Venture Capital Perspective: How important is company profitability?

As Indiana tech companies continue to see venture capital investment from Indiana firms as well as firms from all over the country, they may have questions on what these firms look for in a strong investment option. One such area of interest is profitability: How important is it to investment firms that companies have demonstrated profitability before an investment is made?

I asked three early-stage venture capital firms who are active in investing in and/or researching investing in Indiana tech companies to share their thoughts on the importance of profitability with respect to making an investment in a company.

How important is profitability when deciding whether or not to invest in a tech company?

Greg Beaufait, Dundee Venture Capital

Dundee Venture Capital is headquartered in Omaha, Nebraska, with offices in Minneapolis and Chicago. They have invested in early-stage tech founders all throughout the Midwest along with companies in Massachusetts and Texas. Locally, they led Costello’s $1M pre-seed round raised in September 2017. The firm has previously participated in TechPoint’s Winners’ Circle investable companies events. Greg Beaufait is a partner with the firm and visits Indianapolis regularly.

“A profitable business model is table stakes for investments, and we strongly prefer to invest in businesses that have high gross margins and low startup costs. That said, where Dundee invests, at the seed-stage, companies are still in growth mode. We care most about speed and want to invest heavily in product, sales and marketing, resulting in a reasonable cash burn as we focus on growing top-line revenue (or other growth metrics). Focus turns more towards profitability and maximizing efficiency years down the road once our companies have reached scale and a defensible market position. Above all, we need a team aligned with that vision and capable of executing on it.”

Mike Asem, M25 Group

M25 Group is an early-stage venture firm based in Chicago, investing solely in companies headquartered in the Midwest. They have invested in a number of Indiana tech companies including Cheddar, Costello, Realync, PactSafe, Dattus, BoxFox, Skyepack and Mimir. The firm has previously participated in Winners’ Circle. Mike Asem is a Purdue University graduate who serves as a Director with M25.

“Honestly, we don’t expect businesses to be EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) profitable. What’s much more important to us are unit economics that are realistic and defensible, and a clear path to profitability at some scale. Often times we actually see this as a negative, because it can be an indicator that the founders should be investing more in growth.”

Adrian Fortino, Mercury Fund

With offices in Ann Arbor, Michigan, and Houston, Texas, Mercury Fund is an early-stage venture capital firm focused on entrepreneurs and technology innovation originating in the U.S. Midcontinent. At the time of this article, the firm has not invested in any Indiana companies. The firm has not previously participated in Winners’ Circle. Managing Director Adrian Fortino is based in the Ann Arbor office.

“Net profitability (i.e. cash flow positive) is not terribly important at the stage where Mercury Fund invests (Series A). However gross profitability is important. Some tech companies with heavy service offerings and/or a heavy hardware component can have lower gross margins than one would like to see, especially when compared to software companies. We know that companies at our stage are still figuring out how to acquire customers so their cash efficiency is almost always low. Of course, we expect that efficiency to increase substantially with our help.”

Based on reactions from the three investors I spoke with, it appears that actually being profitable isn’t the critical factor driving their investments. However, the underlying economics, vision for the future and solid plans for attaining profitability do matter. As more Indiana startup and scale-up companies reach the stage where capital investment is important, an understanding of the market and relationships with investors becomes important. Indiana proves to be thriving in this space, and it is exciting to see the growth of our ecosystem as more firms continue to see potential in it.

For more insights on the workings of venture capital firms, check out more capital stories on TechPoint Index.