Anik Bose, GP at BGV, shares his perspective on the challenges of investing in- and raising funding for- startups that are looking to disrupt vertical markets.
Most traditional VC firms tend to invest in startups seeking to disrupt large, horizontal, multi-billion dollar markets. Some VC firms, while maintaining a horizontal scope, have developed specific vertical focus areas for different reasons. For example, Founders Fund and DFJ invest in world-changing ideas in energy, space, and advanced sciences, but still invest in consumer internet. However, the reality is that most traditional VC’s shy away from new vertical markets due to a variety of factors:
- Moment of inertia created by the historical track record of success in horizontal markets. Recent examples include App Dynamics’ sale to Cisco for $3.7B and the $2B IPO of Nutanix.
- Concerns around the size of the TAM (i.e. the vertical market maybe a niche market),
- Inability to effectively diligence and/or add value post-investment due to a lack of domain knowledge around vertical market use cases or ecosystem relationships.
- Concerns around portfolio diversification and size of investment pool (i.e. too small to justify a large fund).
Despite the above concerns, vertical markets are often new fields with promising companies that deliver spectacular value creation. The reason for seriously considering investing in vertically oriented opportunities is that in the evolution of technology-driven markets, vertical solutions tend to precede the emergence of a broad horizontal markets. Many of us will remember that even the horizontal PC market came into existence as a vertical solution for the word processing and desktop publishing industry, before becoming a broad-based horizontal IT platform. Similarly, the digital transformation of the enterprise is also unfolding industry by industry in many cases. Today, a few instances include:
- Self-driving cars – Intel’s $15B acquisition of Mobileye is indicative of value creation in the autonomous vehicle vertical.
- E-commerce – PetSmart’s $3.3B acquisition of Chewy, Unilever’s $1B acquisition of Dollar Shave Clubs, and Walmart’s $3.3B acquisition of Jet.com are good examples of value creation in the e-commerce vertical.
Nowhere is the vertical opportunity more promising than in the Industrial Internet of Things, especially since the first wave of investments in this sector were horizontal and had a mixed track record of success.
- Autonomous vehicle startups like Udelv targeting the last mile delivery problem for the retail vertical http://www.udelv.com/
- Robotics startups like 6Dbytes targeting the food and beverage vertical http://www.6dbytes.com/
- IIOT software startups like Tagnos targeting the health care vertical http://www.tagnos.com/
- AI startups like Drishti targeting the manufacturing vertical http://www.drishtilabs.com/
To fill this gap, smaller VC firms are emerging that specialize in vertical markets such as Fintech, Healthtech, E-commerce, Big Data, Edtech, autonomous cars, Adtech, Energy, etc. Ribbit Capital, with an exclusive focus on Fintech, is a very successful vertically focused firm. Another such fund is Forerunner Ventures with a focus on e-commerce. Data Collective has a focus on Big Data while Learn Tech focuses on Edtech. Vertical Ventures another new fund has an exclusive focus on investing in vertical markets.
Finally, there is a unique benefit for startups that are disrupting vertical markets: it encourages them to focus with a unified strategy, i.e., provide full stack solutions for a specific vertical, combined with tailored sale and marketing/ business development for a specific set of customers and channel partners. Profitect http://www.profitect.com/, a BGV portfolio company, illustrates this approach. The company is a market leader in prescriptive analytics for retail, leveraging the broad trend around the digital transformation of retail specifically for omni-channel visibility and execution. Profitect’s differentiated full stack solution combined with a focused go-to market in retail has enabled it to win large blue-chip customers and grow rapidly. The company’s product and market leadership has been recognized by retail industry organizations like RIS and NFR, as well as traditional IT analysts like Gartner and Forrester.
We believe that there is no simple answer to the question around the degree of ‘vertical’ focus for a VC firm’s investment strategy as it will often vary from one firm to another. So, what should an entrepreneur aiming to disrupt a vertical market do from a financing perspective?
A few considerations:
- Identify VC firms with expertise and/or some investment track record in their specific vertical. This applied research eliminates the need to spend multiple meetings trying to educate the VC on the specific market to attempt to create comfort in this specialized space, which is often a losing battle.
- Raise seed financing from a specialized VC firm with either relevant domain expertise or a partner with domain knowledge. This approach will help address TAM concerns prior to approaching traditional larger VC firms for series A financing.
- Syndicate financing with complementary firms – supplement traditional horizontal deep pocket firms with either corporate VC’s or smaller specialized firms who bring vertical market expertise.
BGV believes that the opportunities of investing in vertical markets outweigh the risks. We also believe that startups leveraging IIOT, AI and Blockchain technologies that target vertical markets for digital transformation will create significant value over the next ten years.