Why Unprofitable Companies Are Winning in 2020

the bottom line the most important part of any functioning business profit after costs expenses and taxes the money that the founders and investors and company get to put back into their pockets for the risk and effort they put into a business sounds like business 101 right and it kind of is a business that doesn't turn a profit is like a freezer that doesn't make ice it's more or less pointless and sure there are things like non-profit charity organizations out there but most businesses exist to make money so why is it that some of the biggest companies in the world are not turning profits why is it that they don't even plan to the rise of so-called zombie companies or companies that have not and have never run at a profit are raising more and more eyebrows in the investing world these businesses are getting too big to ignore and by some estimates over 10 percent of the s p 500 an index of the largest companies in america is now made up of these companies that don't serve the one central goal of being in business what's more is that this issue is not just endemic to a particular industry dozens of major companies and countless smaller businesses in every sector of the economy from energy retail medical telecommunications and of course technology are in this profitless boat together so what is going on here why would anybody invest in a business that is unprofitable what impacts does this apparent misallocation of resources have on the economy and finally will the economic fallout of 2020 show these businesses up for what they really are this episode of economics explained was made possible by our fans on patreon if you would like to gain early access to these videos before they're uploaded to youtube as well as participate in exclusive q a sessions which are now held every saturday at 9 30 eastern standard time please consider supporting our channel at patreon.com economics explained now before we start ripping into these companies as blatant rip-offs it's first important to give credit where credit is due so why are these businesses looking to speculators like a solid investment almost every business in the world starts out as an unprofitable endeavor everything from a corner store to microsoft had to operate for a period of time where they were developing a product building out infrastructure and growing a customer base this is to be expected as part of a regular business life cycle but the big distinction is that most businesses will desperately try to get to a point where they break even breaking even simply means that the business is self-sufficient and can cover all of the costs of its own expenses and make exactly zero dollars in profit or loss for people starting their own businesses this is a really important milestone because it represents a point where the new company owner does not need to contribute their own money to keep the lights on after the break-even point their next step is of course turning a profit by continuing to grow revenue and minimize expenses and for most businesses out there that do get to this point that's where they live happily ever after but of course some businesses want to continuously grow because their model suits a scale slightly more grandiose than a corner store or a cafe to do this these types of businesses will need to attract investors that extend beyond themselves plus maybe their friends and family that's because unless these hypothetical founders are extremely wealthy already they will need to access large pools of cash to develop the infrastructure for yet another new uber rival or oil fracking operation these funding rounds as they're called are normally taken out periodically when one of two things happen either the business grows and achieves a new goal like let's say taking 50 of market share in a new city or the business runs out of cash from the last investment round now investors are much more likely to invest into a business that has hit a growth goal rather than to invest into a company that is running low on cash so these companies develop a growth at all-cost mindset now all of this is still actually fine some businesses naturally take longer to turn a profit than others and they need cash to keep the lights on in the meantime medical research firms for example can take years to develop a new medicine and get it through fda approval once they do they can be in for the mother of all paydays nobody has any major issue with these types of businesses because they have a plan for profitability sure the drug might not be made or it may not get approved but that is just the equity risk of investing what does concern people is companies that have no plan for profitability famous examples like uber and wework are not waiting on the roll out of some revolutionary new product and they have all of the market share they could possibly ask for so what gives how is anybody supposed to make money off this well this is uber co-founder garrett camp's house which was reportedly purchased for 72.5 million dollars so obviously someone is making money here this is because different rounds of funding tend to attract different types of investors let's say two engineering friends develop a new system for extracting oil more efficiently the first pot of cash a company has to get started with normally comes from these founders they will use this money to develop a business plan a name for the company some fundamental technology demonstrations and perhaps most importantly a campaign to attract further investment after this comes the angel investor these are investors that are normally ex-entrepreneurs themselves that will seek out good ideas that need an infusion of cash this money will be given for a portion of ownership in the company by selling shares to that angel investor this cash can then be utilized to do the same thing on a larger scale maybe now an actual product is rolled out and some oil is dug on a test site this market test is very unlikely to make that much money but it will show slightly more conservative investors that hey this technology actually works which is where the big guns will come out at this point the founders can look to raise capital for the next round of funding with other companies in the industry and most importantly venture capital firms which are basically big investment vehicles for rich people now what normally happens at this point and for the first time ever the founders will get sat down in an office and be given a choice they can now sell some of their own equity in the company and that cash will not go towards business operations but will instead go into their own personal bank accounts normally this is actually encouraged for two reasons one it allows these firms to buy into this company without diluting the ownership as much and two it's kind of important for the founders of now potentially billion dollar companies to look successful more investors will need to be attracted in the future and if the founders are still living at home with their parents it doesn't send a great sign for the less sophisticated public now this company may repeat this whole process many many times over with part b c d e f funding rounds and while doing so that angel investor will probably cash out their shares as well this is money that they can use for the next company all over again eventually though these rounds are all shooting for the holy grail of business funding an initial public offering where the business will be listed on a public stock exchange and regular mere mortal investors will have a chance to invest their money into the company historically companies have been profitable when they are listed to the public in 2019 though only one quarter of american ipos were for companies that had ever turned a profit nonetheless ipos of non-profitable companies have been more palatable to regular investors because they have seen the monumental success of companies like amazon which famously did not turn a profit until late last decade outside of being more palatable they are also more essential public offerings are where these venture capital firms will cash out their shares take their profits and get ready to do the whole thing all over again with a new company but hold up investors getting rich by attracting more investors who only make money by attracting more investors you might be thinking hang on isn't this a ponzi scheme and you know what it really does blur the line technically the funds given to these businesses are being used to develop and grow the operations rather than exclusively pay out old investors but for many companies it is starting to look sketchier and sketchier nicola has famously been in the spotlight recently for attracting huge amounts of investment money through multiple rounds of funding and then a backdoor style ipo using a spack we will do a video on specs separately but for now just know they are a bit wild in their own right but despite all of this money being thrown at the business it has been revealed that they didn't even have a working prototype of an electric truck which was their core product and instead they just rolled an empty model down a hill to fool the general public and potential investors alike into thinking they had a working prototype what's more is that it has been reported that the founder of this company trevor milton has had a long history of starting unprofitable businesses with no underlying value selling it off to investors before moonwalking away with millions of dollars for having actually made nothing now in fairness this might very well be one bad egg amongst a bunch but the reality still stands that businesses should turn a profit the central function of the free market and capitalism is that it can deliver goods and services to the economy according to what is demanded at an equitable price these zombie companies may very well be skewing the system and producing an economy of misallocated resources uber rides are a cheap and reliable alternative to taxis but would you take an uber if they were 50 more expensive than they are now for some of you out on the town on a friday night the answer would most likely still be a resounding yes but a good portion of uber's customers would likely revert back to regular taxis or use any one of the myriad of up and coming competitors the reason that this is important is that the operating expenses and all of the overheads of an uber ride are not paid for by that uber ride what this means is that indirectly investors are paying up to 30 percent of your uber fare for you a product that is only used because it is heavily compensated probably shouldn't exist in a regular functioning market now regular channel viewers will know what happens when external forces try to artificially push prices down in an otherwise competitive market you get a dead weight loss i won't go over the exact economic process behind that again but if you are interested go and watch our video on black market economics to learn about how a dead weight loss comes to be but for now just know that it is bad it represents a burden on society almost as a punishment for trying to mess with the efficient market fortunately for now at least that burden is being exclusively beared by the investors but that doesn't mean that it isn't impacting everybody indirectly these investments could go towards genuine businesses with good products that people would be happy to pay a fair market rate for that covers the actual cost of producing that good or service channeling billions of dollars towards pointless endeavors denies these businesses the potential to go to market and make this happen so the question still stands why wouldn't investors just go for this kind of option instead well the unfortunate reality is that growth-based businesses are a more stable form of madness if delta airlines loses two billion dollars in a year it makes headlines as a corporate emergency if we work loses two billion dollars a year it's considered the cost of doing business economic downturns like the dumpster fire that is 2020 are often seen as economists as a necessary evil to weed out companies with poor fundamentals and leave a leaner more efficient private sector behind but in many ways profitless companies are actually more resilient to these shocks for starters their shareholders don't get as antsy about a quarterly loss because that's just an expectation but what's more is that these kinds of companies can actually have their game plan accelerated by a crisis so long as funding is still plentiful these businesses don't have the same risk of going under and in the age of the money printer going brewer it almost certainly is plentiful what's more is that the goal for a lot of these businesses is to take market share if they are competing against other companies that rely on good old-fashioned profits they are going to be able to beat out this competition during a period of reduced consumer spending even beyond this a slump in prices of things like commercial real estate is a great opportunity for these cash rich companies to buy up some locations as a base of operations for world domination into the future amazon has famously been buying up abandoned retail parks to use as distribution centers with the spike in business bankruptcies these opportunities are going to become more plentiful and a lot cheaper all of this means that the stock market rally that we have seen since may of 2020 has been primarily fueled by big tech companies and or businesses that don't know what profit is the idea of investing in something that doesn't make money seems like a foolish endeavor nonetheless it's a reality that we're gonna have to contend with because it's here and it has become hugely influential in our financial markets what does a world look like where these businesses become the norm well hopefully they will all eventually get to a point where they become profitable and pay lots of dividends to their longtime investors who bravely battled through the naysayers there are a lot of companies with genuine promise but with anything short of a crystal ball it's difficult to see this all having a happy ending hi guys i hope you enjoyed the latest video if you did please consider liking and subscribing this video is made possible by our patrons over on patreon so if you enjoy this video please consider supporting the channel like these awesome people did thanks guys bye

Channel: Economics Explained

Views: 649,038

Rating: 4.9262829 out of 5

Keywords: how do companies operate without profits, unprofitable companies, how do unprofitable companies survive, why unprofitable companies are winning, modern ponzi schemes, modern ponzi schemes economics explained, ponzi schemes explained, unprofitable companies explained, how unprofitable companies survive, the economics of unprofitable companies, investing in unprofitable companies, how unprofitable companies raise more money, economics, explained, economics explained

Id: N3LumSN26Ew

Length: 15min 5sec (905 seconds)

Published: Sun Oct 11 2020

Reddit Comments

[u/Jaxgamer85]

American politicians pick winners and loosers, instead of the market.

[u/TrashcanMan4512]

Winning since dot com.

It never actually crashed per-se it just took a little dump in its pants and then started dancing around the room again spraying poop out its pants leg...

[u/pintord]

This guy as a lot of interesting videos. I almost understand something. Many years ago there was a pyramid scheme going around the campus I was studying at it was stupid and a friend warned me about and I never got in despite some pressure from other "Friends". Trying to grow your business by getting more and more people to invest in it really sounds like a pyramid. Anyway, a few more months of bad news should filter these looser companies out. I continue to hold onto my Gold.