Why Services Businesses Can't Raise Venture Capital: Implications for Technology Startups and Strategies for Success
Table of Contents
Introduction
Understanding the Unique Challenges of Service Businesses in the Venture Capital Arena
Solution 1: Steering Clear of Services Jargon in Pitch Decks
Solution 2: Simplifying Onboarding and Shifting Responsibilities
Solution 3: Cultivating an Ecosystem of Implementation Partners
Solution 4: Pivoting from Services to Productization
AngelList Case Study: Pivoting towards Automation and Scalability
Conclusion: Leveraging Services for Growth and Capital Opportunities
Introduction
In the cutthroat world of startups, service-based businesses often hit a roadblock when hunting for venture capital. Some even consider it impossible to attract venture capital as a services business. This issue actually poses a hidden trap for many tech startups. It's not uncommon for these companies to unknowingly portray themselves as service-oriented, a move that can jeopardize their fundraising efforts. In this article, we'll uncover why this happens, explore strategies to avoid this pitfall, and delve into the transformative journey of AngelList - a company that effectively navigated this challenge.
Understanding the Unique Challenges of Service Businesses in the Venture Capital Arena
Service businesses span various industries, including professional services like IT, healthcare, hospitality, and many others. They're all about providing specialized knowledge, crafting personal customer experiences, and hands-on service delivery. These traits make them great at breaking into new markets and understanding customer needs.
But there's a snag when it comes to attracting venture capital. The reason? It's all about scalability.
Venture capitalists look for startups with potential for rapid, explosive growth. They're interested in businesses that can skyrocket from a few customers to millions in a short time. Unfortunately, this is where service businesses often hit a wall. It takes time to hire and train new staff, expand into fresh markets, and handle a surge in customer demand. These steps don't exactly match the quick pace venture capitalists are after.
Take my business, Zendog Labs, for example. In its current state, it simply wouldn't qualify for venture capital funding. But that's not necessarily a bad thing. We're still able to generate income thanks to our loyal customers and the straightforward process of monetizing services.
In a similar vein, hardware startups also find it hard to secure venture capital, but for slightly different reasons. Hardware products can be difficult to scale due to manufacturing, shipping, and storage costs, which chip away at profit margins and introduce supply chain constraints. The cost for each additional unit keeps rising, unlike in software where adding another user doesn't significantly increase costs.
Solution 1: Steering Clear of Services Jargon in Pitch Decks
Interestingly, many technology startups, particularly B2B SaaS companies that cater to high-ticket clients (for instance, enterprise SaaS startups), unintentionally weave services terminology into their pitch decks. Speaking from experience, having scrutinized hundreds of pitch decks as a venture capitalist and fundraising advisor, I've seen this happen time and time again. Whether it's offering services to understand their market better, attracting early customers, or delivering extensive training and implementation services along with their main tech offerings, such wording can doom their fundraising aspirations. Venture capital investors primarily seek scalable products, and any hint of dependency on services can deter their interest.
Take enterprise SaaS companies as an example. They often find themselves offering consulting, change management, and digital transformation services to land deals with larger enterprises. While these services are key for product adoption and successful implementation, startups should frame them as part of an onboarding process in their fundraising pitch decks, rather than explicitly labeling them as services. By emphasizing efficiency and downplaying the need for extensive customization, startups can mitigate concerns regarding scalability.
However, the challenge doesn't stop with obvious missteps like offering extensive services. Subtle errors can also be problematic, such as company names, slogans, or even product names suggesting a service-oriented business model. For instance, if events form a significant part of your product strategy, you risk being classified as a service business. Events cannot scale in the same way as a product business, and this could inadvertently signal to investors that your startup relies partly on services.
Solution 2: Simplifying Onboarding and Shifting Responsibilities
Once you've made sure your fundraising materials, whether it's your pitch deck, website, or LinkedIn, don't hint at your tech company being a service provider, it's time to put that distinction into practice. This means streamlining your onboarding processes without risking user experience or escalating customer churn.
Craft an onboarding process that effectively encourages user adoption and reduces the need for extensive customizations. This way, you can highlight these as valuable features to customers, rather than as gaps in your product platform. For enterprise SaaS startups, striking the right balance between customer support and maintaining potential for rapid scaling is crucial.
You might want to encourage customers to independently seek training and other resources. However, keep in mind that while this approach could free up some of your resources, it might also affect your ability to close deals.
Solution 3: Cultivating an Ecosystem of Implementation Partners
An even more effective solution involves building an ecosystem of implementation partners. These partners undertake the consulting work necessary for clients to fully utilize your product and remain long-term customers.
A notable example of this strategy is HubSpot. HubSpot's platform has a fairly steep learning curve initially, which is why they've developed a network of implementation partners. These partners assist clients in using the platform effectively for sales, marketing, and customer success. This partnership model is beneficial for all involved - implementation partners can run highly profitable businesses, while HubSpot gains and retains clients through its partner ecosystem.
Solution 4: Pivoting from Services to Productization
Assuming you're a full-fledged service business aiming to secure venture capital, shifting from a service-based model to productization becomes an essential strategy. This transition allows you to utilize the cash flow from the service component of your business to invest in developing technology products that hold potential for scalability and exponential growth.
Starting as a service business offers several advantages, even if your end-goal is to morph into a technology company. It provides a deeper understanding of your customers' needs and priorities, builds relationships, and even opens doors to potential co-development opportunities.
In this transition, however, you'll likely want to establish a separate legal entity dedicated to the product-focused side of the business. This strategic move gives the impression that your business is new, suggesting rapid product development and commercialization - factors that investors value highly. Moreover, this step isn't necessarily costly; you can incorporate in Delaware for under $1,000 in most instances.
AngelList Case Study: Pivoting towards Automation and Scalability
AngelList offers an insightful case study that highlights the journey of a service-oriented business evolving towards scalability and venture capital success.
Originally launched in 2010 as a platform to simplify the connection between startups and potential angel investors, AngelList began as a tech-centric platform. It's core function was as a matchmaker, democratizing the investment process for startups, especially those outside the established tech hubs.
Over the years, AngelList adapted and expanded its offerings, embodying the essence of startup evolution. In 2012, they introduced AngelList Jobs, a platform enabling startups to post job listings and job seekers to discover roles in up-and-coming companies.
In a significant pivot, AngelList launched Syndicates in 2013. This feature marked AngelList's venture into the realm of fund management, a domain typically associated with service-heavy, non-scalable operations. Syndicates allowed investors to pool resources, with a lead investor guiding the investment. To achieve efficiency and scalability in this new venture, AngelList automated large parts of the fund management process, reducing the need for extensive human intervention.
AngelList continued to innovate. In 2016, it acquired Product Hunt, a popular platform for product discovery, broadening its footprint in the startup ecosystem. More recently, they've ventured into rolling funds, a new type of venture capital fund that operates on a rolling, quarterly basis.
Today, AngelList has spun out its legacy businesses, including AngelList Talent (now known as Wellfound), and focuses primarily on fund management. This evolution, from a tech platform to a service-oriented, scalable model, underlines the possibility of transitioning from a services business to a technology company. Through strategic pivots and the effective use of automation, AngelList demonstrates the potential for success even within traditionally unscalable sectors.
Conclusion: Leveraging Services for Growth and Capital Opportunities
While services businesses often grapple with barriers to securing venture capital, their role in exploring markets, building customer insights, and honing specialized skills is indispensable. Tech startups, especially, should be wary of the unintended use of service-centric language in their pitch decks, shifting emphasis towards scalable tech solutions instead.
Moreover, for services businesses aspiring to tap into venture capital, transitioning towards productization and establishing a dedicated legal entity can enhance investment prospects. AngelList’s journey from a service-oriented business to a tech titan is a prime example to draw inspiration from.
Venture capital is a highly competitive field and minor oversights can cost significant opportunities. Therefore, seeking external input to refine your investment case and review your deck can help you steer clear of pitfalls and enhance your chance of success.