One of the ways that finance and strategy work need to work together is in determining how to balance profits and growth. Fred Wilson recently wrote a fascinating post with a potential strategic framework regarding the inherent difficulty in balance profits vs. growth.
Wilson is a VC with Union Square Ventures, who despite being based in New York, is widely followed and respected here in Silicon Valley and the San Francisco Bay Area. Much of what he wrote in his post is very consistent with the work that we do as an outsourced / part-time CFO service firm.
Here are some great excerpts from his post elaborating on his “40% Rule”:
"Your year over year growth rate plus your pre-tax operating margins need to be at least forty percent. Meaning you can grow at 100% per year and have operating margins of -60%. Or you can have flat growth and have 40% operating margins. Or you can grow at 20% per year and have 20% operating margins. There is no magic to the forty percent target, but I do like establishing some relationship between acceptable levels of profitability (or losses) and growth. Too many times I have seen companies invest in growth for growth sake without having any constraints or sanity checks on that investment and the losses that result from that investment.
"These experiences lead me to question the orthodoxy in the world of technology that says if you are not investing heavily in growth (and losing money), then you are not maximizing the potential value of your business over the long haul. It doesn’t have to be that way…. Maybe you just need to be a really sharp and experienced business person to be able to do this. [emphasis added]
"I also think the profit motive, generating more revenues each year than the expenses you are spending to do that, is a really valuable constraint on a management team. It forces them to think creatively and logically about the investments they want to make. It roots out bad investments in people, product, sales, marketing, and elsewhere in the business and helps to maintain a lean and mean highly functioning organization."
Read the full post