Why VCs Don't Fund Consulting Companies

January 22, 2017

     I have never been a VC, but I have attempted to bootstrap a software consulting company by myself.  The experience was an educational one, and I believe I can now articulate why I would never invest in a consulting company myself:

     No Substantial Growth Potential  You could define the term 'consulting company' many ways, but the way I would define it as a company that does all of the stuff that doesn't scale.  People hire consultants and consulting companies for one-off jobs that aren't likely to be repeated.  If something is going to be repeated, they will hire a full-time employee to do it, or look for a service that requires less manual interaction.  One of the primary activities of consulting is communicating details about the project.  This means things like figuring out what the customer wants even when they don't know what they want;  Discussing design decisions and domain knowledge about their infrastructure (eg: why are all these values in the database set to NULL?  Oh!  That's a bug we didn't know about.); Clarifying inconsistent requirements and exposing any design flaws they may have (eg.  This specific button should be blue. Also, all buttons should be red as the style guide mandates.).  The point of this is that all of these activities require lots of communication, and they need a human being who is awake and pro-active.  This means that as your consulting company scales, there will be a roughly linear relationship between how much work you do and how much money you make.

     You might think to yourself: "This won't be me, I will crack the code and find out how to make a consulting company scale!".  This is somewhat of a semantic argument, but I would claim that if you manage to scale a consulting company (in the sense of having a higher order than linear growth of revenue as a function of work), you haven't built a consulting company, you've built something else (and there's no problem with that).

     Your Best Customers Are Always Unavailable  Your best customers will be businesses who wake up one day and think "We are so busy, hey let's contract this project out!".  By virtue of being busy all the time, they will also have no time to: talk to you, arrange an initial meeting, sign contracts, etc.  Once you start working with them, don't be surprised if they don't have time to tell you what they want done.

     Your Best Customers Will Have Their Own Customer  If your customer has their own customer, that's good in the sense that it means they (most likely) have revenue and are more likely to pay you.  It's also a huge problem because now you have twice as many bosses!  You now have to contend with situations where your client tells you to do one thing, but your client's client has told you to do something else, and now you're stuck running between them playing Chinese telephone.  Let me give a more specific example:  Let's say your client asks you to build a simple 2 page web app for their client.  Your client's client may now ask you to include 10 pages in this new app, and not back down when you say it's only supposed to be 2.  Note that this is more likely to be caused by lack of communication than malice.  You'll tell your client, and they will re-iterate that it's only 2 pages because they can't afford more.  Now you've adopted the fun task of being a diplomat that has to negotiate some kind of middle ground in order for the project to come to a conclusion (and by the way, these people won't arrange a meeting on their own, you need to do it).

     If you're lucky you will be completely protected from your client's client, but you may end up being involved in meetings with your client and your client's client.  You'll now have to be careful that everything you do preserves your relationship with your client, but you also don't want to make your client look bad in front of their client.  The other dimension to this is that multi-stakeholder meeting are now even harder to plan!  We've already established that good customers are too busy to talk to you already, so they're always unavailable.  Now you have to figure out how to fit a meeting into 3 different schedules, and this dramatically slows down iteration time on clarifying project requirements.  The take-away here is that the best customers you can hope for will also suck up a lot of your time.

     Your Worst Customers Will Not Have A Customer  It's nice to have less bosses, but if you're building something for a client who does not have a customer, the project is unlikely to work out financially for the client (and possibly for you too).  As a bonus feature, you may end up getting some of the blame for the less than satisfactory outcome.  In this situation, it's easy for the person in charge to enter what I call 'Steve Jobs mode'[1], where they simply ask for a never ending stream of 'features' that end up completely exhausting their resources before they discover what the customer really wants (because they don't have one).  Steve Jobs is never wrong, and if the product doesn't make money it was your fault.

     Reverse Survivorship Bias  There is a statistic that says that mental illness is more common among startup founders[2] than it is among the general population.  You should also take into account that for a brand new consulting company you'll likely to find most of your leads coming from other extremely early stage startups.  The implication is that you'll be entertaining a lot of leads with people who might not have the best ideas in their head, and since you're interacting with businesses before survivorship bias has had a chance to kick in, a lot of them won't be 'crazy geniuses', they'll just be crazy.  They are also extremely likely to suffer from the following problems: not having money; lacking etiquette in negotiation of payment or contracts; thinking their idea for a [subset of Facebook] app is novel or valuable.  Also, don't forget that you're starting a business too, so it might just be you that's nuts!

     Increased Liability Risk  The only outcome worth caring about for a VC is the one where you end up being worth boat loads of money.  This is exactly the case where people will start wanting to sue you so they can have some of that wonderful money you've made.  This is true of any successful company, but it's of particular concern if you started out as a consulting company because your business history will be intermingled with those of other businesses.  Contracts, clear communication, and exercising diligence in the projects you take on can help you here, but there will always be increased concern that someone will look at whatever successful thing you've built and say "Hey, that was my idea!".  Even if there person is totally nuts and has no case, it can still affect you emotionally, and waste non-trivial amounts of time or money.

[1] By 'Steve Jobs mode' I am referring to the tendency of entrepreneurs to sometimes feel that they have entered a state heightened awareness where they are able to channel the divine energy of the late Steve Jobs to produce world-changing products. In reality, they're just asking for lots of features they think might be cool, and will soon run out of money.

[2] http://ww2.kqed.org/stateofhealth/wp-content/uploads/sites/27/2015/04/Are-Entrepreneurs-Touched-with-Fire.pdf