Profitability covers a multitude of sins

In a fascinating letter from Sequoia Capital to the CEOs of its portfolio companies, Sequoia urges the obvious: be prudent and conserve cash. The counsel is obvious but largely unheeded in the technology industry, as well as throughout our economy: debt equals unhappiness, while profitability equals happiness (and flexibility).

Like every major shift in the environment, this one will offer opportunities as well as risks. JP Morgan was able to buy two great assets as substantial discounts with government assurances, precisely because they played the game frugally while others were more risk seeking...Many companies that thrived post 2001‐2003 were simply "Last Man Standing" in their industry. It doesn't sound all that glamorous, but it was the exact right strategy to deploy at the time.

As a result, Sequoia urges its companies to "(not) spend money until you have to," warning that "access to...capital...may be dramatically impacted" and that the "cost of capital is going way up."

I'm grateful to work for a company that has prudently managed its resources. Our CEO, the former COO of Business Objects, is very frugal and we've never hired in advance of the revenue to support those hires. Consequently, we have most of our venture money in the bank, as well as a profitable business that should get stronger during the downturn.

I've written before about how a recession would benefit open-source buyers, but it's also important to recognize how it benefits the vendors. Open-source vendors are demand-driven: the software is made available for download and customers find you. Alfresco routinely closes six-figure deals over the phone/e-mail in a 60- to 90-day sales cycle. Virtually none of our deals require an on-site visit.

This means we can invest more in our products while simultaneously charging less, which is what customers need in a tightening economy. Get more, pay less. That's the open-source value proposition for this recession-plagued economy. A subscription model helps, too, because it doesn't require the sale of new licenses, as a license-driven model like Microsoft's does. Red Hat could not sell a single new subscription this year and hold revenue steady. That's the power of open source.

But the fundamental premise underlying all of this is to operate one's business in a prudent and profitable manner.

It's critical, in Clayton Christensen's words, to be "impatient for profits and patient for growth." Following Sequoia's advice, many of the winners in this economy will simply be the "last ones standing." Open-source companies have an opportunity to gain market share and solidify brands in a spiraling economy, but to do so they must be profitable.

My own advice? If your headcount is far out in advance of your profitability, you should strongly consider cutting headcount to get to profitability as soon as possible. In my own house, we went to a cash-based budgeting system a few months ago and paid off all debts to ensure we were ready for any downturn. Today we're reaping the rewards.

Do yourself and your employees a favor: get profitable. Spend less than you earn. Grow slowly. That's the open-source mentality, and it works.

[servermaker]

The open source mentality? Come on. Only in the world of venture-backed technology startups can advice like "don't spend too far ahead of revenue" and "get profitable" be seen as anything other than laughably obvious. It's funny that the same venture investors who have historically cheered for "getting big fast" and encouraging founders and their shotgun CEOs to "go big or go home" while suggesting "if you are profitable you are not investing enough" are now delivering sound operating guidance. I guess when the suckers downstream stop buying the nonsense (e.g. the public markets and big company acquirors) those upstream are forced to build real companies. Evenutally people catch on...

But there is one born every minute, as the old saying goes, so I'm sure most venture-backed startups will be back to business as usual soon enough.

[Vurk]

"to be 'impatient for profits' " is how the economy got where it is today; VC's and other greedy investor-types are always the ones pushing for "impatience".
VC's need to let companies run their own businesses, and stop micromanaging. If they believe in the business enough to fund it, they should then get out of the way and let business happen.

Or dont invest.

[Matt Asay]

@Vurk: I respectfully disagree. We got where we are today by being "impatient for growth," not profit. When companies spend beyond their means (which is sometimes a good thing if a market opportunity demands it), they're begging for trouble if the economy turns.

@servermaker: I somewhat agree, but most of the world's economy is built on debt of some kind. The key is to be wise about it. I imagine you bought a house and didn't pay cash. Good or bad? Good, if you bought a house that is within your means. Bad if you bought the biggest house the bank would let you "afford." The same holds true for business.

[humanssssss]

Greed is good. It is the basis of the capitalistic system. In it, greed is controlled by competitive forces that will drive greed to zero profit. Only people who are ignorant of economic would say greed is bad. Without greed, we all would be not doing work and allow the government to feed us. That was the problem with communist ideology, they believe in a classless society, that the mean of production should be own by the state, and the state would equally distribute it. This kind of ideology creates a disincentive for people to work, thus lowered economic growth. Happened to Vietnam and China. If you read your history, China and Vietnam were quasi-capitalism until the communist revolution begin to take hold. Since these countries abandon communism and accept capitalism, they've experienced tremendous economic growth.

Greed is good.

[odubtaig]

You need to look up the definition of 'greed'. The word 'excessive' features.