About two years ago, we published our first marketplace napkin. Since then, the ecosystem has evolved, the amount of capital available has increased and round sizes and valuations have continued to get larger and larger. In line with this, we’ve decided to give our good old napkin a bit of an update.
As in our previous iteration, this napkin represents a rough guideline for raising capital as opposed to strict rules and there will always be exceptions to it. Founders with significant previous exits can generally raise larger rounds at higher valuations early on. B2B marketplaces selling into large industrial firms may be able to raise at seed stage with lower revenues and GMV than traditional B2C marketplaces. Similarly, SaaS-enabled marketplaces, that start off by building the SaaS element, may not have the required liquidity or potential network effects at the early stages.
So what does it take to raise capital as a marketplace startup in 2018?
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Revenue, GMV, Growth, and Burn 🔥
Four high-level metrics stand out when evaluating marketplaces: net revenue, GMV, growth, and burn.
Net revenue represents the actual revenue generated by the marketplace and is largely driven by the take rate on each transaction. The take can vary from 0.5%-30% depending on the type of marketplace and how much value it adds to both parties. The variance in take rate results in a wide spread in terms of gross merchandise value (GMV) for marketplaces. At the seed stage, we’ve seen GMVs ranging anywhere between €50k-200k per month.
When it comes to growth, seed to Series A companies should aspire to grow at least 100% annually. Growth rates tend to slow down as companies become more established and get to Series B, but should not be too far below 100% for a successful fundraise. That being said, growth is not the be-all and end-all, and should be weighted against solid unit economics (retention and acquisition costs) and operational processes which allow the company to scale smoothly over the long run.
Burn tends to vary significantly across companies. At the seed stage, a company’s seed round should give them 18 months of runway given their burn. As companies scale, we tend to apply the “40% rule”. This rule states that your growth rate plus your profit (i.e. minus your loss) should add up to 40%. In other words, if you are growing at 20%, you should be generating a profit of 20%. If you are growing at 100%, on the other hand, you can afford to burn 60%. At the earlier stages we tend to see hyper-growth, so we are likely to see larger deviations from the rule. As growth flattens out, being closer to the 40% rule is recommended.
Valuation and Round Size 💸
We’ve seen valuations and round sizes increase slightly over the last few years with seed rounds ranging between €1–3m and valuations around €3–8m. At the Series B, round sizes can range anywhere between €10–30m with valuations around €25–200m. This huge range in valuations (most happen at below €100m) is the result of multiple factors, not to mention that certain companies start to look like clear winners as reflected by exponential growth or profitability. As mentioned in the recent tech.eu report, this fluctuates across countries, with German funding rounds being significantly larger on average than rounds in other European countries.
As for every type of startup we evaluate, the team is arguably the most important factor, especially at the early stages. We look for visionary teams that can learn and iterate exceptionally fast and have unique insights and domain expertise. This is particularly important when evaluating B2B marketplaces. Building a marketplace for the shipping or metals trading industry is hard enough as it is, and founders that lack the insider knowledge and the network to break into the industry are likely to face a significantly harder struggle. As companies mature, having a solid tech team in place and bringing in senior leadership becomes increasingly important.
Liquidity is a vital metric for all marketplaces. At the seed stage, companies are still struggling to solve the chicken and egg problem: the platform needs to have both buyers and sellers, but one won’t come without the other. Since the critical mass of suppliers and buyers has not yet been reached, conversion rates tend to vary and the revenue is usually not sufficient to be material to a supplier’s business. At this stage, companies should limit the scope of the marketplace, building out liquidity in a certain segment before expanding more broadly. They should also start tracking some key liquidity metrics that are relevant to their marketplace. Repeat rates and conversion rates, transaction frequency and AOV over time are all good indicators for this. This can be complemented by marketplace-specific metrics e.g. time to pick-up for Uber or the average occupancy rates of doctor slots within a certain area for Docplanner.
At the later stages, companies should have achieved critical mass on both sides of the marketplace within their initial segment and should be starting to expand into new ones. This could be different geographies e.g. in the case of DeliveryHero or different languages in the case of Preply, a marketplace for online tutors.
Network effects ☎️
Network effects occur when a company’s product or service becomes more valuable as usage increases. They are an essential component of marketplaces and can come in different shapes and forms as outlined by NFX. When thinking about defensibility, the more network effects a marketplace can benefit from the better. All marketplaces by nature benefit from 2-sided network effects. These effects can be strengthened further by other type of network effects such as data network effects, whereby large amounts of user data can be used to continuously improve a marketplace’s offering. In case of Amazon or eBay, this could be a better recommendation engine, whilst in the case of Xeneta it could be a better marketplace intelligence platform.
One of the key requirements to raise funding is a multi-billion dollar total addressable market (TAM). In smaller markets, investors will need strong conviction that the market is growing significantly or that the company will be able to expand the market (as did AirBnB for the market for spare rooms). For marketplaces, the minimum required TAM (if defined in terms of GMV) is dependent on the company’s take rate and the potential market share it can capture. The higher the take rate, the lower the TAM required. Oftentimes, the initial TAM will be relatively small as companies tend to start building out a small segment of the marketplace so as to generate liquidity before expanding into other markets.
Market potential should be evaluated alongside the buyer and supplier landscape in the market the company is tackling. Markets with a highly fragmented demand and supply side tend to suffer from intransparency and high friction in the discovery process and, as a result, tend to be better suited for marketplaces. When supply and demand are highly concentrated, individual market participants are likely to have more relative power and may be reluctant to allow new intermediaries into the market.
If you are building a marketplace startup that fits some of the above criteria, we would love to hear from you! Likewise if you have any suggestions for improvement or data which could be used for the next iteration of the napkin, please feel free to get in touch. Here is a google sheet version of the napkin, if you can’t handle the fake writing in the napkin above 😜
For those that want to go deeper into this topic, here are some great resources on evaluating marketplaces 🌟
A Guide to Marketplaces by Version One
All Markets Are Not Created Equal: 10 Factors to Consider When Evaluating Digital Marketplaces by Bill Gurley, Benchmark
The SpeedInvest x Marketplace Scorecard by SpeedInvest
10 Marketplace KPIs That Matter by Andrei Brasoveanu, Accel