Dan Martell - June 01, 2015


How To Build a Product Within a Service Company


Episode Stats


Length

5 minutes

Words per minute

217.23602

Word count

1,257

Sentence count

46

Harmful content

Toxicity

2

sentences flagged

Hate speech

1

sentences flagged


Summary

Summaries generated with gmurro/bart-large-finetuned-filtered-spotify-podcast-summ .

In this episode of the Startup Spotlight podcast, I sit down with my good friend and former co-founder of Spheric, Ben Horowitz, to talk about the difference between a service company and a product company. We talk about how to understand the difference and how to leverage it to your advantage.

Transcript

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Toxicity classifications generated with s-nlp/roberta_toxicity_classifier .
Hate speech classifications generated with facebook/roberta-hate-speech-dynabench-r4-target .
00:00:00.600 Yeah, so that's a question that a lot of people struggle with
00:00:03.060 because, you know, there's all these amazing examples
00:00:05.000 of companies like Hootsuite that was built out of Meme Labs,
00:00:08.900 Shopify that just went public,
00:00:10.400 that started off as a snowboard online e-commerce site,
00:00:13.900 to FreshBooks, it was initially kind of a marketing analytics,
00:00:18.500 marketing automation company for small businesses
00:00:21.200 that realized that invoicing their businesses 0.56
00:00:23.200 or the customers were all pain in the butt, you know, 0.85
00:00:25.700 and they built this great product. 0.84
00:00:26.900 There's all these great examples of companies
00:00:28.700 started off as consulting companies or service companies
00:00:31.140 that built products.
00:00:32.380 Now the challenge, and if you've tried to do this
00:00:34.460 you understand it, because I went through it
00:00:35.740 when I was building Spheric, where I had this team,
00:00:37.960 you know, we had 30 engineers, 30 developers,
00:00:40.040 30 people that could create, and I thought,
00:00:41.940 I gotta build a product, because consulting
00:00:44.320 is very transactional, and it's not repeatable,
00:00:46.940 and it doesn't scale, because, you know,
00:00:48.820 you're always trying to get the next client
00:00:50.340 to fill up the hours, or kind of get new projects.
00:00:53.400 And I feel like the challenge is you have a resource
00:00:57.820 that could be making you money,
00:00:59.280 but then you're gonna divert it to building something.
00:01:01.760 And pretty much I think it's just natural human instincts
00:01:04.820 that when something isn't going well
00:01:07.220 or you're running out of money
00:01:08.340 or you realize that your cash is running low
00:01:10.900 or you have demand that you can't deal with,
00:01:12.700 it's very easy to say, okay, hey,
00:01:14.140 I know we're working on this product,
00:01:15.240 but let's shift it back to working with a customer.
00:01:17.940 So step one, I'm gonna suggest that you take the resource
00:01:22.640 and you put it outside the business.
00:01:24.020 You really gotta treat it like a separate entity,
00:01:25.940 You know, where you can hire a new person
00:01:27.940 and you fund it from the profits from your service company
00:01:31.060 or you can take somebody from your team
00:01:33.700 and kind of start building out that capacity.
00:01:35.780 And you can start as simple as one person.
00:01:37.620 I think 37signals is a great example
00:01:39.740 where they hired DHH as a contractor
00:01:43.380 working 10 hours a week to build Basecamp.
00:01:45.300 Even though they were working with customers full time,
00:01:47.260 they said, hey, you know,
00:01:48.340 we want to build this tool for ourselves.
00:01:49.940 We think there's maybe a need for other people to use it.
00:01:51.860 Why don't you build it part time while you're working with us?
00:01:54.980 So that to me is a really good way to kind of keep
00:01:58.020 the new product and kind of the new entity clean.
00:02:01.240 The other challenge is, you know, what I've seen
00:02:03.340 is a lot of times when you have multiple founders
00:02:06.060 on the service company, where you have two,
00:02:07.680 a co-founder or maybe three or four people,
00:02:09.920 especially if you're like an agency,
00:02:12.440 when you're, you know, if you're the guy that goes over
00:02:15.220 to really expand the product,
00:02:16.640 that if you launch the product, it starts to get lags,
00:02:18.500 and you go off and you start putting all your time
00:02:21.040 and energy 100% into this product,
00:02:23.400 yet maybe the way you structured it
00:02:25.660 was that the service company owned the product, right?
00:02:29.120 Because it financed it through its profits.
00:02:31.160 It's really this weird position
00:02:33.020 where you have partners in the business
00:02:35.300 that aren't active in the business,
00:02:36.820 that aren't really responsible for the success
00:02:39.020 of the product that are major shareholders, right?
00:02:42.120 So that's why I always suggest start clean.
00:02:45.520 What you wanna do is say,
00:02:46.420 I'm gonna dedicate X amount of money,
00:02:48.180 let's call it $200,000,
00:02:50.020 and the next 16 months with one or two developers
00:02:53.320 developer and a designer, and it's gonna go in
00:02:56.660 at a valuation of, let's call it a million dollars.
00:02:59.120 Treat it like an investment,
00:03:00.300 because truly that's what it is.
00:03:01.400 You've got a profit, you've got cash,
00:03:03.540 and you're putting it into another entity as an investment.
00:03:06.960 So you wanna give yourself an extra boost,
00:03:08.700 so you do a low valuation, million dollars seems about fair.
00:03:11.480 And then that way the cap table is really clean.
00:03:14.400 So the service company essentially has an equity stake
00:03:17.220 in this new product company at that valuation.
00:03:20.780 Now that might seem like not a lot,
00:03:22.140 because a lot of people that might be a co-founder
00:03:24.240 in a service company might think,
00:03:25.780 well, I mean, it wouldn't even exist
00:03:27.840 if it wasn't my idea, et cetera, et cetera.
00:03:29.340 But trust me, if you've been building companies
00:03:30.740 for a while, you know that it's never the initial idea,
00:03:34.580 the initial team, really, that makes it successful.
00:03:36.720 It's that, you know, that continuously investing time
00:03:41.420 and kind of overtaking obstacles
00:03:44.260 that is gonna be the reason it's successful,
00:03:46.200 not the initial investment.
00:03:47.860 So, what that allows you to do
00:03:50.240 is it allows that person running that company
00:03:52.140 have enough equity in the cap table,
00:03:54.100 you know, the way that you give away shares,
00:03:56.380 so that you can incentivize to build a team.
00:03:58.280 Because again, I've seen this happen so many times.
00:04:00.460 I've actually invested in a company recently
00:04:02.320 that was spun out of a service company,
00:04:03.740 and when they first looked at it,
00:04:04.740 I looked at their cap table,
00:04:06.020 and the service company owns 70% of this new product.
00:04:09.300 And I thought, well, right off the bat,
00:04:10.760 you have 70% ownership of the company
00:04:12.860 owned by a small group of people.
00:04:14.540 You don't have enough equity to even incentivize
00:04:16.580 the CEO or other vice presidents.
00:04:19.020 If you're building a venture-backed company,
00:04:20.200 it's gonna grow to 100 million a year revenue
00:04:22.200 in the next seven years,
00:04:23.120 because that's what you're supposed to be aiming for.
00:04:25.540 There's no way you're even,
00:04:27.160 you didn't even start off to be successful.
00:04:29.540 Like you're walking around with lead on your feet,
00:04:31.940 like you're just, it's not even gonna get going.
00:04:33.820 So that is the overall structure.
00:04:36.620 Spin it out, keep it clean,
00:04:38.600 take the money from the service company,
00:04:40.340 invest it in the product company,
00:04:42.180 build a new team if possible
00:04:43.820 so you're not pulling that team back into other client work
00:04:46.800 and really allow it to thrive and grow.
00:04:49.700 And by all means, if there's opportunities
00:04:51.400 to refer customers or support them
00:04:53.240 or give any other resources, et cetera, et cetera,
00:04:55.960 you want to do that because you've invested interest
00:04:57.840 in seeing it successful.
00:04:58.840 But doing that will give it the best chances.
00:05:00.840 It doesn't guarantee anything
00:05:01.800 because no startup's guaranteed,
00:05:03.360 but it'll allow you to build a structure to grow
00:05:06.420 to eventually, if you want, raise venture capital
00:05:08.840 and build a really cool, meaningful company.
00:05:12.040 So that's my framework when people ask me,
00:05:14.900 how do you build a product company
00:05:16.080 within a service company?
00:05:17.300 That's the structure and approach that I suggest
00:05:19.420 because it's the one that's going to set you up to succeed.
00:05:22.340 And if the goal is to eventually wind this company down
00:05:25.780 or sell it so that you can work on that one full-time,
00:05:28.880 then that's still the way you want to do it.
00:05:30.740 And that's just a decision in regards to where you spend your time long-term.
00:05:34.360 I hope you find that successful.
00:05:35.840 It was a really great question
00:05:37.060 and one that I know a lot of people have struggled with.
00:05:38.580 I struggled with.
00:05:39.320 I did it wrong.
00:05:40.520 And then I've seen really great examples of companies do it amazingly.
00:05:44.180 So I want to share that with you guys.
00:05:45.680 And I will see you guys next week.