NEW ENGLAND CAPITAL VENTURES

Yes! Any service business positioned strategically in the value chain of the market can raise capital. Though service businesses are rarely funded by venture capitalists, there are exceptions which I will try and explain. I am sure one could argue on all these points below but this exercise is meant to generalize by experiences and observations.

There is an entrepreneur in everyone. We all tend to identify gaps in areas of retail and business through our work, our commute, our daily experiences at grocery stores, the GYM, the yard, etc and many think “I wish there was a better way to do this” or “I am surprised no body ever thought of this before” and my favorite – “How can such a simple thing be so difficult”. Few of us try and investigate better options, the lack thereof inspire us to come up with a solution ourselves. And some take it to the next level by launching companies around their ideas and a select few change the way we lead lives and do business.

Did Tom Stemberg, founder of Staples, loose his mind when he thought of starting a dry cleaning service - Zoots? Same with folks at VistaPrint who make business stationary. Or Paul Conforti’s idea to start a gourmet dessert restaurant - Finalé? What made these people tick and what made their business plan fundable?

Let’s start with the notion of service itself. Service = execution+quality. If I cannot render timely, effective and good quality service, I will loose business because my credibility is brought to light immediately compared to a product only company, which has some wiggle room to defer on quality. I am not going to comment on what constitutes quality as there are numerous books written about it and quality is a state of mind which differs from industry to industry and person to person. (see next paragraph below). But delivering what you claim in a better, faster and in value driven units compared to your competition, is extremely critical.

Over this past week-end, I was in Newburyport, MA. I saw a sign on a roadside food vendor’s cart stating “World’s Best Popcorn”. Few blocks down, I see another sign claiming “World’s Best Burgers”. I recall seeing similar signs in almost all major towns and cities in the US including Topeka, Kansas (let’s not discuss what I was doing there). But which one is the world’s best? Is there a standards body surveying every single burger establishment around the globe? No. Because this is marketing 101, a perception play on how you manage your service brand. Compared to Joe’s Grill, when I go to eat at “World’s Best Burgers”, I expect them to be better, bigger if nothing else. When I walk in, I expect a smiling friendly service, prompt seating, clean environment, pleasant ambience, knowledgeable staff, accuracy of my order and off course – good food. But some might expect half of what I just mentioned and that might be good enough for them.

Service businesses hold 80% weight on execution and 20% on the actual service. From what I have seen, people will pay more if you can execute better than your competition. But execution is the biggest risk for an investor. This is a parameter that is the least predictable and the most volatile with several dependencies. The entire financial forecast depend on your ‘execution strategy’. It takes a heck of a lot of consistent effort to build credibility for a business but just 1 incident to ruin it. Especially in today’s world where getting an opinion on something is just a few clicks away on the internet. Everything is rated now-a-days and everything has stars next to it. I will not go by what the website babbles but by what the folks who used the company have experienced. It is important for a service business to display aggressive sales and brand management effort. The more you sell, the more your brand grows and the more effort you need to put in to manage that brand (complaints, billing errors, mix-ups, etc).

On the hind side, my question is – how can ‘strategy’, a loosely defined non-scientific non-functional term define an exact science like your cash flow statement and valuation matrix five years from now? The short answer is – it cannot. Not even in a product business. The numbers seen on business plans are mere benchmarks and goals to be met. No one can ‘forecast’ anything. I did a study while in business school of how closely institutionally funded start-ups met financial goals. The answer was – more than 90% of the companies were off by at least 75% in year 1 of the forecast, 50% in year 2 and 40% in year 3, on the original forecasted model off course. That is why, entrepreneur’s financial forecasts constantly change to suit the environment he is in. All it means is “how can I fudge some random numbers in order to not look stupid”. But never ignore these numbers as an investor as it defines the level of ludicrousness by the entrepreneur. If someone says I will grow 200% in 1st quarter post-closing, you want to beat up on that and come to a realistic number.

It is important that your service is indeed a people’s business and not something that can be commoditized easily and/or as well. A service business is flexible and has room for tremendous agility unlike product companies – which are structured. If you call Zoots for a pick up, the pick-up guy tells me – “by the way, I am passing by FedEx if you need me to drop anything”. This immediately diversified the business by aggregating multiple services. It’s not in the business plan, but its happening. Why not leverage that and eventually monetize that? Now you have a concierge service. In the same context, a service is delivered by people, not some machine. Employee retention becomes key in this case. Look at the state of Indian call centers. Service suffers because under-trained reps jabber into the phone thinking about where they plan to go next instead of focusing on the business. With only 30% retention, quality suffers and eventually call centers are forced to move back to US, some even by Indian call center companies like Tata. Investors are afraid of these issues. Investors find comfort in knowing that their plan will work. They get nervous if you tell them things could go awry as the company is pretty much these 4 people.

A service company’s ability to display the big picture is key, i.e. franchise opportunity, huge diversification potential, global impact, etc. I love Finalé and have been going there since it 1st started 5+ years ago. I wish there was a location on the North Shore in Massachusetts. I hate to go into Cambridge to experience their service and their products just because of the challenging logistics commuting around Boston. They have been slow in moving to the suburbs and there are reasons for it. Their service is the talent of their bakers - the artists who design their products in real-time. It is expensive to hire, retain and sustain these folks as the restaurant business is brutal with its low margins, high turnover rate, longer ROI timeframes and cyclical markets. Real estate costs and a location that can generate consistent business in a hip environment is key to meet your financial goals in their case. It is difficult to franchise this opportunity in the short term as there are many variables in making this happen on a big scale. But eventually, there will be many more stores and maybe Starbucks will notice them. But there’s no way an institutional investor will wait 10 years see his return. An angel investor might, a corporate investor might – but not a chance that you will raise money from the big guys. At least not in the short term. If you already had an offer from Starbucks or a hotel chain like Starwood or wants to open an eCommerce store in collaboration with Ghirardelli Chocolates or Lindt and you want to raise $20 Million to open a dozen stores around the country, then you are in position to talk.

If your service business has the potential to diversify in several industries and areas and/or if your service can eventually be productized and sold as a packaged solution that will qualify you to raise funds from an institutional investor. However, significant sales traction, a well-known brand equity, innovative service portfolio and high-margins become important before you decide to make your service into a product. H&R Block used to be a tax service many years ago. Now they have a software product, the same one that their reps use. The product we see today was originally built by H&R Block to deliver consistent service along all their chains. Same way, Firedog, an onsite technician help for troubleshooting computer and other technology related issues, now sell their proprietary remote monitoring products.

Defensibility of your service is yet another argument in your fund raise strategy. How does a service business defend itself? When it has a process that is proven to deliver on its promise meeting everything we talked about before. Yes, I can do the same thing you do within a few feet of your establishment, but that does not mean I am going to be able to do it better as I am not yet proven. It’s the same argument that differentiates accountants, laundromats, GYM’s, Insurance companies, grocery stores, etc. If a grocery store has great products but it always takes me a long time to check out, I will stop going there. If my hosted network service provider has fantastic pricing and a bundled package with great value but experiences downtime at least twice a month, I will stop doing business with them. I had 5 pizza joints on the main street of my town – a strip of just quarter of a mile. Why do I consistently call that one place? I have tried all others, on multiple occasions, and they have had consistent issues with orders. 2 of them went out of business last year.

Lastly, a question that I get asked most – which is profitable, to serve the enterprise market or the retail/consumer market? The answer to that is, it depends on what you are trying to do. Many IT Consulting firms (including Deloitte) tried to play a role in the enterprise market, many failed due to lack of product knowledge and applying core competence from an industry stand-point. As long as you can scale your service without heavy capital, know who your customers are, retain higher margins and can serve many people in a short time, I don’t care what you do. In the end, it’s a numbers game for an investor. Service is an experience given by people. As long as that experience is enjoyed by many and you can ‘package’ that experience eventually, you are in the right direction to raise institutional capital.