| | APRIL 2025 9markets. The best funding or exit path for a company can be pursued because these two options exist in the first place and competition from both sides allows founders to weigh up the costs versus benefits to arrive at the best option. Striking the Balance: Growth vs. ProfitabilityInvestors require companies to grow in order to realize a return on investment, but with the era of 'cheap money' gone, herein lies the tension between growth and profitability. Capital is required to grow a business and execute on 'experiments' or innovations, such as product improvements and research & development that result in finding alternate or complementary sources of revenue streams. The availability of capital in 2023 is scarce, and founders are finding that they need to cut back on growth to ensure their business model is sustainable. The tension here is to find the balance of continued growth but not at the expense of profitability. With less capital availability, founders need to be more capital efficient and thoughtful on how capital is deployed to ensure there is a strong return on investment. In 2023, this tension has resulted in many companies being able to streamline operations while maintaining and growing their topline, resulting in a far more efficient and scalable business. In comparison, in the free-flowing capital environment in 2020-2021, there was no tension to reach profitability as companies were rewarded for topline growth only. However, a study by Goldman Sachs on nearly 4,500 US IPOs in the last 25 years demonstrated that high sales growth and a clear path to profitability were most important in predicting IPO outperformance. Only 18 percent of IPOs from 2020 to 2022 outperformed in the first twelve months of listing and in this cohort, only 15 percent were profitable. This is well below the cohorts for 1995-2009 (46 percent), 2001-2009 (51 percent) and 2010-2019 (34 percent). With this historical data and reversion to the norm, companies now need to both grow and reach profitability which is a hallmark of a good growth business.To Raise or Not to Raise?Many companies are not looking to test the markets for a capital raise in the current environment, with falling valuations in the private markets and supply and demand now in the favor of suppliers of capital. This is especially the case if companies raised in the heady days of 2021 at sky-high valuations have yet to grow into their valuation. For some companies, there is no choice but to raise. For investors, it is a great time to deploy into a market with sensible valuations and limited competition, but they also face the tension of how far to go with valuation and structuring. Investors need to be fiduciaries for their investors and drive strong returns, but over-structuring deals can set a precedent and also be negative signaling for a company looking to raise their future round of capital. Founders would also push back on certain terms. The tension here is to find a balance between founder and investor expectations, which would ultimately result in a win-win for both sides as more capital to a founder means capital to `live another day' and fight the scale-up battle or more capital to get ahead of the competition.Final ThoughtsAccordingly, it is incumbent on private companies as well as investors to manage the tension of competing demands to find pockets of opportunity. In a capital constrained environment, it is important to keep all options open and as highlighted, tensions can, in fact, be positive for companies and investors in driving more disciplined and better outcomes. In a capital constrained environment, it is important to keep all options open, and as highlighted, tensions can, in fact, be positive for companies and investors in driving more disciplined and better outcomesSource: PitchbookCapital Demand Currently Outstrips Capital Supply By Up to 3.5x
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