The Peril of Prioritising Start-Up Expansion over Positive Cash Flow

Show me the money!" screamed the character played by Cuba Gooding Jr in the Hollywood hit movie Jerry McGuire. He may as well have been saying this to start-ups. It encapsulates a fundamental principle in the valuation of businesses: the importance of positive cash flow.

- Bhagwan Chowdhry 

Bhagwan Chowdhry 

The author is professor of finance at the Indian School of Business and faculty director, l-Venture @ ISB

Start-ups venture into the unknown. They often start with losses. But they need a vision. They must see a future with positive cash flow. This vision is vital.

Many start-ups chase growth. They want market share. They offer discounts. They aim for more users. But these can be traps. The dot-com bubble of the late 1990s is a lesson. Big valuations collapsed. Why? There was no positive cash flow, not in the beginning, not even in the distant future.

The success stories of giants like Amazon, which operated with negative cash flows for over a decade, are often cited to justify prolonged negative cash flows in start-ups. However, it is essential to recognise that Amazon is an outlier. The median start-up does not have the same trajectory or potential as Amazon. For every Amazon, there are countless start-ups that failed because they could not generate positive cash flow in time.

Indian start-ups provide a rich tapestry of examples in this context. Companies like Ola and Flipkart, in their early days, burned significant cash to acquire customers, often offering deep discounts. While this strategy helped them gain market share, it also raised questions about sustainability. On the other hand, start-ups like Zoho and Freshworks adopted a more measured approach, focusing on building robust products and ensuring positive unit economics before aggressive expansion.