Sure, here's an example - a small startup which occupies an attractive niche, definite market need, product-market fit, and decent traction. The founder developed a software platform in response to market need, but the market also told her that there were opportunities to sell extensive services. Now that the software platform is done and there is a small services team in place, the founder can choose to sell either:
a) the software platform, which might make $20k/year, but you can sell thousands of them without much incremental overhead needed; once integrated, it's also extremely sticky; low customer churn and high customer satisfaction
b) a services package, which might make $50k/year, but for every 3-4 you sell, you need to hire a new employee @ $75k/year fully-loaded overhead cost
Before you say "sell both!" - unfortunately the nature of things is such that, more or less, the founder needs to prioritize selling one or the other. Consciously or not, she is prioritizing the services revenue, and as a result about 90% of new sales are services contracts. I (and the other investors) would prefer that she prioritize software. Even if it makes them unprofitable, it would make for a much better risk-adjusted bet. And this isn't like "it's a much better bet for the investors, because they can diversify risk out in a portfolio, but the poor founder would probably be left with nothing". She understands both sides and says she wants to build up the software revenue, but the culture around her (south-eastern city) is so strongly opposed to it, that the execution has been impossible. This is a classic case of where a smaller PE firm will come in and buy it out for a few million, purposefully cut the services revenue, go hog wild selling software, and flip it a few years later for 10-20x what they paid.
> This is a classic case of where a smaller PE firm will come in and buy it out for a few million, purposefully cut the services revenue, go hog wild selling software, and flip it a few years later for 10-20x what they paid.
Or the classic case where PE buys it, cuts services and all the staff who know anything about the product, go hog wild trying to sell software and realize that that the market isn't there and never was and the services path actually was the only the way to make inroads. The investment craters and everybody loses money.
Certainly, there is always risk of poor strategy and/or poor execution, with an outcome exactly as you describe. Having seen both scenarios play out however (as both an investor and an operator), in this case I think it would be the right move.
Why would that last be a good idea? You're throwing away a good business with 70% gross margins - for what? Okay, to concentrate on something that might be a good business with 99% gross margins, but is the difference between 70% and 99% all that important compared to other factors, like the difference between is and might be? Not a rhetorical question; maybe there is some logic to it that I'm missing.
Thank you; it's very interesting to hear the details on this. One question:
>she wants to build up the software revenue, but the culture around her (south-eastern city) is so strongly opposed to it, that the execution has been impossible
Do you mean the existing company culture, e.g. employees only having service-oriented skills, or the southeastern city culture, somehow being inhospitable for developing software?
I'm curious because I currently live in a southeastern city (Nashville), am about to move to another (Atlanta), and am in the beginning stages of building a B2B SAAS startup.
I had never heard of that distinction before and usually just thought of lifestyle businesses as slower growing vs faster.