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Pros and Cons of licensing software versus building it in-house?

I'm looking at providing SaaS. I have found an existing technology that works well if I were to license and use it as my engine. Will VCs say, "You don't own the underlying technology so I don't care about you." or will they say, "You have demonstrated great value proposition proven by the market share you've accumulated, let's talk." Is it better to build or license?

13 Replies

Lawrence I Lerner
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Lawrence I Lerner Entrepreneur • Advisor
Digitalization and Transformation Coach
Marvin, great question.

I think we'd need to understand the core value proposition that your company brings before commenting on build vs. license.

Some food for thought however. There are great platforms such as SalesForce.com that allow companies to build upon them. If you had a great app and understanding of some market (e.g., convenience stores) and were able to demonstrate:
  • You could take/create market share
  • Create a barrier to entry (E..g, first mover, specialized skills/relationships/addon technology)
  • Great management team
That is something that a VC will buy into. Not all VCs are focused on the same market, so finding the right one is important as well.

This is an interesting dialogue. Looking forward to hearing more from you.

Cheers
Tim Kilroy
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Tim Kilroy Entrepreneur • Advisor
Analytics - LTV - Boosting Profits - Digital Marketing
If you use white-label, you will not be in control of your destiny. Without owning your technology, why would someone invest - there is zero barrier to entry - a competitor could come and do the EXACT same thing you are, with the exact same capabilities, but for less. There is no reason to invest in a company that can sell better than another company (that is what you are adding here - sales). That isnt a sustainable advantage. What you should do is start selling the white label service and use the resulting revenue to build your own service and then transition your clients. At that point, you can start with investors. At the start, you are essentially doing business development for the white label company and collecting a commission. Grow revenue, build your own and then you will have a business that can be invested in (or not - you can, in fact, build a great business out of revenues) T
Tom Maiaroto
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Tom Maiaroto Entrepreneur • Advisor
Full Stack Consultant
I don't think that turns off VCs (not all of them anyway). Some misguided VCs might think owning proprietary tech is the end all be all - but if there's no market for it? Then what? Or if the cost to develop put you in a whole that takes years to climb out of? Then what?

I'd first look into open-source solutions before licensing something.

Your business model is far more important I think. Compare this to servers. Do you need to own the data center and physical machines to run your SaaS business? Or the "software" on there? Many people forget that RedHat and Windows are pieces of software which must be licensed. No, of course you don't. So why would any other software be any different?

Patents? They aren't well suited for software. Completely broken system. Plus, you can patent business methods anyway.

Licensing something now could allow you to go to market sooner (or first). Let's say it gives you a 6 month lead. That could be 6 months worth of profit that you would otherwise not have. Depending on what you're doing that could be enough to actually fund the construction of your own software.

Remember the golden rule of the internet. Things never stop changing. There's too many languages and too many developers out there. There will always be something newer and better.
Tom Maiaroto
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Tom Maiaroto Entrepreneur • Advisor
Full Stack Consultant
@Tim Kilroy - that's not quite true. We do invest in companies that can sell better than others. Look no farther than the retail space. Look at Walmart. Or if you want tech - how about the server hosting space? You think it's called "open stack" because it's proprietary? So Rackspace isn't in control of their destiny for having used it?

Competitors can ALWAYS come in with the same exact offering. I could single handedly clone any web application that you can find out there. Top to bottom. Design, code, server configuration. All of it. And I'm just one person.

It might not be the same exact code (well of course not) or language, but it could do very much the same thing.

Here's the best part: It wouldn't even need to work as well. Most people can't determine what's "better" when it comes to technology anyway. Ahh, but then see? We've come full circle on my point. That's where selling better than someone else comes into play again =)
Corey Butler
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Corey Butler Advisor
Entrepreneur, Consultant, & Web/Data Engineer
Investors primarily care about the proprietary value-add and how it's protected. That's what generates revenue. In some companies, the technology is the proprietary component. In others, the subject matter expertise is the value-add. Don't underestimate the power of specific subject matter expertise. It can be a barrier to entry for your competitors, especially as some technology is becoming a commodity.

In your shoes, I'd ask myself the following questions:

  1. If a product already exists, how is building it myself going to change my value proposition?
  2. If I build it, will that stop someone from licensing the other product to accomplish the same thing?
  3. Who are the VC's and Angels that invest in this space?
#3 is an important one, because investors are just people... everyone has different opinions and evaluates risk/reward differently. Get to know these people... or just ask them what their opinion is.
Tim Kilroy
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Tim Kilroy Entrepreneur • Advisor
Analytics - LTV - Boosting Profits - Digital Marketing
@TomMaiaroto Point taken - but Walmart or Rackspace have distinguishing advantages that wouldnt exist in the case at hand. Licensing software is great - but not having a proprietary value add (Walmart - Logistics & Sourcing / Rackspace - Software & Management Tools) other than selling means that you are vulnerable to price disruption - proprietary software can help protect you from that. If I were an investor looking at a business using open source tools or licensed tools, I would immediately wonder how they can get leverage - what if the cost of the license changes, what if clients demand a new feature not supported by the platform (you cant adapt what you dont own). Open source is different that licensed (Acquia is a great example of a company built on open source that adds significant value). What I heard is something like - I will sell Quickbooks instead of building my own. And that is a GREAT business model for cash-flow and potentially revenues, but would you invest in a reseller with no sustainable value add?
Tom Maiaroto
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Tom Maiaroto Entrepreneur • Advisor
Full Stack Consultant
@Tim Kilroy - Very true. It is different... But I guess I should rephrase and say provided you do have those other advantages, it's not as important as one might think. Just because you need to or it makes to license software doesn't mean you can stop right there.

I'm assuming (and hoping) Marvin Sharp here has a business bigger than the software.

I also don't understand companies like Acquia and WPEngine, etc. They truly are the epitome of this example. They offer a service and have no actual secret sauce. They are actually the closest to grabbing software off a shelf and re-selling it. I don't even believe that they add any actual value to be frank. It's a perceived value. I truly believe these companies only exist due to an under educated market. Once (or if) people become more tech savvy, those businesses can't survive. OR more realistically, if we saw hosting providers provide more "one click" solutions for these needs (CMS' / blogs) ... Poof.

Of course I'm coming from the developer perspective so the challenges they solve are extremely trivial to me. Perhaps others actually do find their services useful. I just don't think they are very well protected is all.

Which would go right along with your point of course =)
Aaron Snyder
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Aaron Snyder Advisor
CEO and co-Founder at DOMAIN OMS
Unfortunately there is no correct answer to your question. Ultimately, with respect to a license agreement, it will depend on the terms of the agreement to establish the value of that relationship. Alternatively, developing a proprietary platform that doesn't do what you say it does isn't worth anything (plus you have spent a lot of time, money and lost opportunity costs) to own a pile of junk code. As an attorney, I have seen a lot of horrible license agreements where the licensee paid (and continues to pay) for very little rights but also some very pro-licensee agreements. As an owner of a SAAS software company with a proprietary platform, I have also experienced the other side of the equation... There is no right answer!
Jake Carlson
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Jake Carlson Entrepreneur • Advisor
Software Development Manager at Oracle
@Tom not to go too far off on a tangent, but I am a very experienced Wordpress developer and recommend WPEngine to clients all the time -- and I use them myself. I don't know how familiar you are with their offerings but their price point is well worth the value they add. Run-of-the-mill LAMP hosts are not optimized specifically for Wordpress, don't have one-click staging deployments, don't automatically upgrade WP for you, don't have a high level of Wordpress-specific technical support, etc. *Of course* all of these things aren't difficult to set up or do manually for a developer, but that's not the point. But the extra $15 or so per month vs a budget LAMP host is well worth it even for people that *could* do it themselves.

Just like I *could* set up and maintain my own server for each and every client. But nobody wants to do that unless it's absolutely necessary. At some point you realize that time is money, and the convenience itself is the value-add. If you value your time at $x/hr then you can decide what trade-offs are worth it to you. WPEngine is worth it to me because neither I nor my clients want to have to think about upgrading WP or patching security issues, setting up staging environments, etc etc.

What your software is built on is a consideration but a minor one to your customers (and hopefully investors). The concern should be how easy it would be to replicate what you've done. And yes, even proprietary software can sometimes be very easily replicated. So without knowing just how your platform will differentiate itself, it's hard to say whether to license or build yourself. If your competitive advantage is the software itself, then obviously you want to protect that advantage by baking in things that can't easily be replicated. But your competitive advantage may have very little to do with the software itself, in which case it becomes less important that the software *could* be replicated.
Eric Wold
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Eric Wold Entrepreneur
CEO @ RingSeven • Web & Mobile Dev • Startups
Credit to Tom for touching on this subject, but I felt it was worth of expansion.

Example for you:BackOps.co. Great example of a cool service that does not own it's own tech base. 7 other major tools all driven by a unifying API layer they do control.

Time to market was accelerated because they didn't have to build out a "utility" tech base. For their market/product NOW was the time to rush to market and grab customers / market share. You need to understand that this was the ideal solution for the current stage of their market. The funding they raised could mostly be directed at growing the sales operation and customer acquisition. Later they can go back and code out each of the sub-systems one at a time (if warranted). That might be a great use of B or C round capital.

The most critical question in a start-ups life is... once we get this to market will people really buy it? Will doing what BackOps did get you to market faster so you can focus your available capital on de-risking that critical traction question? For BackOps their argument was good enough to persuade Google Ventures and others.

For some ventures it's the right move. Can you make a strategic argument like they did? If so VCs will understand and appreciate the funds you are looking for will take you much deeper into revenue territory, and you'll achieve break-even faster.

As an entrepreneur I think it's a dream-come-true to be able to use Seed and A round capital to grow your revenue base, and B or C round capital to build your code base. Yeah, doing that backwards won't work for many (most?) startups. But think about how much better you would know WHAT YOU FRICKIN NEED TO BUILD ONCE THE TIME CAME?!?. If your niche is a natural fit for this approach... my vote is you would be crazy not to do it "backwards" just like BackOps did.

Any more good examples like BackOps out there?
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