When looking at financial projections of early-stage startups, it’s not unusual to see expected profit margins reach 50% or more. Last week I was pitched on a startup promising 95% profits.
The attraction of software startups is that revenues can grow exponentially while costs grow linearly. With no cost of goods other than cloud hosting, profits seem limitless. Except they aren’t.
The operating margin for S&P 500 software companies is 25%.
- Google: 34%.
- Microsoft: 45%.
- Oracle and SAP are the best model for B2B software companies. Oracle’s profit margin is 31%. SAP is 26%.
All have products that haven't changed much in decades, have little competition, and need little advertising, and yet profit margins max out at 45%.
If you think you can have higher profit ratios than these industry giants, be prepared to tell me how. Otherwise, I’ll assume you’re missing most of your costs.
Coming from an early-stage startup with a small group of dedicated enthusiasts working mostly for equity, it can be hard to imagine all the costs that go into operating a $100M company.
-- sales and marketing (the biggest expense)
-- more developers at market salaries
-- quality testing
-- customer support
-- support staff: IT, HR, Legal, finance, IR
-- international operations
-- offices
-- employee perks and taxes
In your pitch, ditch the 60% profit margins, do a proper financial model that includes all the costs, and show how you expect the business to grow realistically and reach profitability. Wow us with your financial acumen rather than ridiculous numbers and you’ll have investors on your side instead of running for the exit.