Following a years-long venture capital (VC) bull market that saw FinTech startups raise billions of dollars in funding, the challenging macroeconomic market has led to a sharpened focus on belt-tightening, with firms now under mounting pressure from investors to have a clearer path to profitability.
But how long will it take to achieve that holy grail of profitable growth? What factors come into play? And what should founders keep in mind as they undertake that journey? These are some of the questions that Mark Fiorentino, partner at VC firm Index Ventures, attempted to answer in an interview with PYMNTS’ Karen Webster.
According to Fiorentino, the path to profitability requires a multilayered approach, the first of which involves “tangible bottoms-up unit economics exercises” to understand the underlying fundamentals that drive not only a firm’s gross margin, but more importantly, its operating margin.
It’s determining “the cost of keeping the lights on” without factoring in any innovation, expansion or go-to-market efforts. It’s a basic skill that was put on the back burner at the height of the VC bull market but needs to be reprioritized again, he said.
Understanding the company’s go-to-market unit economics is the next crucial step to help startups gain valuable insights into the effectiveness of their sales engine and make informed decisions about their growth strategies.
As Fiorentino noted, it’s determining how much a dollar of sales, or a dollar of marketing, generates in incremental revenue and “understanding that to an almost formulaic basis is more important than ever.”
At the third and final level, he said startups need to evaluate additional product, research and development (R&D) or expansion plans through “a net present value lens” to ensure that investments align with long-term profitability goals.
“Essentially, you should have [an idea] of what the actual yield of this CapEx is,” he said.
He acknowledged that the path to profitability is not always a straightforward one and sometimes entrepreneurs may need to consider seeking additional capital or merging with another business if the company’s burn rate is too high.
In those instances, the onus is on investors to initiate conversations with founders, no matter how uncomfortable they are, to re-strategize and reset the business strategy to boost growth.
“It’s helping them see and understand the lens to why it might hurt or not feel good to have this conversation short term, but still be the best for them from an ROI standpoint in the medium to long term,” he explained.
Asked about lessons he learned from the FinTech space that he is now applying as a VC investor, Fiorentino, whose professional experience includes a four-year stint at Stripe, said it boils down to building expertise in a few key areas of the business and not having a finger in too many pies.
“A big learning for me is that if you spread yourself too thin, you might do everything at 60% versus [focusing on] the two or three ancillary core products that you can do at 100% and do well,” he said.
Moving forward, Fiorentino said one area that holds great promise is the B2B sector, which he described as “an archaic but massive industry with a lot of payments volume flowing through it.” He singled out the billion-dollar freight supply chain logistics space in particular as an example of a vertical with huge potential but in need of innovation.
On the flip side, he said that as much as opportunities abound in the FinTech space today, investors need to approach some business models, such as those in the lending space, with utmost caution.
For these balance sheet-heavy business models, he emphasized the need for founders to have differentiated data workflow attached to the lending portion of the business rather than have lending be the core value proposition to survive in the competitive market.
Finally, he said there are still a lot of “solid business models” in existence despite the VC funding crash and advised founders to have a core business model that they understand well from a unit economic standpoint.
“From there, you’re allowed to spend as much money as you want,” he said. “You just have to make sure you’re spending in the right places. But if the core doesn’t work, then it’s like running a car on a bicycle engine. It just won’t make sense.”