outliers that VC has resorted to throwing cash at
the next 1,000 Mark Zuckerbergs, which only one or two probably exist in the
next 10 years.

Capital is chasing returns that are not sustainable.

~~~
eecsninja
Well put. That is one of the fundamental problems with the economy of the
current tech startup boom. There is too much of a winner-take-all dynamic.
From the VC's perspective, it doesn't matter whether the portfolio is 10 or
1000 companies, as long as you get that home run. But to each individual
founder, it's the difference between a 1/10 and 1/1000 shot at success.

Staying at Facebook/Google/etc seems to be the way to go these days...

~~~
mathattack
The other alternative is to come up with an idea that doesn't require scale,
that can become cashflow positive more quickly.

You can do this in software by attacking a very narrow niche, or by doing a
services-heavy business. Neither creates a unicorn, but both can be stable.

~~~
eecsninja
Yes but good luck competing with the big VC funded companies for publicity!

------
saosebastiao
The fact that they opened the article with the example that they did is
absolutely ridiculous, considering there are significantly better examples
that didn't even receive their own complete sentence. Contribution Margin is a
metric that _all_ VCs should keep an eye on. It is a scalability metric:
before CM positivity, you are lose money with every unit sold. After you are
CM positive, growing sales will only ever help you. The only mistake the
SpoonRocket management made (at least as far as referenced in the article) was
trying to expand to new cities _before_ they were CM positive.

The absolutely moronic-bordering-on-Bernie-Madoff example was Instacart.
_Instacart told Bloomberg in February that it was profitable in its biggest
markets and that 40 percent of its volume was profitable. The company later
clarified that it meant gross margin profitable, which is usually limited to
direct costs such as supplies and delivery labor. Instacart 's calculation
leaves out other costs, such as customer service, central office salaries,
rent, and the cost of acquiring its workers. Instacart also said it is gross
margin profitable, on average, across all its markets._

I certainly hope the Bloomberg writers actually clarified (and just made it
sound like they were assuming) how Instacart is calculating Gross Margin,
because delivery costs are typically only included on the inbound side, which
is a cost that Instacart doesn't manage. Outbound delivery costs are very
rarely included, and that is Instacart's whole fucking business. It would be
like a grocery store claiming profitability as long as you exclude COGS.

In other words, if Instacart is including their delivery costs in their GM
calculation, they might have a sustainable business (they'll never be as
profitable as their valuation assumes, but at least they could stick around
after the VC dries up). If they _aren 't_ including delivery costs in their GM
calculation, then Instacart is so laughably unprofitable that they don't have
a snowball's chance in hell.

------
blantonl
"Profitable profitable" \- I, I just can't even understand why someone would
say something like this.

What's next? "We're negatively profitable right now but hope to swing to an
evenly profitable state and then turn positively profitable profitable in Q2
2017"

SMH...

~~~
twic
Our profitability is currently in stealth mode.

------
slgeorge
Ah! reminds me of the dot com bubble where everyone was profitable! ... uh by
EBITDA [0]. A measure that caused all sorts of problems since a bunch of
companies also manipulated their Earnings [1]. For every cycle, the line
swings back and forward between "grow at all costs" and "profit, profit,
profit", with the associated attempts to create "silk purses out of a sow's
ear" by using bad definitions. Not that this fools VC's or investor high-net-
worths, since they know (and create) many of these games themselves.

Every business should know profit by product/shipping-unit, line of
business/division and overall (gross/net). If we don't know them, we're not
running a business, we're running an experiment.

Though I much prefer the phase when the industry is talking about "profit" at
some level, rather than just buying temporary growth and selling it as
"innovation".

[0]
[https://en.wikipedia.org/wiki/Earnings_before_interest,_taxe...](https://en.wikipedia.org/wiki/Earnings_before_interest,_taxes,_depreciation,_and_amortization)

[1] [https://hbr.org/2009/11/how-ebidta-can-
mislead/](https://hbr.org/2009/11/how-ebidta-can-mislead/)

~~~
mbesto
> _A measure that caused all sorts of problems since a bunch of companies also
> manipulated their Earnings_

Just to be clear. EBITDA itself is not the problem, but rather the calculation
companies themselves use to derive it. EBITDA is generally regarded as a very
good metric to value a company (with a multiple of course). Any smart investor
who gives a damn about their private company investment sniff shady EBITDA
numbers out pretty quickly. The problem is, very few VCs actually go through
this scrutiny or have incentives to provide a true indication of EBITDA. On
the other hand, PE firms, who take a large stake in a business, typically do.

~~~
slgeorge
> EBITDA itself is not the problem, but rather the calculation companies
> themselves use to derive it.

Heh, I find it a bit difficult to consider it a useful measure, when (as you
point out) you have to immediately clarify _how_ it's calculated. It's like me
saying "I'm a world champion sprinter" and then mumbling "as measured by
positions in races between my desk and the downstairs loo". There are contexts
for specialist use, but overall I'd avoid it.

The article was referring to more general business use - PR & investment - I
guess another situation where profitability comes up is candidates discussing
whether an organisation they might join is profitable. I would argue that if
someone uses EBITDA then it indicates that you should be asking lot more hard
questions. Not that it's even the worse, as the article points out - my
broader point is that every era comes up with new pet terms and ways of
manipulating them for PR.

~~~
nopzor
Take two identical companies in the same business line in the same
jurisdiction. One got a less favorable interest rate on the same amount of
debt, and also has a higher effective tax rate.

On a GAAP basis, these companies look very different. They should. They are.

But, to someone trying to compare different companies for purposes of M&A,
EBITDA can provide a nice way to normalize these factors. Debt can be
refinanced. Effective tax rate != current tax rate. And that's just the EBIT
part of EBITDA.

You can't say EBITDA itself is not a useful measure. It is, when it's used
properly and understood. However, I do agree with your overall sentiment re:
manipulation. It's misused and misunderstood.

------
Androider
A big company that is profitable is invariably found to have evolved from a
small company that was profitable. A big company created from scratch is never
profitable and cannot be patched up to become profitable. You have to start
over with a profitable small company.

With apologies to John Gall ;) I feel there's some truth to it.

~~~
beambot
Amazon?

~~~
Androider
Amazon is one of the most frugal companies I know, penny-pinching is built
into their DNA and one of the reasons IMO they're not a pleasant place to
work. Amazon actively chooses to invest every cent they make into expansion
(with great results) instead of hoarding profit.

That's a huge difference to most companies mentioned in the article that
essentially sell $10 bills on the street corner for $9: "Oh, another flyer for
a free meal delivery service, why thank you VC-man for paying for my lunch
once again. No, I will not ever pay for your service."

~~~
adevine
But the point is that at the very beginning of their company, Amazon was most
definitely NOT profitable. They took in a huge amount of investment money to
be able to grow their business quickly - exactly what all these other
companies are trying to do.

~~~
ksherlock
Amazon used to (circa 2000) report pro-forma (non GAAP) profit/losses.

------
nunobrito
An an European startup I had a bright smile when reading this article. Always
fun to see how out of touch can startup founders be too often led believing
that VC money without balanced revenue/expenses is "normal".

They'd certainly be quick to get some cold shower around here. Too often a
startup already needs to be profitable in most cases and have some heavy
references before even getting 500k of funding, if at all.

~~~
brianwawok
Is this why we aren't getting Google's and Facebook's and Twitter's out of
Europe though?

~~~
gunshigh
It might also be why the US had the dot com and unicorn bubble.

And note that Twitter is not, and has never been, profitable.

~~~
meddlepal
I think I would take the bubbles over relative stagnation.

~~~
nunobrito
I would like to disagree with that thought because neither are good options,
but regrettably agree.

Would kind of prefer to see more bubbles because then at least you increase
the odds of more companies/people to deliver innovation (in the true and non-
cliché meaning of the word).

------
educar
Did I read the article correctly that uber, lyft are not profitable yet?
That's news to me as I thought they were very profitable given the amount of
media attention and visibililty they gave got. Are companies like say slack
and github profitable? They also get so much attention (atleast here on HN).

~~~
tim333
Github interestingly used to be profitable "We bootstrapped the company on a
few thousand dollars and became profitable the day we opened to the public and
started charging for subscriptions."

They seem to have ditched that for the VC funded, hire loads of people, swing
for the fences model.

[http://tom.preston-werner.com/2011/03/29/ten-lessons-from-
gi...](http://tom.preston-werner.com/2011/03/29/ten-lessons-from-githubs-
first-year.html)

------
mdorazio
To be fair, so do "real" companies like Tesla, which like to use alternate
accounting systems to report profitability while being unprofitable in
accordance with GAAP. I like to think that investors who actually do their
homework can see through the nonsense in both cases.

~~~
kordless
Or maybe the investors are part of the problem.

~~~
quaunaut
You can't really just drop a statement like that and walk off. No one knows
what you're talking about.

~~~
kordless
Investors change the game theory in company's model. A company without VC
doing the exact same thing as with VC will perform and act differently. Pretty
much all we hear about in the news is that VC money is good for startups,
founders, employees, the scene in general here and the tech economy. In
reality, I doubt that's true long term. My rationale is that the WHOLE game is
significantly altered when people who have stored trust get involved in a big
way. Stored trust being capital, money or stored work. The game being the
market we entrepreneurs look to game in moving forward.

The effects of these consolidated investment cycles result in bubbles. The
more stored trust involved, and the more systems put in place to bring more
stored trust to bear on an idea, market, company, etc., the more disruption
there will be on the changes in the cycles. Cycles are a thing with
technology, probably due to the discovery phases of market bubbles. All
theory, of course. I'd like to see it put to analysis though.

Better?

------
outworlder
> (...) Venture capitalists had begun to prioritize profit over growth.

What about "startup == growth"?

------
seibelj
Well, a focus on profitably is much better than a focus on becoming a unicorn
(no matter how bad the terms)

------
doug1001
profit's an opinion, cash (flow) is king.

------
briantakita
One way for companies to game the system is to be late in paying their
employees & contractors. If these expenses don't show up in the books, then
the company can appear to be in a better financial situation.

~~~
PeterisP
I believe that GAAP requires accounting for work expenses at the time when the
work is performed - e.g. the salary due for last week of March _must_ be
counted in March, no matter if you issued a paycheck right at the end of week
or haven't paid it yet for whatever reasons.

Though, one way for companies to game the system in GAAP is to be late in
paying their employees & contractors by having part of their renumeration be
in stock options - people perceive it as compensation, but it can be excluded
from GAAP since the value technically doesn't come from "within the company"
but from reducing the value of other shareholders.

