The Secret Sauce of Valuable Service Businesses

Robert Smith of Vista Equity Partners famously said, “Software companies taste like chicken. They’re selling different products, but 80% of what they do is pretty much the same.”

Service businesses are no different. 

You buy someone’s labor, mark it up, resell it, and spend opex to operate the business. You also spend money on capex to improve the “infrastructure” of the business, and what’s left over is your profit.

Markup – Opex – Capex = Profit

The challenge is that in the long term, the free market is annoyed with your business model.

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Entrepreneurial Motivations: Light and Shadow Forces

The best reason to start a company is to solve a problem that you genuinely, to your core, care about, and you can’t see another way to do it. People who find this are truly blessed.

And then there are the rest of us, and we are complicated. Here is my take.

The motivations for starting a company are complex – there are “light” and “shadow” forces. 

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Build Your Company to Exit

If your long-term goal is to move from labor to capital, then you need to build your business into an asset that you can personally “exit”, not a high paying job.

Assets can be sold or held once you have exited, but they do not require your day-to-day participation. Assets give you free time and capital to invest.

The “gravitational pull” of a service business is to stay small, never let the owner leave operations, and never be acquirable for more than 2-3X EBITDA (if at all).

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