Not All Growth is Created Equal

As a startup your task is to build a company that will be worth billions in a decade, not one that is worth millions today. It’s too easy to mistake rapid early growth for long-term, defensible value in startup land.

Take Tome, an AI-powered Powerpoint competitor. In a 2023 press release they bragged that they were the “fastest productivity tool ever to reach one million users.” On the back of that growth, they raised $43 million and received mountains of press and investor interest. The only issue? That product no longer exists. The churn was high. The monetization was low. The company, after raising $81 million dollars in total, has completely pivoted into being an “AI assistant for sales.” I do not bring up this story to shame anyone at Tome. I hope their pivot is successful, the new product meaningfully delights customers, and everyone involved gets stupid rich.

But, I do think this story is symbolic of a deeper illness in Silicon Valley. There is a sickness, a striving, that pollutes the purity of what building a business should be. Because growth attracts headlines and seduces investors, companies over-optimize on growth metrics in their early years. In the end, it ruins them.

Another symptom of the sickness: Most startups I meet with will tell me their “ARR” and brag about how their “ARR” is top decile. Historically, ARR meant annual recurring revenue. It should be used to describe year-long contracts that the startup has signed with customers. Instead, startups will do “annualized recurring revenue” and use it to describe monthly contracts multiplied by 12. They will not account for churn. They will not mention that many of these contracts are free trials that will not convert. They are so desperate for quick growth that they will be mildly intellectually dishonest. It is yassified growth. Unremarkable underneath, but through technical manipulation, looks good for a quick snapshot.

Today, I want to describe the three factors of quality growth and what that can look like. I’ve taken my title from “All Revenue is Not Created Equal,” an all-timer of a blog post Bill Gurley published in 2011. In it he goes over the reasons that startups are valued on the basis of revenue multiples, and why some companies have higher multiples than others. He identifies various dimensions of quality that make some types of revenue more valuable than others. I’d like to perform the same exercise, but looking at the factors driving growth.

Here’s why not all growth is created equal.

Manifestations of growth

So, the obvious: Fast growth is great. As an investor, if I see that a company is growing quickly, I may not know why, but I’ll know that there is something happening that is worth investigating. This is despite “fast growth” being an unbelievably sloppy term. Is it growing quickly because the company is spending too much money on acquisition? Or is it because of differentiation in product?

Which is to say that fast growth is somewhat overrated as a concept. What matters is the quality of that growth. Quality can be ascertained by three types of analysis. I’ve ranked these from most legible to least:

1. The numbers: If you struggled to date in high school, this category is for you. Many dimensions of growth can be analyzed numerically. Want to know whether the growth is profitable in the long-run? Try the LTV/CAC ratio. Want to know whether the customers you acquire spend more over time, increasing growth? Try net dollar retention. Payback periods, channel pass through rates, on and on and on. There are a million of these things, all of them provide signals about the quality of growth, and none are all that hard. Anyone can do them! Every growth equity firm has a bunch of dudes in their mid-20s, wearing Lululemon ABC pants and hopped up on Zyns, running Excel spreadsheets calculating growth ratios. The skill isn’t in doing the calculations. It's in knowing which ratios matter for which business models. If you are doing enterprise SaaS, I care a lot about net dollar retention. In mobile gaming, I care about payback periods. The reason this is all mildly uninteresting is that there is no secret math. Numbers are numbers.

2. The strategic framework: Does the manner by which you acquire customers increase the power of your firm? Does the type of customer and the way they use your product increase your power? By power, I mean in the sense of Hamilton Helmer, “the set of conditions for consistent differential returns.” I’ve met too many founders who have rapid growth in the beginning, but because of the diversity of their customer set, end up worse off in the long run. Sure they may have a few million in revenue, but their company isn’t advantaged. Depending on what school of thought you ascribe to, the strategic value of growth can be run through frameworks like Disruptive Innovation, Blue Ocean, 7 Power, or Porter’s Five Forces. Each of these are useful! But as I’ve argued before:
   
   “To truly understand business strategy, you have to accept that it is, by nature, bullshit. Of course, the practice of guiding a business, making choices with trade-offs, and responding to unexpected crises is real. But the academic study of business strategy is something closer to divination…So, why are they bullshit? Simple. The value of a forecasting method is in its ability to be right, not sound right. Despite decades of study and the relentless efforts of the good people over at the Harvard Business School, we have yet to discover any strategy that is universally predictive.”

The same holds true for growth. Any strategic framework that helps you understand power isn’t universally predictive. It just gives you a framework by which to evaluate.

You’ll note that both numbers and strategy overlap. You may feel that this is a weakness to my argument’s structure, but consider instead that this overlap is a weakness of the field. Both numbers and strategy are highly legible, measurable concepts that are well known to most practitioners. Importantly, they are able to be done with relatively little investigative work. For the numbers, investors will sometimes ask for access to Stripe accounts and run the calculations themselves versus trusting a startup’s accounting team. The strategy frameworks that are most useful are also the most well-known.

One consistent theme for The Leverage is that qualitative evaluation is underrated. Businesses are complex organisms with thousands of variables determining their success, and any approach wholly reliant on metrics is too reductive. It’s why I write so frequently on taste, stories, and strategies. The fuzzier the concept is, the more challenging it is to evaluate the future, the more alpha is available. If you can figure out a business with a calculator, so can anyone else.

The first two aspects of quality I’ve discussed are fairly obvious. The third category is what I call investigative growth. These are aspects of growth that can only be determined by serious leg-work—talking to customers, deeply understanding their psychology and tech stack, and then making sure that each additional dollar of revenue is solving problems for customers in a meaningful way. Here are three types of investigation that I think are the most valuable (and most challenging to do).