Investing in B2B Marketplaces: Charles Hudson (Precursor Ventures)
The Bowery Capital team is embarking on a ten week journey to cover B2B Marketplaces. We are doing deep dives on various companies, interviewing founders and investors, and learning what it takes to build success in the B2B Marketplace arena. Below is a part of our content series focused on insights from successful VC investors in the space. This week, Charles Hudson, Managing Partner at Precursor Ventures, answers some of our questions. You can read all of the posts in our series by going here.
Charles Hudson is the Managing Partner and Founder of Precursor Ventures, an early stage venture capital firm focused on investing in the first institutional round of investment for the most promising software and hardware companies. Prior to founding Precursor Ventures, Charles was a Partner at Uncork Capital (formerly known as SoftTech VC). In this role, he focused on identifying investment opportunities in mobile infrastructure, mobile applications, and marketplaces. In addition to his investment activities, he supported SoftTech portfolio companies on business and corporate development matters. He was also the Co-Founder and CEO of Bionic Panda Games, an Android-focused mobile games startup based in San Francisco. Charles joins us today to share some of his insights as a marketplace focused investor.
What side of the market (supply vs. demand) do you encourage B2B marketplace founders to focus on at the outset?
For the marketplaces Precursor has been a part of, I feel like the supply is typically easier to find, while the demand ends up requiring a bit more of a behavior change. For example, in an equipment marketplace, finding all of the used equipment that you want to sell is usually the easy part compared with figuring out how to change buyer habits. I encourage people to focus on the demand side first and develop an understanding of whether demand is willing to transact in the way that you want it to. Oftentimes, I find the supply is relatively agnostic, as long as you can bring them the demand.
How do you assess whether a B2B marketplace has product-market fit, and if it does, are there any growth levers you encourage founders to pull on? Any you would advise them to avoid?
In marketplaces, product-market fit is one of those things where I know it when I see it, but it is hard to quantify. What I would say is that with most of the B2B marketplaces we have invested in, they start off really flat, and at the start not that much happens in terms of transactional activity. The rule I try to follow is “Can you complete one end-to-end transaction through your marketplace?” – can a buyer and seller meet organically on the marketplace, negotiate a sale, and finalize the transaction, with only minimal encouragement or handholding behind the scenes. When this is happening on a repeat basis, you are starting to get on to something. One of the biggest mistakes I have seen people make is once they think they have a little bit of product-market fit, they immediately want to turn on paid advertising. This is because oftentimes in that early product-market fit stage, the marketplace works well as long as you have either a really motivated seller or a really motivated buyer; but an arms-length person who comes in is probably not going to have an amazing experience. What I encourage people to do is to instead try to develop organic, transactional growth month-over-month. I recommend focusing more on transactional growth, as opposed to GMV growth, because transactional volume is real evidence that your marketplace is functioning; with GMV, it is easy to get fooled by a couple of really large transactions into thinking the marketplace is growing more quickly than it actually is.
What is your advice for founders to help ensure that repeat transactions continue to occur within a marketplace? In other words, how do you avoid market participants using a platform to find each other and then taking their business offline?
My thinking on this as an investor has changed a lot. I used to be like the churn police, and I was always on the lookout for leakage off the platform. Now I think of leakage as a signal from your market that something about the value prop for the marketplace does not hold over time. For example, with “in-person” services marketplaces, the way I think about leakage is that it is telling me that the customer does not see the ongoing value in those transactions. This raises the question, do you need to adopt a different take rate, or can you adjust the value prop for those repeat transactions, so people are disinclined to take them off-platform? And if you can’t dissuade this leakage, maybe you aren’t in a marketplace – maybe you’re really in a lead-gen model that you would like to be a marketplace. Rather than just immediately trying to put up more barriers to make it harder for people to go off-platform, I think it’s more important to understand what are they telling you about the product or service through this behavior.
Precursor is focused on investing in relatively early-stage ventures – what are the initial indicators that you look for when evaluating a nascent B2B marketplace?
In addition to transaction volume, another thing I look for is how well does the founder understand the ways supply and demand are solving this problem today. Whenever a B2B marketplace founder tells me “this transaction type we’re doing doesn’t happen today,” I am skeptical. Whether you are liquidating inventory or matching people for jobs – these are activities that are already happening, they are just not happening on a software-based platform that you can easily see and measure. I have yet to see a B2B marketplace idea where there is not some offline analog.
For me, the big question is how much friction is there in that offline version. We are looking for industries where those frictions are high and the current process is unpleasant, but it is still functional. That is a place where software could really make a difference, both in terms of liquidity and the quality of the experience for both sides. From an investing standpoint, a lot of what I am trying to figure out is i) what is the status quo? and ii) is there a role for a software based B2B marketplace to make that status quo significantly better? Not incrementally better, but significantly better. That tends to be a qualitative conversation and for most of the marketplaces we have backed, they don’t have any transactional volume when we meet them, but they understand the current situation and have a plan to improve it.
You mentioned that you want to look for opportunities where there is a lot of friction, but that are still functional to the extent that some kind of marketplace already exists. Can you elaborate on that thinking?
I think it goes back to your earlier question about supply versus demand. Getting demand to transact on the marketplace is often the harder piece, and if there is no one transacting offline, you are really starting from scratch. There might be a reason these activities are not happening offline, or we might not have looked hard enough to find that offline analog. A lot of times that offline analog to your marketplace may be a totally different behavior. For example, in a surplus equipment marketplace the analog might be that people just throw the stuff away. These kinds of marketplaces make me nervous because then we need to retrain the equipment owner and convince them that re-selling it is a good use of their time compared with just throwing it away and taking the tax write-off.
Are there any structural factors that might lead you to pass on a marketplace investment?
This might sound obvious but at Precursor we try to avoid marketplaces that have high take rates and do not add a commensurate amount of value for buyers/sellers. I don’t think there’s anything magical about a 10%- 15% take rate, and I’ve certainly seen marketplaces where they are solving a lot of friction for the buyer and they can charge a 25% take rate because maybe they are also inspecting the equipment, arranging for delivery, etc. But in some cases, if you are trying to charge 25%, but all you are doing is a pretty simple software-based match then that is a problem. If you are not really adding much value and you are charging that kind of take rate, someone else is going to come in and do the same thing for 15%.
The other big reason I would pass on a marketplace investment is if I am not aligned with the founder about what the marketplace is solving for at its core. Some marketplaces are really about buyer and seller discovery – these are marketplaces where buyers/sellers just cannot find each other – other marketplaces are more about offering insurance or quality. I always want to be on the same page with the founder about what really drives value in a given marketplace and what are the unique things the marketplace is solving for. If we do not have the same view about where the value is being created, then I will probably pass.
Precursor is an investor in Medinas, a leading technology-enabled medical equipment marketplace, how has vertical marketplace adoption varied among smaller vs. larger health care organizations?
The larger healthcare organizations can be harder to get but once you do, they can help you pick up supply in gigantic bunches. It is similar to SMB vs. enterprise sales, the effort to get these large hospital systems is a lot of work but once you get them, they have a ton of equipment. Medinas is also in one of these marketplaces where I think eventually buyers will be sellers and sellers will be buyers. As that second phase of the model starts to turn on, there will be a lot of new opportunities around getting equipment from those larger players, as well as selling equipment back into them.
Precursor invests in both B2B and B2C companies – how do you think the B2B/B2C marketplace environments differ?
For B2B marketplaces, the nice thing is that it is much easier to talk to both sides of the equation because they are known. Like in the case of Medinas, there is a hospital and there is an equipment broker, and you can get on the phone and interview these user types and the scope of customers is just smaller. Consumer marketplaces can be more challenging because every consumer is different and talking to 10 customers may or may not give you any kind of consistent insight. In general, consumers will also invest less time in trying to understand the nuances of a marketplace – the value proposition needs to be really obvious at the outset.
The times we have had challenges with consumer marketplaces have been when either the value prop was too complicated or the value prop was easy to articulate but the audience ended up being way smaller than we thought. With consumer, there is always the risk of confusing the size of the potential audience you are addressing with the size of people who really want to transact through a marketplace setting. This is harder to do in B2B because you can interview the buyers/sellers and you can get a better sense of how widespread the problem you trying to solve for is.
Are there common traits that you see across both B2B and B2C settings that are strong indicators of success?
For the B2C marketplaces that I have seen succeed, they have had an aspect that was naturally viral – the kind of platforms that consumers will proactively tell their friends about. For example, with Poshmark, once that started to work on the consumer side, it was the kind of thing that sellers were telling their friends about and encouraging them to get on the platform. I do not typically see quite as much of that in B2B, with the exception of maybe labor marketplaces, where people who are finding new job opportunities might tell their colleagues. I have not seen that many B2C marketplaces that can grow without some level of user-driven customer acquisition, where I have seen plenty of B2B ones that grow without it. One commonality is that they both tend to take a while to start working. It is not uncommon for it to take +2 years for a B2B or a B2C marketplace to find its footing and start to take off.
If you liked “Investing in B2B Marketplaces: Charles Hudson (Precursor)” and want to read more content from the Bowery Capital Team, check out other relevant posts from the Bowery Capital Blog. Look out for more content on B2B Marketplaces from us in the coming weeks.