Posts Tagged: Software as a service

What type of market are you operating in?

When we look at investment opportunities, we need to consider the type of market that the potential investment is in. How much room is there for a market leader or leaders? Is it winner-takes-it-all or winner-takes-almost-all? Is there room for multiple potential winners?

Winner takes all

These markets are driven by network effects and only one company will win in the space. Examples of these winners include eBay (auctions), LinkedIn (professional networking), and YouTube (video). When these markets first emerged on the scene, there were dozens, if not hundreds, of companies vying for market share. Yet, only one dominant product survived.

Winner takes almost all

This market trend is happening across the enterprise where adoption is driven by end users, and not dictated from above by IT departments. In this case, a company or tool can emerge as a clear category leader, as word of mouth among satisfied users accelerates adoption across colleagues, departments, and companies. As a result, the tool can grab a large market share in a certain market segment or vertical. Think Mailchimp, Dropbox, Hightail or Unbounce for horizontal solutions or Clio, Jobber or Frontdesk for vertical products (disclosure some of those are portfolio companies). In particular, we see a winner takes almost all dynamic happening in vertical SaaS plays where word of mouth can quickly travel within one industry. For example, lawyers from different firms may work on the same case and spread exposure of favorite tools.

Multiple winners

When markets are not subject to network effects (or there’s minimal network effects/word of mouth), multiple winners can emerge. Today this type of market is mainly in commerce and enterprise IT.

The bottom line

As an entrepreneur, you need to understand what kind of market you are in order to create effective growth and fundraising strategies:

  • Growth strategy: Let’s say you end up being #2 in your market. While second place might be an enviable position for some, it’s essentially worthless in a winner-takes-all market. For this reason, you’ll need to be as aggressive as possible in the first few months after a category emerges to try to lock in the top spot before it’s too late. On the other hand, such an aggressive tactic doesn’t make sense in an e-commerce environment where there can be multiple winners. In this situation, you’re better off adopting a more conservative approach and ensuring you’ve reached product-market fit and nailed unit economics before accelerating.
  • Fundraising strategy: You’ll need to understand your market’s dynamics to know how much money to raise and how quickly. For example, in a winner-takes-all or winner-take-almost-all market, there’s a window to aggressively fundraise while the category is still open. However, once a category leader emerges, it will be hard to attract investors.

Of course, all of this is made even more complicated by the fact that it’s not always clear what the exact category is. For example, do Lyft, Sidecar, Hailo, and Uber all belong to the same transportation category or do they each define their own category? As an entrepreneur or investor, you’ll need to analyze the market and its current players to know how much room (if any) is left.

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Growth versus capital efficiency

I often see two entrepreneurs executing on similar opportunities, but with two very different capital efficiencies. First, there’s the aggressive one who spends money very quickly, building a large team, buying early growth through aggressive marketing and sales, and hoping for a large upround in the next financing round. Then, there’s the bootstrapping entrepreneur who hires carefully (sometimes too little, too late), trying to get as much runway with the current money as possible and build a “real” business.

Finding the right balance between investing in growth and focusing on capital efficiency is one of the toughest challenges for entrepreneurs and early-stage start-ups. It can be particularly tricky as investors are usually looking for growth and evaluating start-ups as defined by growth.

Here are a few observations and pieces of advice to help you navigate which spending model is best for your start-up:

1. Don’t invest in marketing and sales until you have found product-market fit:

Marc Andreesen once categorized start-ups as before product-market fit (BPMF) and after product-market fit (APMF). When you are BPMF, you should be doing everything you can to get to product-market fit…whether that’s changing out your people, tweaking the product, moving to a different market. However, there’s no point in spending on marketing and sales at this point; until you’ve found the right product for your market, you’d simply be wasting your money.

2. Revisit product-market fit from time to time:

Don’t assume that what worked in the early days will continue to work for years to come. External changes in the market can impact your product-market fit, as may your own growth path. For example, as a SaaS company scales and targets larger enterprise customers, its initial product-market fit may no longer be as strong.

3. Evaluate your market: is it winner-takes-it-all?

If you’re targeting a winner-takes-it-all (or almost all) market, then focusing on saving money makes no sense. You’d be sacrificing market leadership. Think about it. Nobody remembers Ryze, or Spoke as early LinkedIn competitors. But if you’re operating in e-commerce or other non winner-takes-it-all markets, then you don’t have to be overly aggressive in the early stages. In this case, you can take your time to fine-tune your model before aggressively scaling up.

4. Get your metrics under control:

Putting the “pedal to the metal” makes the most sense if you understand your LTV (lifetime value) per customer and CAC (customer acquisition costs). As you scale, you should also have early warning systems in place to see if your new customers and acquisition channels are performing at least as well as the previous ones (weekly LTV/CAC cohorts are the best measure for this).

Final thoughts

As an investor, nothing is more impressive than meeting an entrepreneur that has built a great business in a short amount of time and with very little money. Being frugal and knowing how to spend money is one of the most important entrepreneurial traits – as long as it doesn’t come at the expense of growth. Jeff Bezos/Amazon is probably the best example where the right balance of frugality and growth is engrained in their DNA.

 

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How we can improve the odds of finding unicorns

It was my first day at Version One when I realized that finding “VC-fundable” startups would not be easy.  Aileen Lee, founder of Cowboy Ventures, posted a brilliant analysis on why VCs have to look for billion dollar companies (“unicorns”) to deliver acceptable returns, and how rare it is to invest in one: “The odds are somewhere between catching a foul ball at an MLB game and being struck by lightning in one’s lifetime.”

However, despite these kinds of odds, I’ve learned there are several things we can do to improve our chances of finding the elusive unicorns:

1.  Data helps filter through the noise.

With nearly 30,000 startups on AngelList, there’s a lot to sort through. Nowadays, we can learn virtually everything about a company online, from its tagline to founder backgrounds, fundraising history, current investors, and social media traction. However, while data is ubiquitous and free for the most part, it is also fragmented, inconsistent, and seemingly disparate. This makes it laboriously difficult to identify rising stars and make comparisons within a specific vertical.

Fortunately, web apps like Mattermark, DataFox, and PitchBook wrangle, clean and organize the data so that we can focus on analyzing it. We can whittle down those 30,000 companies to a more manageable number by filtering for business models, regions, state, co-investors, Twitter mentions, Facebook likes, LinkedIn connections, iTunes downloads, unique website visitors, and/or other criteria that align with our investment thesis.

2.  Be thesis-driven.

We are often asked what industries we invest in, but it is more important to have theses on business models that serve as strong filters. At Version One, we have 6 investment themes (and more to come – stay tuned):

  • Vertically integrated commerce.  Controlling the entire supply chain brings unique product lines directly to the consumer at lower prices and better margins.
  • Vertical SaaS.  This approach helps capture the market more quickly with lower CAC and capital requirements.
  • Online education.  Mobile and social product experiences are making learning more affordable, efficient, engaging and effective.
  • Hardware renaissance.  Numerous innovations (e.g. Raspberry Pi, Arduino, etc.) are making it easier to develop hardware products.  We are interested in platforms that power this space.
  • Mobile marketplaces.  The ubiquity of mobile makes it quicker and cheaper to connect buyers and sellers.
  • B2B marketplaces.  There has been a lot of focus on B2C marketplaces, but there are still tremendous opportunities left in the B2B space.

3.  Manage your time wisely.

We challenge ourselves to think about tools that we can use to organize and manage our meetings, events, pipeline and readings.  To reduce redundancy in deal flow, for instance, we collaborate online as much as possible with web apps like RelateIQ.  To consume content quickly, I am a power Feedly user and Twitter discoverer.

4.  Be kind and generous.

When most of your time involves working with others, perhaps the most important thing you can do is build genuine relationships.  Because every meeting is a learning opportunity, I make the effort to thank others for their time by being generous with my own.  With entrepreneurs, I try to provide thoughtful feedback, always remembering that they are hardworking individuals with the courage to build a company.  With colleagues, I take note of their interests and share articles or startups with them.

Also, in a world dependent on introductions, I often thank those who make them on my behalf.  For example, in addition to writing the common email line, “Thanks for the intro to Cassidy, David (moving you to bcc)”, I follow up with the “Davids” after meeting the “Cassidys” with notes like “Hi, David.  Thank you for connecting me with Cassidy.  I learned about x, y, and z from her.”  This is a tangible display of appreciation that helps keep me in mind for future connections and deals.

Since writing my blog post on “Why VC is a perfect fit for me” on my first day, I have enjoyed every moment of this work.  I owe this to everyone who has contributed to my learning.  Thank you.  Now to get back to looking for unicorns…

Funding goes global: location is no longer your financing destiny

If we look back ten years, the venture world was quite different. Investors weren’t too keen on investing out of town. And given the fact that the majority of top investors were congregated around Silicon Valley, many entrepreneurs felt compelled to move to the valley to start their business. It was much harder for a “remote” company in the Mid West, Europe, or Canada to draw any attention to themselves.

A recent interview with Union Square VenturesAlbert Wenger reminded me how much things have changed in the past years:

 I’m less interested in the regional differences than I am in the fact that it’s now possible to build very large, global businesses from anywhere in the world…The Internet is global. Geography is no longer the destiny it used to be.

And what is true for start-ups is also true for venture capital firms. The Internet has disrupted traditional geographic barriers for venture capital in the same way and world-class investors are emerging outside of Silicon Valley.

Look global and local

What does this new dynamic mean for today’s start-up seeking funding? In short, you’re going to want to look for the best funding partner (or collection of partners) possible, rather than just focusing locally.

Many firms have developed specific areas of focus and these type of investors can be extremely helpful in strategic matters. For example, NYC-based Union Square Ventures has built up the most experience around “large networks of engaged users”; Berlin-based Point Nine Capital is one of the strongest early-stage SaaS investors; and version one ventures probably has more marketplace investments than most seed funds.

Thesis-driven investors, like USV or version one, can be instrumental in helping you navigate questions like product roadmap or fundraising because they work with similar start-ups in your space and really understand the area.

Likewise, local investors are usually better positioned to provide more hands-on help. One of the biggest advantages here is in hiring: you can pull from their local network and local investors can even interview key hires in person. At the end of the day, you’ll want to find the best partner(s) that meets your specific needs and situation. In some cases, this is local; in others, it’s a remote expert; or a mix of both.

One final word of caution: if you’re going to go with out-of-town investors, you’ll want to see that they have already made investments outside of their own location, so you know they can communicate and operate well virtually (and are willing to travel to their portfolio companies). In other words, you don’t want to be the trial run for a remote investment.

N.B.: AngelList is a great way to identify investors that might be a good fit for you but it is probably not yet the best way to pitch and close them. Getting warm introduction from a trusted source still has a much higher likelyhood for conversion that simply sending messages on AngelList.

 

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Selling to the enterprise: “Sell to few” vs. “sell to many”?

A key investment thesis here at Version One is that we like to invest in companies that “sell to many” over companies that “sell to few.” This preference isn’t necessarily due to market size, but rather the structure of the market: are there only a few dozen customers that might buy your product or are there thousands, or even tens of thousands of potential customers?

Practically all consumer companies fall into the “sell to many” category, but what about on the enterprise side?  How do we differentiate between B2B start-ups that sell to many vs. sell to a few?

1. “Sell to few”: Traditional enterprise sales

Start-ups in this category typically have a target market composed of dozens to low thousands of large (Fortune 500) companies. Selling into this market requires the traditional enterprise sales approach, comprised of a large ‘boots on the ground’ field sales team that works with key decision makers (e.g. CTO, VP of HR) in the customer organization. These are long sales cycles, often with multiple departments and stakeholders involved. And often, enhanced business services – such as custom product development or professional installation and consulting – are involved to complete the sale.

Startups that succeed with this approach tend to have founders with deep connections in the industry they serve, and often previously worked for one of the large incumbents in the market.

2. “Sell to many”: the scalable SaaS approach

Selling to many in the enterprise typically involves selling either to SMBs (where the owner/operator makes the decision on their own) or selling directly to end users (employees) in the organization.

Yammer and Unbounce are perfect examples of SaaS tools that are adopted directly by the end users. In these cases, employees feel a particular pain point and find a solution to address it. Based on the lower price points, these employees often pay for the product with their credit card, without asking IT for permission or assistance with implementation. These acts can often be start of a viral growth curve in the enterprise. Enterprise products that present a high-value daily utility for the people involved can have a high virality potential.

The SaaS model, with its inherent low customer acquisition costs (CAC) and ease of deployment, makes it possible for companies to be successful when focusing on the SMB market, as well as niche verticals. While traditional software monopolies needed to be “all things to all people,” cloud start-ups can focus on one area and do it extremely well.

Final thoughts

Both approaches can create large and important companies, but they require different kinds of founders and investors that understand the nuances of each approach. At Version One, we’ve identified that we’re a more effective investor when focused on the ‘selling to many’ approach.

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