Path to Startup Profitability

You may have heard "grow at all costs" echoed across Silicon Valley. Many companies were richly rewarded for that path, forsaking profits all the way to IPO and beyond. The Bessemer Cloud Index tracks emerging public cloud companies, and only 11 out of its 75 companies earn a profit today. Before its collapse, the index more than tripled in value from its debut in October 2018 to its peak in November 2021. Since then, it has given up the vast majority of its gains, ultimately performing no better than the S&P 500¹.

Profitability runs counter to conventional Silicon Valley wisdom because it typically sacrifices growth. But at Slab, our product's purpose is to steward our customers' knowledge long-term, so we need to be built for and remain enduring for the long term. In 2022, we achieved a long time goal of profitability, generating net income for the year while increasing our bank balances and doubling our team.

Profitability is an important milestone for Slab to fulfill our product's purpose of stewarding our customers' knowledge long-term.

While prioritizing growth has its merits, reaching profitability early is a path more startups should consider. So little is shared publicly about profitable startups that many founders are not even aware if and how it is an option. We're sharing our lessons here today, so hopefully, you can get here faster and better than we did. While our lessons will apply best to B2B SaaS startups like us, most will apply broadly across markets and businesses.

Building your first pricing model

Half of the profitability equation is revenue, so you'll need a pricing model and the prices themselves for your product. For your first, go for good, not perfect. Survey your competitors' and adjacent products' plans in your space and construct a simplified version². This approach ensures your prospect will be familiar with what is being charged for. For Slab, Confluence is a close competitor and Slack is closely related in the productivity space. Both charge per user per month as the fundamental unit. Slack considers a user uniquely, and Confluence charges less per user depending on the total number of users. Skip out on most complexities like these for now.

For your first pricing plan, go for good, not perfect. Survey your competitors and construct a simplified version.

Our plans now include a premium plan, named "Business" to contrast our standard "Startup" plan. The main functional benefit of Business is integration with Okta. Surprisingly, our very first Business customer never integrated Okta. Neither did our 3rd or 6th. In such confusing early days, we actively tried to talk prospects out of our Business plan if they did not use Okta. As time went on, we learned many customers simply want the best version of Slab, even if they will not immediately make use of functional benefits. Some also worry their boss might want to use a feature, but they bought too low of a tier. Others believe there are implicit benefits, such as stronger weight to their feedback or more flexibility if they need help.

Regardless of the motivation, you should let such prospects self-select into a higher-tier plan by offering one. You do not need functional feature differences; it is enough to offer priority support and/or an SLA as initial benefits. Priority support can be as simple as a rule in your support tool that sorts those tickets first. The SLA could in practice be for everyone but only guaranteed for premium customers. Offering a premium tier also creates a contrasting price anchor, so your standard plan looks comparatively better.

Let your prospects self-select into a higher-tier plan by offering one. It is enough to offer priority support or an SLA as initial benefits.

Now comes the most delicate part: the prices themselves. The true answer is "it depends" but we're here for practical learnings, so a more actionable offering is this: for your first plan, unless a core value of your offering is being cheaper, price the same or ~20% higher than your direct competitors. Then experiment and iterate for the rest of your company's life. People complain far less about price decreases than increases, and an initial 20% difference is palatable to most prospects. Every negotiation will give you signal on how expensive or cheap your prices are, and once you have strong enough confidence and a big enough price gap, you can and should update³.

Cash flow buys time until profitable

It will take time to grow your customer base and revenue — a race against your bank accounts hitting $0. This movement of money is cash flow and your "runway" is cash divided by cash flow. As it becomes less negative, your runway multiplies, until eventually, it gets to zero, and you will have an infinite runway and infinite time to reach profitability — as long as you keep cash flow at least zero! It is easier to achieve cash flow positivity than profitability, so that should be your intermediate goal.

A simple way to increase cash flow is to offer an annual plan with upfront payment in return for a discount (typically two months free). Discounts reduce overall revenue but the cash flow is worth it to extend your runway⁴. As an added benefit, the annual commitment reduces churn. New financial services like Arc and Pipe can also effectively turn monthly subscriptions into annual upfront payments and are worth considering. But they are more expensive than you might think⁵ and you'll miss out on churn reduction benefits.

Offer a discounted annual plan with an upfront payment to increase cash flow while reducing churn.

On the same coin, don't pay vendors upfront for annual plans, despite their savings. As a startup, change is the only constant and you'll want the flexibility to switch vendors as soon as your needs change. But now, your cash flow is another reason to stick with a monthly plan.

Most startups neither get to cash flow positivity nor profitability. David Sacks of Craft Ventures was one of the first to warn of the impending downturn in May 2022, urging portfolio companies to improve key metrics. Having positive cash flow was so exceptional that it was not pushed as a plausible goal for portfolio companies. Achieving even this intermediate goal will be a major milestone for your company!

Hire contractors before employees

Salaries are almost always the biggest cost for a company. Outside core competencies, first hire contractors or small agencies⁶. This allows flexibility in commitment and needs for all parties, but also easier access to specialists and top-tier talent. You will often not be able to afford top talent as full-time employees, nor will you have 40 hours a week of work for them⁷. Contracting solves both problems.

Contracting allows you to work with top talent while being able to afford them.

In many domains, learnings scale more from exposure to different businesses than personalizing for one. For example, you want your immigration lawyer to have obtained visas for many other clients. In contrast, you want your account executive to be exclusively focused on your company and product because personalizing is crucial for closing sales⁸. Slab saved substantially in salaries by hiring contractors or agencies in numerous domains including brand design, illustrations, animations, video production, SEO, SEM, content marketing, accounting, and more. If needs do grow, the contractor to full-time employee path is a well-trodden win-win as you'll know each other far better than from any interview.

Also look for contracting opportunities in areas of high skill or knowledge curves. For example, even with Slab's very capable engineering team, we contracted experts for specific technologies, including Kubernetes, Electron, and dbt, in some cases the core maintainers themselves. We not only got to quickly adopt these technologies but could also be confident they were set up the "right way" according to their best practices.

Hire contractors especially in domains with high skill or knowledge curves, or where learnings scale more from exposure to different businesses and clients.

Hire senior and remote

Slab embraced remote work in our earliest days simply because we wanted to work with the best and did not believe that every talented person lived in my home city of San Francisco. Top talent in tech has never been more dispersed amongst the rest of the United States and the world⁹. Hiring in lower cost-of-living geographies creates a win-win for employers, who can offer more competitive salaries at lower costs, while employees can command greater purchasing power with those salaries. Remote work is too large and nuanced to fully cover, so I'll simply offer that the salary savings alone can be game-changing and should be strongly considered for profit-seeking companies.

Because of management, more people and salaries lead to even more people and salaries. One way to slow this is by hiring senior individual contributors, who can get more done, even relative to their higher salaries. This further saves from operational overhead and complexities inherent to employing more people, including regulatory requirements but also simply the need to get more people on the same page. One caution is some senior people most prefer to influence or mentor junior people, so not having them can create issues. Some of this preference can be directed outwards through blogging or open source but ultimately you want senior individual contributors who mostly want to build, not mostly want to influence.

More people and salaries lead to even more people and salaries due to management. One way to slow this is by hiring senior individual contributors.

Squeeze savings outside salaries

For most vendors, it will not be worth the effort to find savings, but one exception is infrastructure. All major providers currently offer six-figure credits, including Amazon Web Services, Google Cloud Platform, and Microsoft Azure. You will likely not use all these credits, saving time in your early years from optimizing infrastructure efficiency and costs. When you run into scaling issues, you can literally throw (free) money at the problem. These credits are so substantial that at Slab, we deliberately started with our #2 choice cloud provider and switched to our #1 when credits expired. This is not trivial from a technical perspective, but the maturity of Kubernetes makes it easier than ever to double-dip.

All major cloud providers offer over $100k in startup credits, including AWS, GCP, and Azure.

For all others, savings can be worthwhile only if the effort is very low — on the order of minutes of Googling "{vendor} startup program" or examining discount directories. Some example startup programs include Amplitude, Gem, and Segment, offering tens of thousands in savings, but startups are unlikely to utilize their maximum benefits. YCombinator has an exclusive deals list (many are available to alumni) and I'd imagine many other startup accelerators do as well. One widely accessible discount directory is provided by Ramp to any cardholder¹⁰.

Payroll tax in the United States is 7.65%, and all companies pay this through their payroll provider (Gusto, Justworks, etc). But as of 2016, you can get this refunded by filing additional tax paperwork for R&D tax credits. As with regular taxes for your company, you should use an accounting firm to do this. To use realistic round numbers, if you have an early 10-person team costing a total of $1.4m in salaries, you can extend your runway by over $100k per year with these credits. It was a great feeling to open letters from the government and see a check for such large sums.

Stay profitable and control your destiny

Profitability as a goal requires a mindset that is not typical of Silicon Valley startups. Instead of growth at all costs, the growth needs to be much more deliberate and sustainable, typically over a longer period of time. Instead of acquiring 100 customers one month at a loss, you might spend two months acquiring 50 customers a month profitably. Even successful startups typically exit in a 6-9 year horizon. With this slower, deliberate growth, it will take you much more time and require much greater commitment to your company's mission.

With that greater commitment and time horizon comes opportunity and optionality. To quote Jeff Bezos, "If you're willing to invest on a seven-year time horizon, you're now competing against a fraction of [the competition], because very few companies are willing to do that." Most Silicon Valley startups think in 18-month time horizons, the average time between funding rounds. Grow your costs and your team as fast as your revenue growth will allow, and you will remain in control of your and your company's destiny for much longer.

Thanks to Nicolas Dessaigne, Anurag Goel, Ravi Parikh, Julian Shapiro, and Ilya Sukhar for reviewing drafts of this post.

Notes