Services Revenue is Not a Dirty Word

We’ve seen it too many times — a B2B company comes in to present to a VC and all goes well until the words “services revenue” are uttered. The VC looks skittish, the founder embarrassed, and the pitch goes off the rails.

VCs tend to hate services revenue for a couple reasons. It’s not recurring, so it lacks the beautiful “rinse and repeat” nature of SaaS. It can be lower margin (sometimes substantially so) than software. And it is valued at a significantly lower multiple than recurring software revenue by investors and the public markets.

These are all valid concerns, and very important things to think about, particularly as you build your business for the long-term.

However, they ignore one very important positive of services revenue: it’s the purest form of non-dilutive financing (with benefits). Instead of raising outside capital and selling down 20–30% of equity each round, founders with services revenue are able to leverage large chunks of discrete customer revenue to pay salaries (with some margin on top to offset other fixed costs). Not only that, but it also allows creative founders to get paid to build out their team’s SaaS product roadmap.

We’ve been seeing several examples of strong, bootstrapped B2B SaaS companies in recent months that got their start doing exactly this. Instead of incorporating and immediately going out to raise VC, they started with their target customers and sold these folks on discrete product builds. They made sure that the services work they were doing was aligned with their product roadmap and they leveraged this funding (typically 5-to-6 figure contracts for 3–12 months of work) to gradually build out a standalone product that they could pivot into the SaaS model when the time was right.

Plus, they had the huge benefit of having an existing roster of happy customers rearing to go when SaaS was ready to sell. Instead of building product and then starting from scratch, they had built product guided by some of their largest customers and then had someone to sell it to who had been instrumental in its development.

Of course, services revenue is not all rainbows and unicorns. It’s important to only take on contracts that are aligned with your long-term product roadmap and to not let your team get too distracted from this long-term goal. It’s crucial to ensure that you’re earning incremental margin on top of labor costs for your services (ideally 50%+ margins) — otherwise, your other fixed costs will add up. Your ARR-to-headcount ratio will suffer (see more on that very important metric here). Lastly, and importantly, it generally takes longer — you have to be patient and the transition of existing customers from services to SaaS is not easy (particularly with legacy customers who aren’t otherwise used to the subscription model).

However, if you pull it off right, you’re able to much more efficiently capitalize your business and get to a place where you’re at $1M+ of ARR without having sold a third of your cap table to get there. If you eventually sell for $100M, that is $33M of difference to your bottom line. This makes all the difference in the world when it comes time to exit — that extra year or two it took to get there make a lot of economic sense.

At Reformation, we’re huge fans of founders that leverage creative customer funding to get their businesses off the round — or any creating financing solutions — see our alt finance landscape here. They tend to have some of the strongest customer empathy and the most loyal customerbases.

So next time service revenue comes up, don’t look down and lower your voice. Be proud of creatively financing your business in the early days from the stakeholders who matter most.