On revenue, gross profit, and profitability

A follow-up from last week's piece, The Billion-Dollar Revenue Club.

Welcome to issue #48 of next big thing.

This is a quick follow-up to last week’s post on The Billion Dollar Revenue Club.

One of the best parts about writing for me is the joy of getting feedback that improves my thinking, and I particularly enjoyed the feedback on this piece. For example, venture investor David Greenbaum of Quiet Capital commented on LinkedIn:

I feel like each of these companies have very different gross margin profiles so is revenue much better than valuation? Almost think the goal should be $1B gross profit or $1B net revenue.

There are two interesting questions to respond to here:

1. Is revenue much better than valuation as a goal post for companies to aim for?

2. Is gross profit or net revenue a better measure of “success,” or better goal post than gross revenue?

On the first question, the point of my last piece is that I believe the answer is “yes.” The $1B valuation that signified a Unicorn became the goal many companies were trying to achieve over the past decade. Companies that took that approach were mistaken. The goal should have been to build a strong and scaled fundamental business. And that’s why I felt it important to call out that companies reaching $1B or more in revenue are better companies for startups to look up to.

The second question raises a good point. As I explained last week, “revenue means something different for every company, what it recognizes as revenue (vs. gross merchandise volume, for instance), the margin profile of that revenue, the stickiness of that revenue, and more.” My favorite blog post on this subject is by Bill Gurley of Benchmark titled All Revenue is Not Created Equal. As a result of this, David’s comment is valid — a goal post around gross profit or net revenue is a better, more equalizing measure of companies’ scale, than gross revenue. There’s one key issue with this, which is that private companies may report their gross revenue publicly (or it may get leaked with highly credible sources), but gross profit is almost never shared publicly. This means that any discussion of a “Billion Dollar Gross Profit Club” would be limited to public companies.

But if we’re talking about success, and the ultimate north star for any business, why not go further than gross profit? My friend and venture investor Sarah Guo of Conviction tweeted the following this week:

A friend of mine who runs a multi-billion dollar public company with top-tier VC backing and faced activist investors over the cost structure of his biz, told me over coffee 5 or 6 years back: “Sarah, tell all the founders their job is to generate cash flow. No one told me.”

Ultimately this is what every business is working towards: profitability and generating cash. Of course we shouldn’t expect early-stage companies to be profitable, for they are investing in technology, sales and marketing, and more, in the hopes of scaling their businesses such that one day they can be profitable and growing companies. And profitability in and of itself isn’t a goal that yields to a massive venture-backed success. Which is why I still think that the best goal post for startups to think about trying to achieve is one around revenue (or gross profit, if we easily had that data available for private companies).

Thinking about these goal posts, I thought it would be an interesting exercise to look at the 64 public companies (referenced last week) that are the U.S. technology companies founded since 2003 with over $1 billion in revenue in the last twelve months, studying their gross profit, free cash flow, and EBITDA. Here are some findings (all metrics are last twelve months):

• 64 total companies with Revenue of $1B+ (U.S. public tech companies founded since 2003)

• 57 of 64 companies with Market Caps of $1B+

• 38 of 64 companies with Gross Profit of $1B+

• 44 of 64 companies that are free cash flow (FCF) positive

• 24 of 64 companies that are EBITDA positive (screenshot below)

• 7 of 64 companies with FCF of $1B+ (Meta, Tesla, Airbnb, Palo Alto Networks, Opendoor, Workday, Zoom)

• 4 of 64 companies with EBITDA of $1B+ (Meta, Tesla, Airbnb, Arista)

While this list is likely not comprehensive (e.g. I believe ServiceNow should be on this list, and am checking to find out why it wasn’t in the original screen — please let me know if you think of others), and omits companies domiciled outside of the U.S. (so Shopify and Spotify, for example, are not included, despite both being $1B+ of revenue and founded after 2003), my main takeaway from looking at this data is the following:

Very few tech companies end up being very large and profitable, twenty years after being started. Those that do are the ones we should celebrate, the ones worth looking up to, and very likely the ones that have built the next big thing in the course of their journeys to the most rarefied air.

24 public tech companies in the U.S. (founded since 2003) with revenue over $1 billion and EBITDA positivity. Screenshot from Koyfin.

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I started next big thing to share unfiltered thoughts. I’d love your feedback, questions, and comments!

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