A good article, but the thing I liked most about it was following the link to discover Dave Kellogg's superb blog post, Why Palantir Makes My Head Hurt:
which, among many other points written up in an entertaining manner, gives the better summary of how investors look at the difference between service and product companies:
>That last point [about whether Panatir sends in consultants or research engineers to its clients operations] is important. Why?
> - If field technical staff are engineers, then the associated revenue is presumably license fees and the cost is R&D.
> - If field technical staff are consultants, then the associated revenue is services and the cost is COGS.
>Why does this matter? Because most software company boards and investors see the world in a pretty black-and-white way:
> - License revenue is good. Services revenue is bad. (Largely because gross margins run 98% on the former and 20-30% on the latter).
> - R&D expense is investment and ergo good. Cost of goods sold is bad.
>Almost all Silicon Valley boards will want an emerging enterprise software company to run with a consulting business that’s no more than about 20% of total sales. In practice this means a company can have at most about 1.5 consultants (pre- and post-sales) per salesperson. Any work that can’t be done either as R&D investment or by that small consulting team needs to get handed off to partners.
So, do you want high growth or do you want to help your clients? The two do not always go together quite as well as you might have hoped. To rephrase the point in Dan Shapiro's terms, many of the most worthwhile businesses out there have reasonable, not outrageous margins.
Lifestyle businesses are not to be sneered at. Small, cash-flow businesses that can be run at any hour of the day give you freedom. I am currently living in South Africa for 4 months just kiting and coding. Next stop Norway and then San Francisco. I work 3-12 hours a day depending on wind, friends and plans. Tim Ferriss's 4-hour work week is very possible and, as I have discovered, very enjoyable. I know that I want to build a meaningful company when I have found a concept that I can happily commit a decade of my life to. I can say that about my kiting but not about any business idea I have found so far.
There are actually quite a few of us here (surfing in nicaragua myself at the moment.) every month or so another article will come through with somebody you've never heard from before summing up a year's worth of traveling and building a business from the road.
Seems it will only get more popular over time, since every one of those articles has at least one comment along the lines of "ok, screw it, you've convinced me. I just booked my flight!"
Yeh it is definitely a growing trend. I am not interested in going off the grid for a year. I love being online all the time. Love it. I just want to kite and code. I have decided to write more about a few things here:
He said that investors pressure you to run at a loss so they can plow more money in and grab more equity. Sounds like a bit of a conspiracy theory, but I'm currently running my angel-backed company at break-even, approximately 30% monthly growth, and investor is pressuring me to run at a 100% loss.
Are there any more experienced guys out there who can say for sure whether investors try and screw you out of equity by pressuring you to run at a loss?
Do you have cash in the bank? Are you running neck and neck with competitors? Are you leaving growth on the table? Could you survive 100% loss for a few months?
When you take outside money, there is an implicit commitment to growth and risk. If you're playing it safe and your competitors are outpacing you, it's fair for you investor to push. But at 30% growth MONTHLY (which is insanely good), you can probably comfortably push back. But if there are obvious investments that could accelerate growth, you should consider making them at the expense of month to month profit (if you have the cash to do it). If you don't have the cash, you should consider raising money (at good terms) so that you have the ability to make this choice.
That doesn't sound like a conspiracy theory. What is with the desire to paint everything in the ridiculous. It sounds like a good way to make more money, though risky.
Do all investors behave like this or is it just more common in SV VCs?
No wonder we have such a boom and bust economy if this is the general practice.
What is wrong with simply investing a reasonable sum to help a business with a high probability of success getting off the ground and then make a good reliable long term return?
VC money is for the high-risk. A lot of their punts fail (companies die), so you need to make enough money off the ones that succeed that you cover all your losses and still make a great pile of money on top for future investments and profits.
The only way to make that stash of cash off the winners is to exit for high returns, and in the case of backing a winner to increase the stake over time so that your high returns are multiplied by the stake size.
This shouldn't be news to anyone. Did you think VCs were your friends?
I understand that point , but surely if there is a lower risk then you can afford to not get a higher pay off.
I mean surely there's a case for investing in say a consultancy business and rather than worrying about a high ROI in 3 years simply take a small % per year throughout the life of that company?
Either that or consultancy businesses in general have a crappy risk/reward ratio in which case I am surprised they are so popular.
VCs would happily invest in low risk, high-return investments -- that is in fact what they are looking for.
But wherever there is truly low risk, multiple funding sources will compete, and returns will be driven lower. Companies that fit the profile you describe will generally use debt financing, which is not available to venture startups.
Quite an irony,
I have met many entrepreneurs who start off to be their own boss & within few months they start running around to get their new boss (read VC)
Nicely captured Dan, liked statement "You will have a new boss"
This is certainly an inspiring article. I've seen both bootstrapped companies grow and VC companies grow and for a personal experience I would say bootstrapping and doing it right from the ground up feels like the best way. I've also seen how stressful it can be on people if you have a VC invested who is demanding more revenue, more sales and better margins.
If your business can generate cash and support itself there needs to be no reason for a large VC cheque that will add extra costs and stress to your business. Just as the article talks about a Taxi business getting VC, there are a number of small web startups that will just never return the capital quick enough to keep their head above water.
I've also seen investors with personal interests place roadblocks as they want you to use a particular platform, their services or a related company they own for your outsourcing. While this can work very well it often seems to work the opposite and slowly bleed the business to death as the investors draw out capital.
Many businesses don't operate on double digit growth figures and I don't believe it's sustainable in most cases to expect all businesses to grow like Twitter or Facebook.
http://kellblog.com/2011/06/27/why-palantir-makes-my-head-hu...
which, among many other points written up in an entertaining manner, gives the better summary of how investors look at the difference between service and product companies:
>That last point [about whether Panatir sends in consultants or research engineers to its clients operations] is important. Why?
> - If field technical staff are engineers, then the associated revenue is presumably license fees and the cost is R&D.
> - If field technical staff are consultants, then the associated revenue is services and the cost is COGS.
>Why does this matter? Because most software company boards and investors see the world in a pretty black-and-white way:
> - License revenue is good. Services revenue is bad. (Largely because gross margins run 98% on the former and 20-30% on the latter).
> - R&D expense is investment and ergo good. Cost of goods sold is bad.
>Almost all Silicon Valley boards will want an emerging enterprise software company to run with a consulting business that’s no more than about 20% of total sales. In practice this means a company can have at most about 1.5 consultants (pre- and post-sales) per salesperson. Any work that can’t be done either as R&D investment or by that small consulting team needs to get handed off to partners.
So, do you want high growth or do you want to help your clients? The two do not always go together quite as well as you might have hoped. To rephrase the point in Dan Shapiro's terms, many of the most worthwhile businesses out there have reasonable, not outrageous margins.