Printed on The Economic Times, Op-Ed page.
Entrepreneurs should not rush to show profits in fledgling ventures, but focus on building long-term value, says Mahul Brahma
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counts and make a quick profit. Or, he could invest in infrastructure and improvement in service standards. The second strategy would mean slower ramp-up in the client base and postponement of the date with profit. It was simply a toss up between quick profit and long-term value. First-generation entrepreneurs often look at their first profits as the vindication of their business model and are hence quite eager to reach there as soon as possible. After all, the ultimate goal of any business is profit and why not early? So, it may be baffling to them to see seasoned entrepreneurs and financial investors appearing comfortable with losses in new ventures month after month, worrying about everything else but profit. A lot of venture funding happens in loss-making firms, which don’t seem to have any disadvantage relative to profit-making ones. Does that mean profits are not important in a small firm?
The answer lies in the decision taken by Carwale founder Dubey. He figured that shortterm profit may be attractive, but long-term value is what he wants to build. So, he chose to build a critical mass for the company before opening the cash box. That meant spending for the future and taking a knock in the nearterm. “We took about a year to reach the critical mass, that is take Carwale to a credible level where customers are given a standard level of service. It took us six months to make profits after that,” he says. “We could have taken an easier path earlier by giving discounts, for getting early profits but that would have been a short-term gain and a long-term loss.”
Of all the tricks that a rookie entrepreneur will need to make a success out of a new venture, perhaps the most important is to figure out when the company will break even. It can’t be left to chance and the CEO must plan for increasing revenue in a graded manner, investing in infrastructure and processes to support the growth and know how to fund initial losses. The first objective, of course, is to reach a viable cash flow position when the entrepreneur knows that the business can sustain itself. Scaling up then will bring in the benefit of size and profits.
Profit timeframes differ from business to business, sector to sector. Unless a business is a one-man show like home-based consultancy, “one should look for scale and size in the business rather than worry about profit when it is started,” says K Ganesh, founder and CEO of TutorVista.com. In fact, profits too early in the life of a new company can be counter-productive, he warns. “Unless the business scales up, the fact that you can make a great profit will not mean much. It is easy to break even or make a profit at small scale, but doing it on a large scale is what building a business is all about,” he observes.
For product companies, the span can be longer since development, testing, validation and marketing take up time. Services companies may be able to reach profitability quicker, but they should not rush in and rupture their growth impulses. There are too many small scale industries that never became large companies, because entrepreneurs tasted early profits and stopped taking risks at some point of time. They may spend their most productive time lobbying for government concessions or complaining about the ills of small scale industries, rather than capturing opportunities and growing out of the bonsai mindset. Early profits may also mean that not enough cash is being pumped back into the business. While everybody likes to do business with or work for a profitable company, few discerning investors will be keen to put their money on a company that drives the balance-sheet before driving the business.
Venture capital funds, when evaluating companies for investment, do not look for profit figures but for the soundness of the business model. So, a company playing for the long haul and hoping to win the trust of investors, must focus on the model itself. Profits will follow automatically. “You plan revenue, not profit. You should know where the revenue will come from and when it will overtake break-even and start making profits. There is a need to go to the market to experiment and work on your strategy,” says Pravin Gandhi, president of The Indus Entrepreneurs in Mumbai.
An entrepreneur who fails to invest for the future just to show a shortterm profit is unlikely to have a sustainable business, say veteran entrepreneurs. Profit or loss is not a choice, only the timing and planning are. In fact, if a company can reach profitability easily, it may not need venture funding. It may also not be scaleable. “VCs never pressurise you for quick profits if you are able to explain when you aim to get profits and the details of how you are working towards it,” Kreeda Games India founder Quentin Staes-Polet says.
Sanjay Kanth, CEO of ESS Solutions, says an entrepreneur must adopt a profit stance in his mind from the first day of his business. “That does not mean that you will not scale up and be tied down with the gains,” but only that you will remain focused on the financial health of your firm. “During the refinance boom in the US, to move beyond offshoring, ESS bought a title and a mortgage company. We started off with just a computer in a small room but this doesn’t mean we will remain that way because we are making profits. That’s business. You need to take risks and expand, and look beyond profits to make more profits in the future.”
Successful entrepreneurs often stray from established and easy route to profits. Vishal Gondal, founder and CEO of Indiagames, says he faced resistance from VC investors when he wanted to move to mobile phone gaming business. They wanted him to continue with internet gaming and subsequently move on to information technology services as it was already a profitable sector. But Gondal stuck to his plan and investors eventually relented. “You have to have faith in what you want to do. Then it becomes easy to fight resistance from financiers,” says Mr Gondal.
Here is a thumb rule for entrepreneurs. There are two kinds, bad profits and good profits. Bad profits come at the cost of growth, reduce value to the customer and drain future shareholder value. Good profits aid growth, add to customer value and bequeath longevity.