In our post about why traditional VCs are not a match for services companies, we dashed your hopes of being able to change their mind about investing in tech services. So, VCs won't show you love. What about those who will? Even if you are not seeking funding, we'll help you understand the funding landscape available to your company so you can create a better-informed strategy. Remember, the golden rule of fundraising is: "Start looking when you don't need the money.”
Banks
We're all familiar with banks. We all use banks. Banks are an important source of funding. But as a tech services founder, you will be disappointed with them. Think of the scene from any movie where ambitious entrepreneurs present their business plan to the bank hoping to get a loan, and get their dreams dashed as the loan officer says no.
Well, your experience with them won't be very different whether you're starting out or making millions of dollars. The truth is tech services companies are very asset-light companies. Banks may give you a line of credit based on your accounts receivables and contracts, but this money will not be enough to provide you with growth capital.
Pros:
Extremely inexpensive funding. Compared to the cost of dilution or other debt, it is nearly free.
A line of credit can be useful even if you don't use it. It can give you more of a margin of error as you try to hit the bull's eye while keeping profits low to avoid taxes.
Cons:
The limit will be enough to provide some flexibility but not to give you growth capital.
Requires repayment so if your current cashflows can't handle repayment, you cannot spend on something that is not creating future cashflows.
Private Equity
Private Equity is the closest option to VC that founders in tech are already familiar with. Unlike VCs, they're not aiming to create a small number of jackpot winners, but rather they try to bring operational skills to good businesses. This makes the risk-reward ratios private equity companies need from their investments more aligned with the tech services industry.
Private equity does both minority deals and acquisitions that they grow with management control. They usually don't do minority investments in tech services businesses with less than 10 million dollars in revenue. For smaller sizes than this, they’re likely to take a controlling interest and try to do a roll-up.
Pros:
Institutional capital for funding in exchange for equity.
Many PEs bring operational expertise and shared services to reduce costs.
Cons:
It may require giving control of the company for an early-stage company.
Angel Investors
There is one type of investor that does carry-over from the product world into services. Angels are high-networth individuals who invest their own money into businesses. Angels in tech services businesses are usually successful founders of tech services businesses. So they often also bring mentorship.
Pros:
The only source available to early-stage tech services companies.
Ideally comes with mentorship and a network.
Cons:
Angel investors often have more limitations on money. For example, they may need an immediate path to profitability and expect disbursements.
There are no angel groups specializing in tech services so it's harder to find them.
Strategic Partners
Platform partners understand the importance of a robust partner ecosystem to the success of their business. So they will have a lot of funding to help their partners. Strategic partners have formal programs for funding go-to-market and innovation efforts. Sometimes they will even make an equity investment into services businesses enabling their customers. Just beware, the value to them is the ecosystem and they won’t damage the overall ecosystem for you.
Pros:
They are interested in your success more than the returns they’ll get from you.
Cons:
They often have many limitations on what and how the funds can be used because ultimately their interest in your success is not in returns but rather in how your success translates into success for them.
An Unmet Need: Specialty Funds
If you look at the market, there is a gap. Now, specialty funds are being created to fill this gap. These specialty funds are closer to VC but they are specailized in tech services companies and are designed accordingly. Having said that, this market is still fairly underdeveloped. These specialty funds are also closer to super angels in many cases.
At Vixul, we recognize that the lack of a robust ecosystem for tech services companies hurts tech services startups. That's why we launched the Vixul Continuity Fund (VCF) to fill this gap. We will be sharing more information about VCF in the weeks to come, but broadly VCF provides growth capital to Vixul portfolio companies. Please follow VCF on LinkedIn to keep up with the latest news.