Although most companies that pitch VC firms are product companies, sometimes consulting companies that are raising money will approach venture capital firms.
Most venture capitalists tend to shy away from investing in pure services businesses. Typically they exit for low revenue multiples and they only scale as quickly as you can hire billable resources (with costs increasing linearly).
On the flip side, these businesses tend to reach cash flow positive on Day 1, so they can be great businesses for founders. They’re just not the type of businesses that early stage VCs will be able to realize the level of ownership required to hit their return goals.
Some consulting firms try to augment their services with managed, repeatable offerings than can scale without hiring additional resources. Others use their consulting profits to finance the development of products and when those products are complete they morph from a consultancy to a product company. Moving to a product or managed services centric model is certainly more attractive to venture investors, but of course such a move has its own set of challenges (not limited to a lack of focus as a company tries to keep consulting customers happy while doing product work on the side).
Some very sharp venture investors do invest in the services space (Sigma comes to mind with their investments in Glasshouse and Virterra) so I hesitate to write off the consulting services space completely, but it seems like a tough place to generate venture returns.
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1 comment
Good post John. One other reason why consulting firms aren’t great VC investments: the company’s critical assets have legs that can walk out the door at any time.