David Weisburd here.

Startups come in all shapes and sizes. There are software startups and there are hardware startups. There are startups that are mobile-only (Uber, Lyft) and there are startups that have no mobile experiences at all.

Regardless of the shape, size, or stage of a startup, there is one thing that all billion-dollar startups have in common: positive unit economics.

Before we go into what positive unit economics actually means, let me share a business idea that is almost guaranteed to result in a billion-dollar revenue company.

In fact, this method is so failproof that it is sure to work 100% of the time.

What is this business?

Let’s call our startup Cashly. Cashly is in the business of selling money.

Cashly’s business model is trading consumers’ quarters for Cashly’s dollar bills. The way it works is that a customer comes in with a handful of quarters, and Cashly provides a dollar in exchange for every quarter.

If done correctly, Cashly is likely to be the fastest growing company of all time. After initially focusing on consumer demand, Cashly will be able to tap into the hedge fund market, and will quickly start booking hundreds of millions of dollars in revenue on a daily basis!

There’s just one problem. For every dollar that Cashly sells, the company loses 75 cents ($0.25 – $1.00 = -$0.75).

That means the company has negative unit economics… otherwise known as not having a fundamental business.

While this is an extreme example, the startup graveyard is filled with hundreds of venture capital-backed startups that have never achieved positive unit economics.

Which brings us to the question: How can a business with negative unit economics raise hundreds of millions of dollars?

Many people outside of the venture capital world love to lampoon VC’s as foolish and overconfident backers of businesses that have no fundamental business behind them. This is an inaccurate characterization.

For one, venture capitalists are no fools. 40% of venture capitalists attended Harvard or Stanford, the two most selective schools in the world, and typically were in the top 10% of their class.

Secondly, the biggest metric that outside investors get wrong is the difference between a company being profitable and having positive unit economics.

While venture capitalists oftentimes back startups that have negative profits, they rarely back companies that have negative unit economics unless the company is very compelling and there is a plan to achieve positive unit economics down the line.

These plans don’t always pan out, but when they do, they can have amazing effects.

In fact, some of the largest companies in the world, including Facebook and Google, started out with negative unit economics, but built a product so valuable that they now make billions of dollars a year in EBITDA.

What’s the difference between positive unit economics and positive EBITDA?

While most successful startups have positive unit economics, many do not have a positive EBITDA. That’s because EBITDA doesn’t only take into account the profit made on every individual product or service, but also includes all the management and operational expenses that come along with servicing the business.

For example, Uber may make a 25% profit margin on every ride – in other words, positive unit economics. But if you zoom out, that same company may spend billions of dollars acquiring drivers and customers in a grand plan to gain market share over their competition… resulting in a negative EBITDA.

Before you invest into any business, make sure you ask yourself:

What are the business’ unit economics?
How does the business make money?

Outside of very extreme cases (like Facebook and Google), there are only two legitimate answers to this question:

1) Our business makes money via buying the product/service for $X and then selling it for more, which leaves us with corresponding amount of profit per unit sold.

2) Our business currently loses a certain amount per order by buying the product/service for $X and selling it at a loss, but we expect our margins to increase due to [a very good reason that makes the business much more profitable as it grows].

At its very basic level, business models should be simple. If a founder can’t answer your questions about the path to profitability directly, it is a hard pass. Business, unlike hard science, is relatively simple, and nothing is more fundamentally important than how a business makes money.

With that in mind, the best advice I can give you is to always ask the hard questions. If you’re hearing a pitch from a startup that hasn’t turned a profit yet, find out why – and always find out how they plan to do so in the future.

Trying to poke holes in the pitches you hear doesn’t make you the bad guy. It means you’re doing your job, and the best entrepreneurs know to expect just that from the smartest investors.

I’ll be back soon with more advice – plus a new opportunity you won’t want to miss.

Very best,

David Weisburd