Why Start A Software Business?

It looks like the reason that so many want to start a software business is that software businesses are simply more valuable.

That’s intuitive.

This fact has less to do with an overall affinity for the software business itself and more to do with how the margins of the business shake out.

Here is a good question that shows the difference: If you let go of half your employees, by how much would your revenue drop?

See, the recurring revenue of many product-based businesses has certain advantages over service-based businesses.

I mean – if you can – why not build a scalable version of the same company, if it has the potential to be worth three times as much?

I know I would.

Here is an example of how the math can shake out.

Say we have two entrepreneurs who’ve built similarly sized, strong businesses over the last few years and are both ready to sell and retire. Niki’s firm is a software-subscription business, and Silvio’s is a consulting firm. Both have fifty employees, $10 million in revenue over the past twelve months, and a growth rate of 30 percent in each of the last four years. My examples here are vastly oversimplified, but the raw, average outcomes are instructive. Niki can reasonably expect that her company will yield, on the very low end, $30 million, and on the high end, $80 million in a sale. It could be even higher if her technology is especially in demand or if the skill sets of her engineers, the unique data she’s collected, or the market she’s tackling is massively interesting to multiple powerful companies. Silvio can probably anticipate a sale of $10 million to $25 million for his similarly sized business. The modifiers will generally be his company’s EBITDA (earnings before interest, taxes, depreciation, and amortization), his net margins (profitability), and some elements of relative demand, bidders, and industry. Little wonder that investors, then, put so few dollars into consulting businesses and so many into software companies. And little wonder, too, why at Moz, once we started to understand these numbers, we quickly doubled down on software and put less energy into expanding consulting.

-Rand Fishkin, Lost And Founder