Blue Dots Partners

I believe that over the past few years, some in the venture capital industry, particularly here in Silicon Valley, have been doing a disservice to many entrepreneurs. Some investors have been aggressively pushing their CEOs and management teams to grow at unsustainable rates to attract new investors so that they can pour in more and more capital, hoping that the company continues to sustain an unrealistic growth rate. This vicious cycle has been detrimental and has hurt entrepreneurs, forcing them to grow for the sake of growth or grow at all costs, in order to justify unreasonably higher and higher valuations. This is especially true in the challenging environment we face today where companies are forced to cut their burn rate and lay employees off.

Additional capital dilutes employee ownership and raises the bar for new employees to make money from their stock options as a result of valuations that are artificially inflated and liquidation preferences that are punishing. Over recent years there have been numerous rounds of financing at valuations in the hundreds of millions of dollars and even in the billion-dollar range. Uber and SoftBank were the poster children for this exuberance.

In order to sustain these growth rates, management teams cut too many corners. Unit economics are forgotten, and the line-of- sight to profitability is so blurry that no one pays attention to it. It is certainly not top-of-mind, and in many cases, not even in the picture. Profitability has become exceedingly rare for companies going public, in the name of insane growth to win the horse race. Recruiting, training and retaining hundreds of new employees in a very short period is a massive challenge that threatens the wellness of the culture and the very DNA of the company. During hyper-growth, it is very difficult to onboard the right talent fast enough to support demand. This leads to dilution of tribal knowledge and raises the likelihood that old mistakes will be repeated, but with much greater impact. Business infrastructure, fiscal responsibility, business planning, processes, progress tracking and disciplined execution become an after-thought. This is unreasonable growth that only works in some very rare, but unfortunately well publicized, cases.

For most companies, it is very difficult to maintain a high growth rate. Growth does not last forever. A 2012 study done by Andy Vitus, partner at Scale Venture Partners, shows that next year’s growth rate is likely to be 85% of this year’s growth rate for recurring-revenue companies. In other words, growth rates tend to naturally decay. The dataset covers more than 60 companies ranging from $1 million to $1 billion in sales with growth rates between 10% and 120% (very few rules seem to apply outside these parameters).

Some VC-backed companies, in order to maintain a high growth rate, waste a lot of money on marketing and sales and hiring the wrong people. Reed Taussig, a successful CEO with a great track record, explained to me that throwing salespeople at the problem is rarely the answer. The issue is not the supply, it’s the demand. He was asked by some of his investors to look at the effect of additional revenue when the sales and marketing budget is increased by 50%. It turned out that only 22% of companies saw a large increase, 10% saw a modest one, 33% saw their revenue decline, yes decline, and the rest were essentially flat. Instead, the CEO should focus on truly understanding the CAC (customer acquisition cost) and find the right go-to-market strategy that supports a low enough CAC to reach profitability. It is fine to stay on the edge of growth, but don’t get ahead of yourself in terms of spending and recruiting. This will give you freedom and sustainable power. It also forces you to be focused.

Once you see the opportunity to grow, then you can scale at a responsible rate and enjoy that well deserved glass of (French of course) wine!