Why Money Burning Startups Are Currently Facing Crisis

Ethan
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NO MORE FUNDING

Traditionally, the number one goal for any company is to maximize profit for shareholders. But, for quite some time now, we’ve seen a new breed of companies who don’t care at all about profit. In fact, profit isn’t even part of the equation. It’s all about growth. If these companies are able to show large enough user growth figures, nothing else matters. And I’m not just talking about random background startups. 

Many of the most recognizable startups in the world have never made a single penny. Zillow, for example, loses around $200 million per year. Snapchat loses $1.3 billion per year. Lyft also loses $1.3 billion per year. But no one is as bad as Uber, who till just 6 months ago was losing $9 billion per year. One of the main reasons for this is the insane growth is everything's perspective of modern investors. 

They’re willing to stomach insane losses for not just a year or two but 5, 10, 15 years. But, it seems that things are changing and they’re changing fast. In fact, funding has fallen off a cliff across the board. In Q1 of 2023, global funding had fallen to $76 billion which is a 53% decline from the $162 billion that it was the year prior. 

And this was despite two massive deals with OpenAI and Stripe, who raised $10 billion and $6.5 billion respectively. Without those deals, funding would’ve been down to $60 billion or over a $100 billion less than 2022. 

global seed and angel investment through Q1 2023

You would think that the startups that are affected the most are the early stage ones that are just getting started as the risk with these companies are the highest. 

global late-stage technology growth investment graph


But, it turns out that the startups that are being affected the most are actually the late stage startups with a chronic money burning problem. As such, most of these companies are scrambling to get their act together. Uber, for example, has been magically able reduce their losses from $9 billion per year to just $300 million per year. 

But not all startups are having such an easy time as they’re realizing that becoming profitable isn’t as easy as they originally thought. So, join me as we take a look back at how this new breed of companies even came to be and what this funding cut means for some of the most well known startups in the world. 



GROWTH INVESTING

Seeing all of these massive companies constantly burn money, it’s easy to think that that’s just how tech works, but that’s completely false. Companies like Apple, Google, and Microsoft pull in tens of billions if not hundreds of billions in profits every single year. 

GROWTH INVESTING


If you want to build a massive tech company, it seems that you have to be willing to burn money for at least the first 5 or 10 years but this is completely false. 

In fact, this was never a thing with traditional tech companies. Intel, for example, became profitable just 3 years after being founded. Apple became profitable just 2 years after being founded. Even Google, a more modern tech company, only took 3 years to reach profitability. It also wasn’t like these companies were burning money on user acquisition or marketing or insane amounts of overhead. 

Rather, they were just investing in getting their first product to market, and as soon as they were able to release their first product, they were able to become profitable. But all of this would change with a company called Amazon. Unlike the tech entrepreneurs that came before him, Jeff had a different perspective. 

Instead of trying to sell a superior product for a premium price which makes it easy to achieve profitability, Jeff wanted to center Amazon around killing margins. His catch phrase was literally “Your margin is my opportunity.” But, while this sounds nice on paper, it’s not as clean in application as this usually just turns into a race to the bottom. And that’s exactly what happened. 

Most of us only remember Amazon and eBay but that’s not to say that they were the only players in the ecommerce market. They were simply the only ones who survived. The reality was that dozens of players entered the ecommerce market strapped to dotcom funding. This included companies like boo.com, Webvan, eToys, and pets.com. To their credit, many of these companies actually become quite large. 



Webvan, for example, was a grocery delivery business that’s eerily similar to Instacart. Thanks to Dotcom funding, they were able to expand to 26 cities, hire 3,500 employees, and even have a billion dollar IPO. But scale wasn’t the only thing these companies had in common. All of them were also burning ridiculous amounts of money. 

Boo.com was burning through $135 million within 18 months. Pets.com was burning through $300 million within 2 years. As for Webvan, they were pulling in a good amount of revenue: $178 million, but their expenses were wait for it $525 million. This meant that for every dollar they pulled in, they spent 3 dollars. And it wasn’t on building out the product or expansion or anything like that. 

Almost, all of the expenses of all of these companies were just marketing. In fact, Boo.com spent $25 million on advertising before they even opened. The cost of the product itself was miniscule for these companies compared to their other expenses. 

One of Boo.com’s main technologies for example only cost $6 million to develop but $135 million to market. With these sorts of economies, it’s no wonder why things eventually came crumbling down with the dotcom bust when all of these companies went under. After this disaster though, it seemed like investors had finally learned their lesson. 

Economics doesn't work differently just because it’s a shiny tech company. But somehow, 20 years later, we would end up in the exact same position once again. So, what in the world happened? 



EXCEPTIONS MAKE A CASE

Likely the number one culprit in normalizing money-losing tech endeavors once again is big tech starting with, of course, Amazon. After the dotcom bubble burst, Amazon was feeling the pain just like every other dotcom company but had a rather unique solution. Instead of just trying to focus on profitability with their retail business, they decided to just open a whole new business called AWS to pay for the unprofitabilty of their retail business. 

So, essentially, they became their own funders and I think we all know how this played out. Amazon would end up growing 500x and become synonymous with online retail despite the fact that they were never able to consistently turn a profit to this day. Seeing this, many investors, many investors, started feeling a bit of FOMO. 

Maybe they were right about the dotcom companies all along. Maybe all they needed was more time and funding to succeed. In the end, it took 20-30 years for Amazon to reach its stride. If Amazon was the only instance, things wouldn’t have gotten so out of hand but they weren’t which brings us into our next culprit: Google. 

Ever since Google became profitable, they’ve built a career out of building no margin/negative margin products. This includes Gmail, YouTube, Maps, Android, Google Cloud, the Pixel and basically anything else that comes out of Google. Their strategy is to simply reach as many people as possible with these products and monetize all of them using Google search and Google ads. 

Once again, this ended up playing out extraordinarily well, as Google would end up growing 50X as they grew multiple ubiquitous platforms with billions of users each. But all of this was nothing in comparison to what Zuckerberg would do. Amazon and Google were simply subsidizing in-house products with other in-house products. 



Zuckerberg, however, would go out of his way to buy money pits just for the users. This of course included Instagram for $1 billion and WhatsApp for $19 billion. While Facebook got a lot of flack for these acquisitions back in the day, they ended up becoming cash cows. Instagram is now valued at over a $100 billion and WhatsApp is likely worth even more. 

These big tech companies were clearly making a strong case for pursuing money-burning endeavors, but the factor that pushed investors over the edge was the exponential startups of the late 2000s. This, of course, starts with Uber. 

Uber was founded in March of 2009 and is still not profitable but it’s worth $90 billion. Lyft was founded in 2012 and is still not profitable but it’s worth $4 billion even after falling 90%. Doordash was founded in 2013 and is still not profitable but it’s worth $30 billion even after falling 50%. Stripe was founded in 2010, and is only now becoming profitable, but it’s already worth a $100 billion. 

Stripe worth a $100 billion


I can go on forever. Robinhood, Coinbase, GrubHub, AirBnB, MongoDB, Zoom, Affirm, Carvana, Twilio, SnapChat, Octa, Rivian, Palantir, Peloton. Basically any startup that you recognize and founded within the past 15 years likely falls within the category as dozens, if not hundreds, of money-burning startups were founded in the late 2000s and early 2010s and went on to be phenoemnal investments despite never turning a profit. 

With each and every passing year, investors and VCs were becoming just a little bit more tolerant of losses leading us straight into the pandemic. 



DOTCOM BUBBLE 2.0

When the pandemic hit, investors FOMO went into overdrive. Tech companies seemed like a gold mine as everyone was sitting at home spending all of their time on phones, computers, or TVs. All of the big tech companies started hiring like crazy as they thought this was it, this was the new frontier, the new era of tech domination. 

Meta nearly doubled its employee count from 44,000 to nearly 90,000. Google also nearly doubled its employee count from just over a 100,000 to nearly 200,000. Big tech stocks and pandemic stocks would go insane, and VCs couldn’t help but feel that they had missed it. And that’s when they decided they may have missed out on this last run up, but they sure as hell weren’t going to miss out on the next run up. And with that, they started pummeling money into basically any startup that came through the door with insane valuations out of date. 

number of new unicorn global graph


I think this graph really showcases the essence of what was going on. Back in 2012, there were a healthy 5-10 unicorns every quarter. This increased to 20 to 40 in the mid 2010s before rising to 50 to 100 in the late 2010s. And then finally, it would explode to 220 unicorns per quarter in 2021. 

That’s the same as over 2 unicorns every single day and keep in mind the stock market is only open 252 days per year. So really, 3 companies were reaching unicorn status on any given day in 2021. And make no mistake, this has nothing to do with rising innovation or more opportunity. The only thing this has to do with VC funding and investor greed.


global funding to startups from 2006 to 2021


I mean, just look at this graph. Funding literally grew by 10X between 2011 and 2021. But the good news is that this madness is finally coming to an end which just leaves the question: what happens next? Well, it’s really simple honestly. A large number of money-burning startups will simply go bankrupt. This has already started to play out. 

Within just the first half of 2023, 338 US companies filed for bankruptcy. 54 of these companies had VC or private equity backing, meaning that if this trend keeps up, over 100 startups will go bankrupt by the end of this year alone. And as interest rates continue to stay high, the economic pain for these startups will simply get worse and worse. 

Most startups that manage to fend off bankruptcy for another year or two will likely be bought out by larger companies for rock bottom valuations. If things play out similar to the dotcom crash, only half of them will make it past this initial purge. Most of the companies that make it through will be a shell of their former selves with no way back to their all-time highs. If we look back at their stock graph in 20 years, it’ll probably look something like this. 

Of course, a select few companies will defy the odds and not only return to their former highs but make new highs. These companies will become the Googles, Facebooks, and Amazons of the next generation. But for everyone else though, this is pretty much the end of the road as the VC money printer has finally stopped..


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