The Details

????I have had this discussion with many a first-time entrepreneur. They have have raised $2-3 million, built a product that has some amount of market traction and got to annualized revenues of around $1 million.

????At this level, as a founder you feel SO CLOSE to profitability that many say, "I'm going to keep my costs really low this year to try and hit profitability. I don't want to be beholden to investors." My response is often, "That's fine. What's your objective? Are you looking to potentially sell the company in the next year or two? Do you plan to run this as a smaller business but maintain healthy profits? Do you imagine eventually raising VC and trying to build a faster growing company?"

????Because of the circles I run in I tend to meet many people who eventually do want to build large companies and therefore do want to eventually raise VC and "go big." But they want to do it with leverage. Investors at this stage care way more about growth than profits so be careful not to shoot yourself in the foot. I certainly understand the desire to be in control, which is what you are when you earn a profit. Just be careful that it doesn't come at the expense of investments in growth.

????The likely response of a VC to your company that raised $3 million and now is profitably doing $1.5 million in revenue three years later is, "So effing what?" Harsh, but real.

????If you had huge customer growth but just didn't focus on revenue that's a different story. If you spent the 3 years perfecting some hugely differentiated technology IP that may also be different. But if you simply went more slowly to show you could earn a profit you may need to look for alternative funding sources to fuel your future growth.

Understanding profits

????When I look at an income statement, I start by focusing on the revenue line. One thing that should matter to all people trying to understand the performance of a company is whether it has revenue growth.

????I always remind this to journalists who ask me about public stocks. If you have two companies each with $100 million in "earnings" (profits) they might have vastly different prospects for the future. One company might be growing its revenue at 50% per year and the other might be growing at 5% per year. And assuming they both had the same net profit margins (profit / revenue) then the former company would be much better off at the end of the year. So while the simplest way that people often evaluate stocks is by P/E ratios (price-to-earnings), one also needs to look at other metrics such as the PEG (price-to-earnings-growth).

Investors value growth

????The value of a company is the expected value of all future cashflows discounted back to today's dollar (because as you know a next year is worth less than a dollar today) and a company that is growing more quickly is more likely to yield better overall profits in the future.

????So for a start when you want to evaluate companies you want to evaluate "growth." Looking a earnings alone across two companies won't tell you the picture of the different prospects.

????And when you're looking at even earlier-stage companies (as VCs do) you might be even more focused on customer growth than revenue growth.

The nature of your revenue matters

????When I do evaluate companies that already have revenue, I actually want to understand the revenue line in more detail. What makes up revenue? Is it one product line or many? Do 20% of the customers make 80% of the revenue or do the top 3 customers represent 80% of the revenue.

????This is called "revenue concentration" and the more concentrated your revenue the higher the risk that your revenue could decline in the future.

????I also try to understand things like how you're pricing your product, how your competitors price and what your pricing expectations will be in the future. Fast early growth in a market is often eroded when competition gets fierce and prices are forced down due to competition.