Challenges and Observations from Investing in B2B Marketplaces

Our team at Alpaca has always had a soft spot for marketplaces and a particular love for those in the B2B space. Our investments across Transfix, Ocean Freight Exchange, Toolbx, Trade Hounds, and others has certainly proven that. Many great pieces have already been written outlining the massive opportunity for B2B marketplaces, including articles by the folks at Bessemer, and Point Nine, and it seems like founders are finally waking up to the opportunity in front of them.

In the past couple of months, I’ve noticed a big uptick in the number of B2B marketplaces and it doesn’t appear to be slowing down anytime soon. While I’m a huge fan of these businesses and love digging into old school industries that haven’t seen much innovation, there are a number of challenges and themes that have stuck out to me lately. Keep in mind, these are my personal observations and I would love to hear any thoughts in response. Now let’s get into it!

Supply Side First

The age old question when it comes to marketplaces is how to solve the chicken or egg problem. At the end of the day, do you start with buyers or suppliers? More importantly, why do you choose one side over the other? Different people have different opinions when it comes to tactics here and reasonable people can surely disagree. The most common advice I’ve come across from other investors is “figure out which side is harder to get and then focus on that side.”

From recent conversations, I’ve come across significantly more teams that are tackling the supply side first. The reasoning often comes down to the suppliers being easier to identify and having a more acute need for a new software offering. Knowing what to build from day one and identifying a specific wedge has proven to be an effective strategy for many founders. Another interesting aspect is that while many founders see the ability to monetize on the supply side, they see a much larger opportunity from actual buyers, often through payments. In these cases, founders want to have more than an MVP live with a fulsome offering in place before approaching the buyers. They also want to ensure they have enough liquidity on the supply side to entice buyers to the table when they eventually turn that side of the marketplace on. By building for a specific use case on the supply side, teams are buying themselves time to further study the market and understand the core issues faced by buyers.

To be clear, I’m not suggesting that targeting the supply side first is the optimal strategy. While many feel strongly about this, I don’t think there is one right answer here. From my experience, I think that the GTM strategy is much more dependent on the specific market, how many different types of players there are, and how fragmented those players are.

Workflow Tools to Edge into Market

B2B marketplaces are generally targeting industries that are complex and inefficient. While that may sound like an opportunity for some basic software that can improve processes and instantly take over, the reality is much more complicated. The way that many of these businesses operate with legacy ERPs, living out of their inbox, and calling customers and suppliers to transact is often deeply ingrained. Suppliers and buyers have long standing relationships and many are reluctant to transact online.

In order to bring transactions onto a marketplace, few founders I’ve spoken to recently are attacking the inefficiencies head on. Instead, they often have to build tools that can handle some of the problems these industries face in order to gain trust and a foothold with one side of the market. These productivity tools also become a crucial early revenue source as the bigger ticket transactions on an actual marketplace won’t come for some time. In the early days, these companies look like vertical SaaS tools rather than marketplaces. Trust is the key aspect here with many players skeptical of new software.

When it comes to software in the early days, founders are most often building tools that are adjacent to the transaction. The biggest risk of most of these businesses is bringing buyers and suppliers together while having actual transactions go off-platform. Additionally, business owners are laser focused on their margins and are skeptical of any take rate that could eat into their profits. As such, the early tools being offered are most often focused on either convenience or discovery, and attempt to edge their way into a deal that doesn’t entirely change how deals were previously coming together. Buyers are more willing to try out a new product when it makes their daily tasks significantly easier or gives them an opportunity to bring in additional revenue.

Despite trying to solve a “simple” problem, these early tools need to be robust in order to handle the complexities that come in B2B transactions and a specific workflow. Teams are hesitant to change their workflow, so the software can’t just be a marginal improvement over the status quo. Founders need to understand buyers’ problems and the eccentricities of the market, which leads us to our next topic.

Experience and Skillset of the Team

At Alpaca, we’ve always been big believers in founder-market fit: why does this founder have an unfair advantage in this market specifically? I believe that this aspect is especially important when it comes to B2B marketplaces given the complexity of these types of transactions.

The founding team almost always has at least one member who has spent significant time within their industry and often experienced the inefficiencies they’re solving for firsthand. That being said, the actual amount of experience in that industry tends to vary pretty significantly. At the very least, founders need to understand the players in their market in intimate detail. They need to know how buyers and suppliers think, what’s most important to them (convenience, price, execution speed, etc), what they’re willing to pay for software and additional services, what their margins look like, how many parties on the other side are they usually interacting with to transact, and so much more. While it’s certainly possible that a founder can stumble upon a problem and become an expert by talking to industry folks and doing research, it’s much more common for founders to know the answers to all of these questions by experiencing them firsthand.

Expertise and experience in a specific market is a necessity to build a successful B2B marketplace, but so is a complementary set of product and technology chops. All of the expertise in the world isn’t going to be worth much if the team can’t build an intuitive product. While digital adoption is certainly getting better, many of these industries where B2B marketplaces are popping up are old school and their tech stack is largely being held together with proverbial duct tape. The tech being built here needs to strike a balance between being able to handle all the complexities of a B2B transaction while being simple enough for non-tech forward individuals to be able to onboard and use the tools everyday. Not to mention the myriad of other skill sets needed around the table such as sales and marketing, general leadership capabilities, and the ability to attract, hire, and motivate an incredible team. At the end of the day, B2B marketplace founders face many of the same problems as other founders with a bit more complexity and know-how needed on the GTM and product building front. Founders can’t expect to have every team member or skill set onboard from day one, but they at least need to be aware of what their strengths and gaps are with their founding team.

Timing, Sequencing, and GTM Strategy

One of the more challenging aspects that I’ve come across lately with B2B marketplaces is that these businesses often take longer to break out and demonstrate clear product-market fit compared to many other companies we speak with regularly. The reality is that these are very complex businesses that take a lot of infrastructure and careful planning to get right, which takes time to build and implement. In most cases, the productivity tools being built are fulsome and require various features, but also integrations with legacy ERPs, accounting systems, and more. There’s also plenty of education and hand holding to be done in the early days to get users onto the platform, although the best products and teams find ways to minimize this as best as they can.

Since many of these marketplaces are trying to disrupt incumbents and change the way business is being done, founders have to be incredibly thoughtful about which offerings to introduce and when. It’s never as simple as standing up an app for the buy and supply side and allowing them to transact. As mentioned, you have to establish trust and that often means slowly edging your way into the market. This isn’t to say that founders shouldn’t move quickly, they just need to be mindful of how their market functions and how they should sequence their product launches. I’ve been incredibly impressed by how thoughtful many founders have been when it comes to their GTM strategy in recent days. Digging into this decision making process and understanding why a founder has chosen one route over another is often the most interesting part of my conversation with teams.

One final aspect here is that teams often undercharge for their initial product offering in order to establish their foothold. While it’s usually the best way to enter a market and gain early customers, it’s important to keep in mind that the revenue from a single underpriced offering often won’t be enough to reach the traditional metrics expected of companies by the time they reach Series A. Again, reasonable people can disagree about what those metrics should be in this market and whether investors are truly paying attention to them when the team, product, and market are right, but that’s a whole separate conversation. Founders also need to have a strategy around customer success, whether they can raise prices for their software offering, and when is the right time to do so.

Fundraising

Both founders and investors need to be aware of all the complicated dynamics when looking at early stage B2B marketplaces. I’ve found that many founders underestimate how much time it will take them to not only launch their marketplace, but realize any meaningful revenue growth. Investors often also think that teams should be able to do more with less and discount the amount of time it takes to build the initial product. The ramp up is frankly slower with many of these businesses and that needs to be top of mind when doing diligence. While there is no right answer, fundraising options usually come down to:

1. Raising a smaller amount of capital that’s needed to build an initial team and prove out a couple of the major assumptions around a business. This can be viewed as more of a pre-seed and may mean that it takes the team a bit longer to actually launch the marketplace, although it may also be a bit more de-risked from an investor perspective.
2. Raising a larger round that takes into account the time needed to fully build your product, ramp up with initial customers, and still have enough time to reach the metrics needed for Series A. Note that these rounds are getting bigger (~$4.5M+) which will eliminate many funds from being able to participate based on their check sizes and ownership thresholds.

Both investors and founders should be mindful of what is realistic for founders to achieve and take that into consideration when discussing a Seed round. As it relates to raising capital, nobody wants to have to raise an Seed extension, though we are noticing it becoming increasingly common. We all want to see companies immediately go up and to the right with a clean fundraising story, but the reality is often much messier.

Despite all of these challenges, I still remain incredibly bullish on B2B marketplaces as a whole. While they’re challenging to get right, they have tremendous upside, and when they take off, they become massive quickly. These markets tend to be at least winner-take-most with the majority being winner-take-all. Once you have both sides coming to your marketplace to transact and they’re sticking around to use the platform consistently, there are a myriad of ways you can monetize, which leads to these opportunities becoming huge. If you’re working on an early B2B marketplace, please reach out to me at eric@alpaca.vc or on Twitter @EricSchoenbach, I’d love to speak with you. Thanks for reading!

Special thanks to Ryan Greene and Michael Butka for their help researching and evaluating the space. And thanks to friends Julia Morrongiello, Taylor Brandt, and Dawit Heck for feedback and input on this post!