Amit Ashkenazi is VP Business Strategy at Fiverr, and also formerly a Partner at Viola Growth. This post was written during his tenure at Viola.

As a growth equity and buyout fund that’s focused on high tech companies, naturally we at Viola Growth see many companies enjoying tremendous growth – often ignited by significant investments in Sales & Marketing and R&D – but also accumulating significant losses as a result. This isn’t necessarily a bad thing, unless the premise of the company is built on shaky foundations and poorly thought-out unit economics, a.k.a. “a recipe for disaster”.

We usually support investments that are designed to help companies reach critical mass and become category leaders, but only as long as we can see a clear path to profitability. It doesn’t have to be immediate, but the company’s unit economics must make sense for us to feel confident that it will become profitable once it reaches scale.

Sometimes, it can be hard to understand the unit economics of early stage businesses, especially if they are based on a SaaS (Software as a Service) model. These companies invest in customer acquisition in advance, and expect to make a return on their investment throughout the lifetime of the customers who pay monthly or yearly subscription fees (assuming a relatively low churn rate).

In other industries, such as E-commerce, companies need to make sure that the gross margin on the merchandise sold covers the customer acquisition costs (assuming repeat purchases over the lifetime of the customer).

Recently, I met Sass Darwish, Managing Director at RBC Capital Markets. We lamented over the fact that so many companies these days spend a fortune on increasing their subscribers or user base – and essentially lose it because they don’t have a clear business model. These types of companies just don’t make sense to us.

Sass pitched me a hypothetical website called GoldNet.com – “an amazing idea that could make us filthy rich”. The company’s value proposition is very simple: All you’d need to do as a subscriber is send us $0.99 and in return, we’ll send you $1 back. Sounds great, right? Who wouldn’t want to join?

We would easily ramp up to mouthwatering revenues of $100 million while only losing $1 million dollars. In fact, even if we had to spend additional $5 million on clearing fees and on building the website for our little venture, it would still be a much smaller expense than that of many other tech companies who attempt to reach this level of scale.

So what is the exact business model for GoldNet.com? I don’t have a clue, but hopefully we’d figure out a way to monetize all those eyeballs!

I really love this fable because it does such a great job of describing how some companies subsidize their client base with unit economics that makes no sense, or without a clear path to profitability at all.

Investing millions of dollars (and sometimes much more) just to increase revenues and buy users is a lousy idea when you don’t have a clear plan for generating profit in the long term, because once the money runs out, or investors stop “pumping air” into the company, it will have zero chances of making a profit and returning the invested equity (let alone yielding profit for the investors) – no matter how promising the original premise for the business. Without a well thought-out strategy for ongoing growth and sensible unit economics to go along with it, the most likely outcome would be to sell the business for peanuts or face a Chapter 11.

I’m not implying that companies shouldn’t be aggressive sometimes about boosting growth and eliminating competition, even if it means losing some money in the short term. But it should be done very carefully and with full consideration of the long-term unit economics and path to profitability, otherwise all that ambitious aggression and dreams of “a sea of money” will surely be replaced with red faces and a sea of tears!

My thanks to Sass for inspiring this post.

More posts by Amit Ashkenazi:
From Don Draper to Sheldon Cooper: The Transformation of CMOs
Everything as a Service (EaaS): Why eventually we might not need to “own” anything
Change Agents and how they impact new technologies
Raising money for your startup? Why you need to beware of inflated valuations
Love thy Competitor: Why competition can be a good thing for startups
What your approach to recruiting top talent says about you and your company (and why it really matters)
Seeking a strategic investor for your company? Here’s what you need to know

More posts on Unit Economics:
Why Unit Economics should be a priority for B2C startup marketers (and why it REALLY matters to VCs)