What Series A Investors Look For In Marketplace Investments

my name is Rashid Garg I'm a partner at the Mayfield fund we're an early-stage venture capital firm and prior to this out of 14 year offering career at a bunch of consumer companies like Twitter and square Josh right so I'm Josh McCown a general partner at Greylock and at the firm I oversee a couple of different investments on the consumer side including one managed marketplace called saunder in the travel space I actually got my career started building marketplaces including being an early product manager at Google building AdWords which is kind of like thinking that it's a massive managed marketplace and then from there I started a company called teleport which is in the marketing technology space but that's about 170 million in revenue sold it to Twitter I was vice president Twitter for a couple of years and then joined Greylock which in fact me as an entrepreneur now on the Investor side hi everyone my name is an academy I'm a general partner at red point most recently I was working at uber actually on the operating side and helped build the uber freight business from zero product zero revenue up to several hundred right both employees and revenue dollars I before this and I would also an investor another fund called CRV and there I invested in some other marketplaces like um door - which many of us are probably using more than we have been historically recently and classpass and patreon very nice-nice great so we're gonna run through a variety of questions here are some kind of introductory and and some little bit more sophisticated for the wide variety of folks we have in the audience let's earth the basics get everybody on the same page how do you define a marketplace well so I'm curious what you guys I think about of marketplaces in the simplest form a business that connects at least two groups of people typically viewed as kind of supply and demand sometimes you can have a three or possibly even a multi side in the marketplace and as Josh mentioned there are other businesses that are like ads businesses as an example that you could consider a marketplace - yeah I think that's right and and I'd say most marketplaces are two-sided and and we'll probably talk about those a bunch just because that's where you can tell you what supply and demand as Andy mentioned in a really explicit way unless you wear off yours tend to focus their time on building those kind of two-sided market equity and the role I would save the marketplace is to should for both sides or multi size depending on the nature of the business the purpose the marketplace should exist to do something that couldn't be done before for either shop so there's sort of this hot what's interesting about them and also very hard about them is that there's this really high bar to make the marketplace sing for its supper in terms of adding value both more questions life so if you end up finding the scale yeah and I agree I think I think for the sake of this discussion we should focus on on two sided marketplaces generally but just as a quick intellectual exercise can anyone give an example of a three sided marketplace when I think Annie already mentioned door - right so that's an obvious one between the consumer the restaurant and the delivery driver and you've got to make it work for all three parties both in terms of convenience liquidity the price of each is willing to pay or accept I think that's you know the the multi-sided marketplaces are ones where I think technology can really play an incredible role and that's where that's where I think to reach each point you get to these places where things that start being done that could never have been done before certainly some some common two-sided market places include companies like lyft and uber connecting drivers with riders Airbnb or couchsurfing connecting hosts with with guests and so on and and so so let's move a little bit into the metrics that are associated with with marketplaces and marketplace investments and the KPIs people think it'd be talking about gross revenue and net revenue and and I mean we can briefly define those terms and and which as investors you care more out and and when you're looking at a marketplace investment do you think more about gross revenue growth or net revenue growth or some combination I mean I you know they're both important gross revenue is an indication that there's you know gross volume of transactions going to the system and most marketplaces although not all of them the business model is a transaction fee on whatever the gross revenue is if I sell $20 of food I take 10% cut or whatever the number is 25% cut the net revenues what pays the bills for the company for the startup which is why we care about net revenue but that can vary really widely sometimes the take rate that percentage is very small sometimes as much larger and and then the question is sort of what what is driving whatever that percentage is and how sustainable is that you know gross revenue is great but it could be misleading because if your takes really low you can have very little margin business and so you have to think about these things together never revenue is sort of the real revenue of the company that you're trying to invest in and so we care about what the income statement usually looks like and uneconomic from the net revenue line in particular all the grid form is a good example of both market size customer impact a little bit yeah one thing I might add that you know Josh and Richie and I have all invested in early-stage marketplaces where you might evaluate these metrics slightly differently and then what you would at a later stage company as it's growing and at the earliest age the one kind of addendum revenue is usually you're gonna make some assumptions about how never revenue is going to ideally expand but potentially contract as the marketplace grows over the course of time and so another metric that and I spend a lot of time on I'm sure these guys chew is net revenue retention and that's like a cohorted view of the people that are paying you money maybe it's a take rate is Richie month as I mentioned or maybe it's a subscription and some way shape or form are they continuing to pay it over the course of time I think this is an early-stage marketplace actually arguably a more important metric than what your kind of total net revenue is and maybe this is too simplistic a question but if you if you were looking at one business that had you know 100 million in in gross revenue and and 1 million in net revenue versus 5 million in gross revenue and 1 million in net revenue is there is there as you have a need in terms of the profile that you would prefer well I need to know what the total market size is for both there probably a need I mean yeah you said is there a knee-jerk reaction you assuming the old market size constant to any point then usually make your 1 million I'm 5 minutes more interesting provided that there's a pathway to expand and take a meaningful portion of that market share because it may suggest or may not stuff but it may suggest that you're doing something of real value for the supplier in the buyer so you're able to convey on the 20% a versus a 1 percent take the challenge might also be though is if those two businesses were in the same market because then you look at the one on 100 and believe that that one on 5 is actually maybe just gonna trend that direction and so you might not have those stronger I'm level of conviction and that margin profile you have that trait yeah the worst the worst case is you start out with a one on five business and then you end up becoming a 1 on 100 business yeah the interesting thing about marketplaces especially today given all the tools that we have at our employee is that it's really hard to build a winner-take-all marketplace today and most marketplaces only get to true unit economic profitability if they're number one in the space and they have to be number one by a wide margin right so I think there there are a number of examples in food deliveries it's a good one where you just had too many well-funded competitors that are kind of slogging it out more or less neck-and-neck sometimes you know all three of them with equal parts of the market share in a given market and it's only in markets where they've been able to break out as number one that they've shown unit economic profitability so part of what we do and we look at an investment is certainly we'd rather see 20% gross margin you know though the 1 million dollar net versus five gross in the early days but we also need to believe that there's a pathway to sustain something close to that it doesn't have to stay at 20% we definitely don't want it to get sort of whittled down to 1% yeah that makes sense yes sustainable defensibility is always an intriguing topic especially when it comes to to market places and and and the nature of the defense ability is something we we talk a lot about at my reduce myself in the introduction time I apologize for that my name is Daniel Hoffa I'm with Auto tech ventures we do ground transportation investments so that's that's the perspective that I'm coming from but it's a pleasure to interview all of you who are generalist investors not just focused on ground ratification one of the topics that just came up with with regard to how you view those investments was the topic of market size and and so is there is there a a minimum market size necessary to get you excited to invest and and and I realized that sometimes market sizes can can change they can expand and to adjacent markets and so on so but but from a founders perspective when they're when they're assembling their pitch deck and and looking at their own industry you know what size does a market need to be in order to give interest to to investors I'll tell you from our perspective this is a really just rough rule of thumb but we have a billion dollar fund and historically we've been able to turn that into college somewhere between five and seven billion dollars for our limited partners to invest with us and most of those gains come from very very big bets that we take with companies that get big upside so historically Airbnb LinkedIn Facebook workday Palo Alto Networks on the on the b2b side and so the rule of thumb that we try to approach entrepreneurs with is a simple question is what do you what do you have to believe for this to be huge and huge for us and around roughly call it a hundred million dollars in net revenue in the case of marketplaces we want to kind of be able to pencil that and it doesn't have to be super obvious today like it doesn't have to be numbers that you can clearly plug into a spreadsheet but you need need a general sense that can roughly get there even if that includes a couple more turns on the on the strategy but yeah I'd say being able to pencil to one hundred million dollars to attend college you know like I'm five to seven-year time frame would be would be a good anchor so to be clear we're not talking about market size were talking hundred million in net revenue yes right which is which is sort of the byproduct of a large enough market and I might just kind of think about that one of the biggest one of the biggest head fakes in marketplaces can be market size right over kind of being one of the famous examples Pilger always talk abut open table a lot because if a marketplace is really singing for its supper and doing something spectacular for the consumer and for the supplier you have to be excellent for both sides if you were doing then operationally then usually not always but often you can expand the market pretty dramatically food delivery as a market sort of youin those percentage of food sort of expanded really dramatically over the last ten years the when we looked at the window the square early on we got into the taxi business believe it or not I looked at the market I think was like twelve billion dollars of total like revenue in the country in 2011 oh you know and it wasn't that much better in the country around the world and so you you know really great marketplaces will enable something that wasn't possible before so then the question is looking at the Whistling market is often kind of a bit of a head shake you have to thank you at least what we try to think to ourselves and the businesses that we've invested in that have been successful marketplaces like lift and Poshmark and stuff like that is like hey can you imagine that everyone might be using this could this be a third estate kind of the everyday person was like oh yeah that's like one of my options oh yeah everybody versus a hotel oh yeah door - oh yeah instacart you know so that's like more of an interesting rule of thumb is what is the work provided something that's really valuable because these are micro plates are so hard to build you know and then to create the really big outcomes you know you often you need to get not just a hundred million but no can could this be a company that's what has ability and ten billion in gross or net revenue V because there's so much potential for that which is hard thing to see in the early stages it's something really interesting but we try to run that thought experiment as long and hopefully but here's also a compelling entrepreneur in this nice stage she's pitching for an a hopefully can help the investor dream with them about why that could become an everyday experience that's kind of the best ways to help us do is so we can dream alongside make all the comfort I might not add one quick thing but she said in an audience to your question directly in terms of kind of market a size minimum threshold the first is his points a good one the taxing markets investing the best example I can think of right you would have looked at that and thought where the black car market right and you would have scratched your head and thought like how can think of a business can you build there and the counter is that sometimes markets can look a lot bigger than they actually are to so with uber Freight as an example write something and again you probably know this market pretty well too right it's something like 700 billion dollars that Freight is moved by long-haul trucks in the US every year you look at that number in you're like holy you can build a really big business there but in reality only about a third of it is trestle and in this case the market so big that still you know to 250 million dollar market a billion dollar market so it's you know plenty large but sometimes you have to cut it the other way too and then tans to the question and if I if I think about a kind of talk down I get to a very similar answer to Josh where you're looking for about a hundred million in that revenue to me that implies the market size of about forty billion if I'm assuming a market penetration of kind of no more than 2% because I I'd like to be able to hang my hat on the market place that doesn't have to own the whole market because that is so hard to do yeah that's great perspective I think I agree I think I I was not actually working as a VC back in the days of oberus series i although i actually was at the ir there at benchmark around that time but but i but i do think it's an interesting case study of how you know looking at the taxi market it's very deceiving and certainly some some great investors passed on the deal because it's hard to visualize that Facebook is another great example you know why would you sell ads to college kids they don't have any money it's alright you know from from a VC lens that's it's easy to understand how one might not recognize the opportunity and that's part of the job VC to try to think creatively and see possibilities that but sometimes even the founders don't see ya and add one more thing with any such thing is so right on like look at the food market today ok it's a trillions of dollars right so a lot of a lot of emerging companies are looking at food as an interesting market because the market so big and it is but then the question is for these very competitive markets is the market is the emerging market place the new marketplace is doing so much work in such a unique way from the consumer so your demand ultimately will pull you in these hyper competitive markets you can get to that hundred million in that revenue right and that's where a lot of companies that's what's really hard to do that's really hard to find these areas where you're doing something really inspired that can like actually break through in a market and capture any share I think I think many founders are seeking some sort of assurance that they're on the right track in order to get funded and looking for an algorithmic formulaic kind of approach to metrics which I realized may not may not be applicable in many cases but but at the same time you know in an interest of trying to address that kind of question and thinking is there is there a typical range for for gross margins or or month over month growth that you are expecting or wanting to see in a series a marketplace investment or to put another way what are the ranges that you do see and and what are you comfortable with I think it's rare that we would invest if there's and this is a very rough range but usually we see for compelling business that shows that there's some customer pull at least 10 percent month or month over month growth in the early early stages you have so you know you generally have a law of small numbers so if you're not able to generate that then you say there's a question of whether matters consumer demand not always and I don't even know what the top end of that is question is to double-click on what's driving that growth and is it is it because that work is being done for the consumer and it is really compelling to both sides I'll give a so I guess I'll just give a rough floor which is sort of like a ten percent although it can get a lot higher yeah say this is a this is Prada start of putting together these models if you will any expectations around them is that you as an investor you want it all right you want to see an entrepreneur who's dive deeply into a small enough niche or specific geo market that they've really started to make a thing sing and hum and that's where you're starting to see this pull directly from consumers you're not having to pay for all of your traffic you are getting repeat usage it's Annie mentioned and you want the sort of faith that the entrepreneur can expand out of just that nature out of just that one geo market and that's that's tough so it's almost like you want to see that ten percent month-over-month growth take take a food delivery service right in in a specific area of a specific city and then you want to believe that they can replicate that rapidly across other neighborhoods in the city and then quickly across other cities and then quickly across other gos and so it's it's rare that we come across a business that we believe both can execute in this microcosm as well as see an entrepreneur we think can rapidly expand and with handle the logistics of doing that that's what my general partner Reid Hoffman calls blitzscaling but when we see it it's it's magic and the the analogy that I've come up with is if you've ever seen tilt shift photography it's where you can just google it there's some really cool examples it's actually a physical apparatus that photographers used to both tilt and shift the lens and it makes you know they take a picture of a stadium for example and it makes everybody look like these tiny little little figurines and it's this idea that an entrepreneur can both hold the big picture in their mind as well as focus on the really small component of it that makes it seem tractable right and actually master that on the on the path to what is a much bigger vision and I think the last part this kind of dovetails with the last question is it I think as an investor you want to believe in some sort of macro tailwind and so in the case of food delivery it's that people aren't gonna want to go into restaurants in the case of something like Etsy is that there is an anti Amazon contingent of the buying population that really wants things that are hand handmade or there's a sneaker marketplace called goat right which does these trades in these high-end sneakers from all the different manufacturers and you gotta believe there's a there's a way than the aesthetic of street wear that's gonna drive that to be much bigger than it has been historically cool makes sense are there are there anything else any other factors we've talked about growth rates margins market size we've not really touched on team but are there are there other things that you look for in a series a marketplace investment again you expect I think you um you kinda brought up one thing Dan and the question for Ian we didn't we've talked about net revenue we have really talked about gross margin and the one observed phenomenon is I mean I think we'll say like higher margin businesses are better high margin often that revenues better that's no that's that that's great it shows scalability and software being applied to the service etc but what we what I've often seen at least is like in the early stages of a marketplace in particular often gross margin is lower because there's a lot of work being done to kind of make the business work and if you're being really honest about what your gross margins are you're spending a lot of operational time like onboarding the driver and doing the customer service calls and all the stuff you have to do to kind of get this thing to have liquidity and actually gain momentum and that's also one of the tricky parts about being investor is that you have to see that happening that's very common to be happening in then understand then be convinced of a pathway whereas their liquidity in a marketplace the margin might go the gross margin the real gross margin might go from something like 40% or 50% it's not uncommon even in very good marketplaces and then over time approach sort of software like margins at 70 or 80% because there's some scale effects in the operations in the business that are during costs so and then the only other point to make on that one that I think isn't he said earlier it's like on cohorts you know we really you can sustain a lower margin a lower gross margin business if you're an addictive service that becomes like utility that just people use a lot and they don't tend to switch very much out of it so if you're a low margin business has to require users a lot competitive market then that can be really challenging you know the money to be able to do so but those are some of the dynamics that we think about on the consumer side at least about whether or not if I'm you know for marketplace and any margin level can sort of be sustainable yeah I remember a number of years ago Bill Gurley blogged about revenue quality and there's also this concept of of gross margin quality in terms of the amount of effort you need to put into to getting the gross margin and the sustainability of that merchant anything else to say I'm just gonna add one thing I spend a lot of time thinking about I years ago tried and failed to start my own company there was a localized marketplace mean that you have like a neighbor for example or door - you have supply and demand that is net new and every single geo because it's kind of naturally local right so that is a brutal business that it's hard to like rebuild your supply and demand if you're going geo by geo and so I think a lot about how you know how expensive is it to expand and say if you have a localized marketplace where you are trading goods services on a local level that's almost always going to be more expensive and slower to expand than if you are digitally native and kind of call it national or even global from day one and and then one way to ask that question like classpass I think is an interesting example kind of against a bunch of these questions right it is and sometimes supply is known and you can scale that from inside sales team really quickly in the case of class it's like you could literally scrape Yelp and find every single yoga studio and spin class and Pilates studio or whatever in any single Gino and so turning on these new markets was actually very easy relatively speaking as opposed to having to go out and find that new supply and of course demand if we're talking about be to see market fences yeah one of the questions from from the audience is how do you gauge in market places the ability to drive enough supply to generate sustainable growth is that is that a market size question or or are there are there specific supply KPIs that you like to look at and I don't know if that's distinct from from demand because some some market places are something like supply constrained while others are are demand constrained but what are your thoughts on that I love to see a market place that has a wait list for supply right if you're gating your supply that's a very good sign and I can give you a lot of examples of completely that you have that and they're able to then learn from what happens if I bring on these really big suppliers which is kind of a bunch of small ones right in the case of Etsy right what happens if like you know Josh's yarn shop and Richie's candle shop and you know Annie is like homemade coaster shot come on as opposed to Dan has like kind of been like hacking it at eBay and already does two million dollars a year and comes on like what's the implication of bringing on different types of suppliers and is an interesting test to be able to run so it shows also I'm the breath of opportunity which i think is really an interesting thing to double-click on and supply or early on in kind of how broad are the set of users that want to use your platform and obviously in my opinion the brought under the broader that's the better because that would translate to a bigger market and then two and then one one way that I think we could look at that is these your are the existing suppliers you have like wowed by the fact of their supplier so like if you're an early Airbnb host you're like okay I all of a sudden hit me and my mortgage I don't know right now they're like literally like these life-saving moments on Airbnb and and then the question that will constantly really enjoy it will everyone else enjoy it too right I mean they wouldn't like like a lot of people getting some more benefit then you can sort of gauge supply that way but but that they go back in and on both sides of these of a marketplace this change or gap in impact to the consumer or the supplier that ultimately helps determine what a lot does that can be helpful I think we're we're just about out of time and any any quick comments on the kovat impact on marketplace valuations or series evaluations in marketplaces I mean I've just offered that there will obviously be some winners whose paths are accelerated from this and people that continue to struggle but I do think you know marketplaces in many cases remove the friction of the real world and so I think that that if I even look at it my parents who were 73 now like their affinity to potentially order food be their house has gone up tenfold because of the limitations on their ability to move and that that is exactly the type of challenge that something like a3 decided marketplaces is efficient at handling so I think it's actually going to be a really good thing for society in the long run cool great well thank you all very much on behalf of auto tech ventures I'm honored to have gotten the chance to speak with you about this and thank you for participating in the marketplace conference we've got about one minute and then we'll be we've got a few overall other sessions happening simultaneously along with breakout rooms and general networking

Channel: Marketplace Conference

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Length: 28min 26sec (1706 seconds)

Published: Thu Jul 02 2020