B2B Marketplaces | Investment Strategy

Investment Thesis 1.0 | Part 3 of 5: Investment Strategy

This part of my thesis will discuss a WIP investment strategy that investors can use when assessing B2B marketplaces. I’ll walk through success drivers I’ve seen in my operating experience as a Product Manager and through my research of the sector. A combination of these success drivers and the outlined assessment metrics are meant to factor into a scorecard that can provide a more systematic approach to diligence. The factors outlined spread across the product (e.g. SaaS-enabled), financials (e.g. ARR growth), deal dynamics (e.g. valuation), the team (e.g. leadership experience), etc. If you need to backtrack and gain more context on my thesis here is Part 1: Overview and Part 2: Sector Summary.

Photo by CHUTTERSNAP on Unsplash

Success Drivers

• Vertical instead of horizontal: A reason why B2B marketplaces haven’t found as much success as B2C marketplaces is due to the specificity of the underlying industries and the complexity of the purchasing processes. For example, at Rocketmiles, I uncovered the detailed nuances of the hotel industry that proved a generic API could not be used. I found immense non-standardized detail in hotel information (i.e. amenities, room details, meal offers, types of photos, reviews, etc) and fee structure (i.e. refundability statuses, booking fees, credit card fees, resort fees, etc). With this amount of detail, a horizontal marketplace that spans across multiple verticals cannot offer the proper user experience to satisfy users in each vertical.
• Highly fragmented markets: The markets that are most ripe for disruption by one of these startups are those with industries that contain many small service providers. This means that the providers of the product or service do not have the means to build their own tools and there are no large providers to build a tool for the rest of the industry. I’ve seen this firsthand in the caregiving industry on one of my side projects. In the homecare industry, there are many thousands of small homecare agencies that are focused primarily on service delivery. They do not have the budget or expertise to build, for example, SaaS products for scheduling sessions or a marketplace for finding caregivers.
• SaaS enablement: For a B2B marketplace, one of the most important tactics is offering a freemium SaaS product that provides immediate value. It will entice the businesses into the marketplace and get them onboarded with less friction. The SaaS product or platform on top of the marketplace can streamline the users' workflow and improve efficiency or provide new insights on top of their normal transactions. It is also a way to create stickiness and loyalty within the platform and reduce switching tendencies. If you add value to the businesses over time with this SaaS product, then transactions and further spend will come.
• Consumerized user experience: Over the past decade, as I’ve gone from school to industry, I have seen consumer tech companies invest heavily in user experience and user-centered design. Needless to say, as a student of design thinking, I am a fervent believer in intuitive, pleasing experiences and have personally seen the payoff in terms of retaining users. According to Roland Berger, 80%+ of B2B buyers now expect and demand similar purchasing experiences offered by B2C websites.

Roland Berger | The Summer of B2B Marketplaces

• Liquidity: The primary side of the marketplace, likely the purchaser, must have ample options of supply. Liquidity in the marketplace will reduce churn of the purchasers and will allow for repeat usage. Solving this issue is essential and was one of my first challenges at dscout as I worked on the B2C side of our business sourcing and retaining research participants.
• Product-driven, bottom-up model: An “organic” sales process allows users to naturally and willingly adopt a platform. If prospects are able to trial a product for free or at a much lower cost, then they will be able to assess and envision future experiences. This is more economically sustainable because sales qualifications are entering the system naturally. Moreover, this trial period allows the company to collect behavioral and purchasing data to customize the platform and sales approach for each client. For dscout, our trial projects have been an efficient funnel for converting qualified leads into subscription customers. Prospects are easily able to find their fit with the platform and get a peek into our exceptional customer success practices.
• Data-driven customer success: SaaS has necessitated customer success and it is crucial that these services aid the retention of clients and spawn loyalty. It’s important for Customer Success to track usage and health metrics in order to identify churn-risk clients, inform product roadmap, identify opportunities for upsells, and groom renewals. As a product manager at Rocketmiles and dscout, this has been one of the keys to our success. We have a constant feedback loop between customer success and product (i.e. CRM case tags, feature request funnel, bug report system, etc) to make sure we are addressing customer pain points and planning for the future.
• Promotion of quality products: Unlike in a B2C marketplace, convenience is likely not the main criteria for purchase. In fact, the purchasing process is much more complex in some of these marketplaces with multiple stakeholders. Across these stakeholders, one key criterion is quality. The products, services, or data purchased need to be as high quality as the end product the clients are trying to build. At dscout, we make sure our participants and data output is extremely high quality. This has impressed our customers and has become one of the keys to preventing churn.

Assessment Metrics

In addition to the success indicators outlined above, there are a number of quantitative and qualitative metrics to look at when assessing a B2B marketplace deal. I have assembled some of the essential metrics based on my own experience and articles from firms like Bessemer Venture Partners (BVP), FJ Labs, NFX, PointNine, and versionone:

• Pre-money valuation: At the Series A & Series B investment stages, these companies should be generating revenue and be well past proof of concept. With the popularity of Pre-Seed rounds, we may also now see revenue generation for Seed investments. Calculating this valuation will be dependent on multiple factors including total market GMV, company ARR, AOV, margin percent, growth, burn rate, etc. Furthermore, it will be essential to assemble a set of comps within the vertical and tangential verticals. For the B2B marketplace sector, a few firms ballpark valuations in the range of 1–3x GMV or 6–12x annual revenue with variance on vertical and stage.
• Market size: When thinking through the TAM of these marketplaces, a reasonable practice would be to first understand the GMV of the specific vertical as well as the tangential verticals that the company could expand into in the future. Then based on either comps or better yet company experiments/proof points, the calculated GMV can be downsized by the take rate. For B2B marketplaces, it is important to balance revenue for customer conversion. As investors, we must understand the flexibility within the take rate. Marketplaces must stay conservative and test their way into the right pricing structure and make sure it is not creating extra friction towards usage and customer acquisition. For reference, Bessemer’s benchmarks outline the GMV of a few popular marketplace verticals.
• Revenue growth: As with all startups at this stage, exponential revenue growth at the rate of 2x or higher over an annual basis is ideal. High-velocity startups that have proven customer demand and have the potential for large-scale expansion should view this as a basic threshold. If there are significant regulatory or industry hurdles, these can be considered for dampened revenue growth. Bessemer has outlined through their GRIT score standards for ARR growth as a component of time.
• Business model resilience: The ideal state for a marketplace that produces the most revenue would be high AOV and high purchase frequency. This can be achieved in some industries like metalworks or freight shipping, which make these markets more attractive than others. However, achieving this is difficult for many industries. A worrying case would be a marketplace with few purchasers at high AOV and very low frequency. This case is susceptible to churn derailing the business. AOV and purchase frequency can be viewed in isolation as metrics and NFX outlines ranges in their essay. In agreement with FJ Labs, I believe we should measure the balance of AOV and purchase frequency through an LTV/CAC ratio. If this ratio is large enough, the business will be resilient. The ratio will also dictate the necessary and acceptable timeline for the company’s runway.
• Competitive advantage: These startups may be tackling the old wave or riding with a new wave of competitors. In either case, it is important that the startup has either started to put up a competitive moat or has the building blocks to do so. This moat can come in the form of end-to-end SaaS across the value chain, technical edge, partnerships and/or integrations, user experience differentiation, data network effects, deep market penetration, etc.
• Team experience & leadership: A well-rounded, experienced team is essential at this point as the startup is at the crux of its product-market fit phase. An industry expert on the leadership team is a key element to some of the best startups. In the B2B marketplace space, it is especially important that the CEO and leadership team have experience working in the industry as they will best be able to identify pain points and opportunities within the entire value chain.

Read on to Part 4 of 5: Case Study.