The time required for a startup to reach profits depends on various factors including the nature of the business, the sector it operates in, and the startup’s initial costs.
One of the most important questions that a budding entrepreneur has while starting a business is how long it will take for the startup to become profitable.
A company’s net profit is the revenue it has generated after deducting all its expenses. When a startup is cashflow positive, it means that the company is generating more cash than it spends during a given period of time; simply put, there is money in the bank. This money goes to the owners or shareholders of the company.
Profit is often the primary goal for any company. Without it, no business can survive for a significant amount of time. Profitability can help a business in attracting investors, expanding the business, and acquiring another business, among others.
The simplest means to calculate your company’s profit is by subtracting all your expenses from the revenue generated. If the answer is a positive number, you have made a profit. If it’s negative, your company is facing losses. On the other hand, if the answer is zero, it means that your business is breaking even.
It is important to carry out a break-even analysis before you start a business or launch a new product to estimate how much revenue your business will have to generate to cover your expenses and how long it will take to generate the required revenue.
While typically it is estimated to take a startup two to three years on average to make profits, it can vary to a large extent depending on various factors including the nature of the business, the sector it operates in, and the startup’s initial costs, among others.
That being said, some startups never become profitable: over 9 out of 10 startups fail within 10 years of being set up. According to 2019 data from the U.S. Bureau of Labour, 20% of startups go out of business within the first year of operations.
Profitability vs growth
It is important to note that non-profitability does not imply that the company is not growing or that it is performing poorly. In fact, some of the world’s most famous startups are non-profitable, and others took many years to turn profits.
Around 83% of companies that launched IPOs in 2018 were not profitable. Facebook first turned a profit in 2009, five years after it was founded. Similarly, Amazon, which was founded in 1994, started making a profit only in 2001, and even then, was only making moderate profits until a few years ago. Both companies focused their resources on growing into new markets.
It is common practice for founders to reinvest the profits into the startup during its initial stages, because, “in its infancy, the lifeblood of a startup is cash infusions.”
“90% of the time a founder should reinvest their profits back into their business, because it helps them grow and means they won’t stagnate,” Matt Jonns, founder of ucreate – a co-creator of software startups – told Forbes.
However, recently, there has been a shift in the growth-at-all-cost mentality of young startups.
The 2019 WeWork debacle, which resulted in the company’s valuation dropping from $47 billion to around $5 billion, and Uber’s disappointing public debut, resulted in investors becoming cautious of investing in startups. Investors are now focusing on pushing startups to focus on building sustainable business models and reaching profitability, rather than focusing on growth-at-all-costs.
This means that founders need to start considering profitability and business model much earlier in the game, rather than taking the high-growth approach that has seen startups like WeWork fail.
Profitability depends on various factors
The time frame in which a company becomes profitable depends on the amount of start-up capital needed to create the products and services, as well as the amount of money drawn from the company for compensation and investor servicing.
Businesses trying to make and sell a product that’s new to the market could take an average of at least three years to become profitable due to expenses like hiring experienced talent and marketing costs. In contrast, a home-based business with little to no startup costs can generate profits much quicker.
According to Julian Shapiro, founder of growth marketing agency BellCurve.com, ecommerce businesses become profitable faster than other kinds of startups.
“On average, an ecommerce company is more likely to first reach profitability than an SMB SaaS company,” he wrote in a 2019 article for TechCrunch.
According to him, this is due to the extent to which ecommerce businesses lend themselves to online ads.
In a podcast, Darwin Liu, Founder, and CEO of X Agency, a digital marketing agency, said that ecommerce startups ideally break even in their first year of operations and become profitable within a year and a half.
However, this would again vary depending on other factors. For instance, if the company is run by a solopreneur who is putting in just a few hours a day into the startup, it would take longer to turn profitable. Liu adds that because of this, he doesn’t consider time a very good benchmark.
According to Shapiro’s analysis, after e-commerce, Chrome extensions, mobile apps, enterprise SaaS, and SMB SaaS are most often profitable.
For SaaS (software as a service) companies, once they have built a platform, they can sell it to the customers without major additional expenses except for hiring a sales and marketing team. With the bulk of their work done, many SaaS operators are surpassing US$100 million in ARR (annual recurring revenue) milestones, or are becoming unicorns.
In a 2018 blog, Wil Schroter, Founder and CEO of Startups.com, a startup launch platform, estimated that it takes around 7-10 years to make a startup truly successful.
“The reason most companies don’t find their footing until Year Four and beyond is because it takes that long before every aspect of the business has been refined – customer acquisition, product development, brand message, management team, unit economics – the list goes on,” he wrote.
Ultimately, there are no set benchmarks as to when a startup should turn profitable. Whatever type of business you are running, to reach profit, you have to build a sustainable business model, cut your fixed costs, and invest in areas that bring in revenue.
Header image courtesy of Nattanan Kanchanaprat from Pixabay.