Profitable Growth, Tech, and Innovation Done Right

2020 was a record-setting year for private market exits, despite a global pandemic that upended life as we knew it. COVID-19 sparked dramatic market volatility and spurred immediate, large-scale investments in software and technology as millions of employees started working remotely, digital learning became the norm, and healthcare, logistics, and other industries worked to accommodate unprecedented demand. Against that backdrop, 14 companies from the most recent CNBC disruptor list – from Airbnb to UiPath – managed to make successful exits. That means that over a quarter of companies named to the list in the past nine years have gone public through IPO, direct listing, or via SPAC. 

Silicon Valley has always prized new ideas and enjoyed the rapid user adoption and sales growth that come with those ideas. For years “unicorns” have been celebrated for innovation alone, with profitability and economics being an afterthought. A focus on the bottom line has historically been branded a barrier to innovation – a signal of the inevitable creep of a once-cool startup selling out. Some time ago, investors began accepting excessive spending as a necessary evil for rapid growth and a bet on eventual outsized profits.

Professor Emeritus Brad Cornell of UCLA and NYU Professor Aswath Damodaran refer to this mindset as “big market delusion,” arguing that the allure of the broadly-defined “big market” for products can cause overconfidence on the part of entrepreneurs and their financiers. Victims of “big market delusion,” according to Cornell and Damodaran, believe that if a company can just grow fast enough to dominate the market, then profits will follow. A recent cautionary tale against this approach is Katerra, a Silicon Valley construction tech startup that raised $2 billion from firms including SoftBank and filed for Chapter 11 bankruptcy protection earlier this month. Katerra’s investors reportedly “encouraged [the company] to engage in a WeWork-style expansion”, pursuing ever-accelerating growth that it couldn’t sustain.

2020 showed that innovation and profitability aren’t diametrically opposed; in fact, ideally, they are intrinsically linked. It’s a simple enough premise – when companies improve profit margins, they end up with more dollars to reinvest in the parts of the business that create innovative solutions (R&D, Product, Talent Acquisition). This model enables a fast-growing company to be self-sustaining without sacrificing what made it so fast-growing in the first place. It’s time for investors to demand a healthier balance of growth and profitability in the due diligence process. Now is the time for innovation done right. 

Up Next: Growth and Profit

When I first began investing, shortly after the dot-com bubble burst, the market was saturated with public companies that no one wanted to buy. It was an opportunist’s dream: for the first time, you could buy established software businesses for relatively low prices. By working with existing management, many of whom were original founders that knew their businesses inside and out (Charles (Chuck) Boyle and the Prophet21 team come to mind), it was possible to take these under-appreciated companies from good to great. My early Thoma Bravo partners and I found that we could optimize operations without sacrificing the creative thinking and unique cultures that made these companies so desirable – then use the improved cash flow to invest in more disciplined innovation. As we expected, companies can (and did!) grow faster and generate better ideas the more self-sustaining they were. 

2021 may well prove to be a similar inflection point. Companies that became unexpectedly essential (Zoom) or mobilized a new generation of passionate users (RobinHood and Coinbase) are being valued not just as disruptors but as engines for profitable growth – valuable examples of “innovation done right.”