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Extract from article by Rory O’Driscoll

Venture-backed startups live in a crazy hyper-cyclical world driven by the constant and mutually reinforcing dynamics of burn and valuation. It is easy to sound like the elder statesman “worried about high burn” or “worried about high valuations,” but tolerance for burn and willingness to “pay up” for high growth are core aspects of the entire venture model.

The question is always whether the money being spent (burn) is creating enough fundamental value (revenues, customers etc.) to justify the high valuations. From that perspective, absolute valuation (billion dollars, yes or no) is the wrong metric on which to focus. It is an output, not an input — and it is extremely prone to overshooting, with the last five years being a clear example. In that period, capital markets have been in love with growth.

High-growth companies have attracted  high valuations, which allowed them to raise capital, which was then spent to generate still more growth and raise the valuation again. The result has been a self-perpetuating cycle of high burn, higher growth, still higher valuations and a strong positive feedback loop.

This puts pressure on companies to keep that growth going at all costs. Because the number of profitable ways for a company to spend money is finite, at some point that pressure to grow leads to investments that deliver growth, but at the expense of profits. Unprofitable sales channels, subsidies to acquire customers and expensive advertising campaigns are all signs that a company is focused on growth at all costs rather than growth at a profit. Companies get sloppy.

 

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