VCs typically look for:
- A large and growing market size
- Favorable competitive landscape
- Opportunity for solid margins
- Attractive distribution model
- Visionary founders building a strong team
- An unfair advantage
- High exit multiples
A large and growing market size
E-commerce is already close to a $400bn market and growing at 15% per annum according to Forrester. The Goldman Sachs 2013 Annual Report stated that “e-commerce is the #1 opportunity for growth” and expect it to be >$600m by 2018.
The factors contributing to this growth are:
- The market, through social acceptance, and infrastructure are now ready
- Shopping is an inherent behavior in us
- Consumers now trust online payments
- Phones are larger and easier to shop on at just the touch of a button
- Shopping for fun, not just for need
- Every step of the user experience is more appealing now
- Significant data available for brands allows better targeting
The specifics are what matter here so I would focus less so on e-commerce overall and more so on the specific market that your business is in.
Favorable competitive landscape
I read an interesting story last month, The end of the Billion Dollar Brand, which argued that there will be no more billion dollar e-commerce companies given the low barriers to entry in the space. This view omits the “lamb effect” that consumers, especially young teenage girls, have. This “lamb effect”, where young people follow one another, is inherent in us and is one of the factors that leads to the creation of a brand. Once a brand is truly created then low barriers of entry in a particular category don’t matter anymore. Or rather, you created your own barrier to entry.
The Honest Company, with its incredible celebrity endorsement, is a good example of a strong brand. It does have competition but has created such an incredible brand that: the mothers want to buy the products, the Stanford grads want to work for it and the public market investors want to invest in it. The competitive landscape is less important once a company, like The Honest Company, is identified as a top brand.
Opportunity for solid margins
I am not going to try to argue that e-commerce brands will ever be able to achieve the type of margins that software companies have achieved in the past. I am, however, going to argue that on a relative basis e-commerce margins are far more attractive than ever before. This is due to vertical integration, technology improvements, and employing on-demand manufacturing to reduce inventory risk. Smart investors and entrepreneurs don’t look at all e-commerce companies as the same low margin businesses but instead look on a case by case basis.
Attractive distribution model
Historically, e-commerce companies have had to run on the CAC/LTV arbitrage treadmill to grow, which means spending tens to hundreds of millions of dollars to acquire customers. Gurley’s post here is one of the best reads on this topic of LTV.
We’ve uncovered some companies using clever new low-cost channels to drive growth. I delve into details on the specific companies next week but think of Dollar Shave Club with their effective (and cheap) marketing campaign, or The Honest Company with its strong celebrity endorsement, or IPSY with its Youtube fans driving much of the company’s early user growth. These factors are leading to startups both accessing and acquiring customers in a more capital efficient way, which ultimately contributes to a far more attractive Lifetime value/ CAC ratio.
Visionary founders building a strong team
Founders who are both strong visionaries and product pickers, that remain unique to their own style is exactly what we look for. People that have an intense focus on adding value and getting to product market fit. A players hire A's and B's hire Cs, so a founder who maintains the quality of top A players that they hire is a major factor that we look for in a startup.
An unfair advantage
Competitive advantage in the early days centers around your IP, team, network effects and any special relationships. It’s key to think about what your specific unfair advantage is. The specifics here are key but one angle I would emphasise, especially as your word of mouth continues to spread, is that your brand is a key advantage.
High exit multiples
Unfortunately this still remains a problem for e-commerce where most exits we see are on 1–3x sales. The U.S. public market investors that I spoke to remain concerned that e-commerce companies will continue to trade on a 1x revenue multiple. In Europe and Asia we are seeing significantly higher multiples. I question whether the U.S. will follow suit once consumers become more convinced. More on this in the 3rd and final blog.
Why this, why you and why now?
We have discussed what VCs look for in an idea and team, but the why now is equally important and I continue to ask what is changing that would make us want to invest now. Timing is everything. Ask yourself, is there an inflection point emerging that will change the size of the market? Are tastes of your core user changing that could create a new market?
If so, these inflection points are exactly what I want to hear about, so please drop me a line.