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Two roads to start up land

Reflections from John Thompson on choosing between a services or a product startup.
John Thompson John Thompson Mon 5th May 2014 11:13

By John Thompson of UserReplay

When it comes to tech start-ups there are two very different kinds of company you can create: product companies and service companies. Service companies can be bootstrapped with little capital. Product companies (and I include SaaS in this category) require significant funding, which, unless you are fortunate enough to be rich, means external investors.

Product start-ups

I have always gone down the product route; for me it is more exciting, growth is faster, and exits more frequent. You can realistically do one of these every 5 to 7 years. This means there is every chance of your career including at least one huge payday.

However, it does require other people's money, but I quite enjoy the challenge of raising capital, and interacting with the interesting and successful people who have cash to invest. I also really enjoy the diversity of the product companies I have run, and the new challenges each brings.

External funding does have implications though. Firstly dilution; by the time you have involved co-founders (which is wise) and done several rounds of fund raising, you may own only 10% of your baby. Again, not a big problem if you produce something worth £10m or more.  And not an issue at all if you generate over $100m in exit value like the first start-up I worked in.

With the dilution in ownership there is a dilution of control, but if you are good at your job your investors will generally let you get on with it. They are investing in you and your team after all.

You can also get mentoring and support from your investors, who hopefully have been highly successful, so you can grow quickly. You do need to respect and work closely with your backers, and recognise that they will have the right to fire you if this is in the interests of shareholders.

With a product company the value comes at the exit. You are likely to have little in the way of profits or dividends as you ride the venture capital rocketship. I paid my shareholders a £1m dividend once, and one of my VCs said they didn't quite know how to process it, as dividends were so rare.

There is also always going to be downward pressure from the board on your salary, at least until the business is really thriving. A product company can never be a lifestyle company; it is always a ‘work hard, grow fast, then sell up’ project. I love high growth product companies, but they are definitely high risk and high stress.

Services start-ups

In my network I have a colleague who runs his own IT professional services company. He started over 20 years ago, and grows it by 10% or so a year. He always seems happy and relaxed. I initially thought that his approach to business was incomprehensible. The business could have been much bigger and therefore, in my opinion, should have been. To me it seemed boring and unambitious to grow so slowly, and to take so few risks. However, year after year he serenely makes over £1 million in profit, which he doesn’t have to share with investors.

Last time we had lunch we talked about world travel. I had just had to pack a visit to Australia into four days of annual leave, while he had just had a  three month vacation. Maybe his approach to business is not so crazy after all.

Creating a services company is easy. You just quit your job, set up a limited company and start selling out your time, maybe with a few colleagues.

The challenge is going from freelance to services company mode. Many people end up just freelancing forever and not creating a growing company. To grow you need to find a compelling services proposition. You have to know how you are going to hire and train people; how you are going to acquire new customers; and what compelling results you are going to deliver. Then you need to have the courage to not earn fees while at least one person creates the engine to make this happen. Get this right and you can build a business that you truly own and control, that can pay you dividends year on year.

Two radically different approaches, but surely both are far more attractive than the politics and constraints of corporate life?

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