Early in my VC career, I was sitting in a board meeting when Frank Adams, the founder of VC firm Grotech, told the CEO he needed to grow or become profitable; those were the only two choices. I was fresh out of business school and had somehow missed this lesson. I felt like asking for a refund.
Fast forward to today. Whipsawed by free money, then no money, all SaaS businesses have tightened their belts in the last 18 months. Some companies cut expenses, maintained growth, and became profitable, while others cut expenses, saw growth deteriorate, and remained unprofitable. Many of those companies are in a holding pattern to see what’s next in the funding environment and broader economy.
In the public markets, the low growth/low profit companies are in the Dead Zone and Grey Zone on the chart. They must find a path up, to the right, or both. Hanging out in the slow growth but unprofitable zone is risky and destroys value, especially when rates are high.
How to choose between growth and profit
Choosing between profit and growth is not overly complex, but it’s not easy either. All SaaS companies can be profitable. The question you need to answer before picking a lane is:
Is there an objectively reasonable, data-driven, and fully-funded plan to re-accelerate growth?
If not, the business needs to start making money. Now.
SaaS businesses have a great business model: recurring revenue, high gross margins, and discretionary expenses. Making them profitable may be painful, but it’s doable.
Getting to breakeven is the first step. Breakeven allows more time to identify incremental growth plans. But there are risks to staying in the slow-growth and breakeven position for too long. In addition to opportunity costs, technology risks, economic risks, and competitive threats can quickly turn slow growth into decline.
Upon committing to profits, target at least 20% of revenue, which is the median for the Max Profit group of public companies. This level of profitability generates an acceptable valuation on an EBITDA basis and allows for a sale, re-cap, or M&A strategy, as it can support leverage and is attractive to PE firms.
Circling back to the growth question: “Objectively reasonable” is a filter designed to emphasize clear thinking. This is not a test of will or grit; it’s an “objective” exercise, and “reasonable” is the bar to be cleared.
“Data-driven” means the growth plan needs to be based on things like successful go-to-market experiments, early adoption of a new product, or a successful cross-sell program. These plans should not be based on a “good pipeline” or an “amazing” new VP of Sales.
And finally, “fully funded.” If the growth plan requires capital, and there is none, it’s not helpful, and a capital raise becomes the critical next step.
It’s possible to survive with slow growth and weak profits, but not long. It’s time to pick a lane.
About the Author
Todd Gardner is the Managing Director of SaaS Advisors and the founder and former CEO of SaaS Capital. Todd was also a partner in the venture capital firm Blue Chip Venture Company and was a management consultant with Deloitte. Todd has worked with hundreds of SaaS companies across various engagements, including pricing, capital formation, M&A, metrics, valuations, and content marketing. Todd is a graduate of DePauw University and Indiana University.