Why Your Professional Services Business Shouldn't Aspire to Be a SaaS Business

When I talk to founders of service companies, many of them express the same desire to me: they want to become software companies. They see SaaS companies taking the world by storm, and they wonder if they made a huge mistake by not going this route.

They see the valuations of SaaS companies and get drunk on the numbers.

It's understandable, with a SaaS company like Salesforce worth $132 billion and the most valuable professional services company, Deloitte, worth $27.9 billion.

Risk of being an entrepreneur

Some founders believe that service companies are more labor intensive and that starting a SaaS company somehow means a better work-life balance. And there are founders who are driven by the need for fame. They want to be mundane names the same way the Zuckerbergs, Musks and Kalanicks have grabbed the headlines and had documentaries made about them.

However, SaaS companies are twice as likely to fail within five years, according to Professor Scott Shane of Case Western University.

The five-year survival rate of service companies is 47.6% and the five-year survival rate of product companies is 23.4%. Founders of service businesses and product businesses take a big risk when they become entrepreneurs, so it's wiser to play the odds and start a service business rather than a product business. Three factors to consider before moving to SaaS

In reality, and this is what I tell professional services founders, the challenges and limitations of the SaaS life should put you off, maybe for good. Consider three things before jumping into the world of SaaS:

Evaluate the financial impact of SaaS

The SaaS world can be very attractive, but remember the potential of your business before you start building a SaaS business for fear of missing out. Founders of professional services companies can create more personal wealth than their product company counterparts. This is explained by the impact of capital intensity.

For example, let's say two friends, Sue and Kim, are starting businesses at the same time. Sue starts a consulting company and Kim a software company. Sue doesn't need to raise any capital.

Consulting firms have very low costs and are not capital intensive. Therefore, Sue owns 100% of the business. Kim, on the other hand, needs to raise $5 million from investors. SaaS companies have product development costs and are capital intensive. Therefore, Kim only owns 15% of his business.

A practical example of selling a SaaS business

Ten years later, Sue and Kim are selling their businesses. At the time of the sale, the two were making $10 million in revenue a year. Sue's business is valued at 1.5 times its revenue, which translates to a purchase price of $15 million. Since she owns 100% of her business, Sue earns $15 million.

Kim's business is valued at 5 times its revenue, which translates to a purchase price of $50 million. Since she owns 15% of her company, Kim earns $7.5 million, which means Sue earns double what Kim earns on exit.

In addition, Kim's investors pay Kim a salary and prohibit him from withdrawing money from the company. Sue has no investors; she pays herself a salary and receives regular cash distributions.

Kim must sell the business to be rewarded commensurately for her efforts, but Sue rewards herself twice, once with regular cash distributions and once on exit. Efforts and rewards are consistently aligned.

Decide on the work-life balance you want

Second, founders of professional services companies work less than founders of product companies. The reason is that they can control the scale (sterlingwoods dotcom). Founders of commodity companies are pressured by their investors to grow at all costs. And this requires an exhausting and continuous work schedule.

A founder of a well-run marketing agency, for example, can achieve work-life balance. She can speed up work when she feels inspired and reduce work when she feels exhausted by accepting clients as she wishes. It controls the company and has no obligations to technology venture capitalists.

Its cost structure is variable...