In the previous articles we looked at how a revenue model for a design services company can develop and how it can be grown to create multiple independent revenue streams. This obviously increases the value of the business. The ability to decouple, even loosely, the revenue growth from the headcount is a key step for a design services company. It makes it more robust, more valuable and less impacted by market fluctuations.
Whereas the earlier (staircase) model is a good approach in scaling up revenue and creating new revenue streams, the foundation of the company is still based on the service model: headcount continues to be the main driver (typically up to 60-70% of revenue). In terms of (enterprise) valuation the additional revenue streams, however, will already make a significant difference.
A much bigger leap is possible when shifting the complete model: from service to product. At that moment the enterprise value of the company is determined by the market potential of its product. This is not an easy step to take. The different models we have supported include a buy-and-build approach and a spin-out approach. Both have design services and accumulated product knowledge at their foundation. Both have advantages and challenges, and the root of their choice often depends on the historical developments of the company and its size. Larger companies are more likely to choose for a spin-out approach as it leaves the “mothership” more or less intact (and as such an additional anchor for the spin-out). It also allows for further spinouts based on other valuable technological tangents being developed by the company. Smaller companies tend to be better suited to make the jump as one. For both scenarios successful exits have been achieved with exit values in excess of €350M. As the path to this type of exit requires more thought and preparation, it is less popular.
However, we do observe a higher degree of success when this path is followed. This should make it more worthwhile to (deep-tech) investors to consider and support design services companies.
One of the challenges that comes with design services is the cyclical nature of the services business. When the economy tightens and corporates are watching their operational expenses, the first step will be to halt any external contracts/contractors which are not deemed absolutely essential.
Whereas the earlier (staircase) model is a good approach in scaling up revenue and creating new revenue streams, the foundation of the company is still based on the service model: headcount continues to be the main driver (typically up to 60-70% of revenue). In terms of (enterprise) valuation the additional revenue streams, however, will already make a significant difference.
Design services companies typically start small (some exceptions when it concerns management buy-outs) and natural growth is a slow process as it requires hiring and training of engineers based on/driven by the revenue stream of the company. Growth of business is tied to growing the team and it is not always easy to find the engineers.