Early Stage Marketplace Investing

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One of our Launch Capital staff, Ed Coady, pinged me the other day regarding marketplaces and asked me how does one find the next big marketplace startup at the seed stage. We both remarked that there are a ton of posts on marketplaces and what makes them successful - BUT they are all written as if the marketplace actually has traction. In stark contrast, there are practically no posts written on how to evaluate and pick the next big marketplace at early stage when there is no traction.

For example, some funds will invest in a marketplace when they get to $500K-1M monthly gross market volume (GMV) . But, as a startup, how do you get to $500K-$1M monthly GMV without a series A? And how do investors pick the next one that will get there BEFORE series A?

Those who know Launch Capital know that we invest in early stage where startups are often missing traction, revenue, product, or any combination of the three. In fact, although we call ourselves seed stage investors, we have really moved to what people now call pre-seed, where it is more typical that all three elements are missing and we are only betting on the idea and the strength of the founders. If those are the only knowns, then how does one pick a marketplace play that will be successful?

Ever since I joined Launch Capital, I've been looking at marketplaces in a variety of industries. Here is what I look for in a marketplace for investment which will give it the best chance for success, either reaching breakeven or metrics good enough for the next round:

The marketplace must have no competitors.

I am OK with old traditional, offline competition. However, I don't want to see another startup or three or ten working in the same space. Competition for customers is fierce and with too many things competing for our attention, sometimes everyone becomes your competitor. Thus, it is much better to be the only one in the market trumpeting a service and solution to your problem. Customer acquisition becomes so much easier when there is only one solution available. When there are many, customers need time to decide and this slows down the adoption process. Lack of speed is death to the early stage startup! They need revenue as soon as possible or else their bank account will empty before they reach breakeven or metrics good enough for the next round. Thus, I have found that lack of competition is potentially the most important criteria for early stage startups to have in order to be successful. With today's crowded startup world, most projects we meet have many competitors - all the obvious stuff is being worked on ten times over. When we find startups that lack competition, this often leads to untapped, unsexy markets where I need to spend a lot of time researching the industry and learning about it. In effect, I need to work to fall in love with something that is unsexy!

The market itself must be believably big, in the tens of billions of dollars at least.

This provides not only the biggest opportunity, but also it provides something attractive to other investors who are also looking for big market sizes. When you step into untapped, unsexy markets, it's amazing how big they are and how many are still out there that are untouched by today's entrepreneurs.

Generally for today's early stage marketplaces, I like to see margins be 25% or greater.

Margins that are small require tremendous traffic to get to any meaningful monetization. It's just too hard for startups to reach scale without significant amounts of capital now so I like to see some survivability built into their model by enabling a larger take for each transaction. Note that high margins are tough in marketplaces; more than likely there will need to be some specialness to the marketplace that will enable it to justify higher margins to its users.

However, if the transaction size is large (like in the thousands of dollars or more), then I'm ok with a lower margin. Certainly I like to see larger margins whenever possible, but I am more forgiving on lower margins realized on large dollar transactions. This is more often seen in B2B marketplaces.

The marketplace must have figured out a believable lock-in strategy.

Often entrepreneurs will enable the first transaction, but there is the possibility that subsequent transactions will not happen on their platform. I think this is extremely risky and could leave a lot of future dollars off the table. It is much better if the marketplace has figured out a believable way to incentivize both buyers and sellers to keep using the platform so that they can continue to monetize hard-won users.

I like to see that the founders have depth in the industry their marketplace operates.

Too many founders think there is a problem in an industry but have no real world experience to validate it. Or they lack business contacts in that industry which could give them an advantage in gaining business usage of their platform.

If they have traction when I meet them, even better.

Using the above decision process, I've invested in 8 early stage marketplaces over the years. 4 are doing amazingly well; 2 are too early to tell if they will be successful, and 2 are questionable. With 4 out of the 8 doing extremely well, it seems that something is going right!

Spotting the next successful marketplace is not an easy task. It's always easy to write about how marketplaces get big AFTER they get there, but it's not easy to find them before they are anywhere. There is still opportunity to build big successful marketplaces but they will most likely be in places where few tread but yet are still big markets.

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This page contains a single entry by DShen published on August 12, 2015 12:40 PM.

Angel Investing at Today's Market Rates is a Losing Proposition was the previous entry in this blog.

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