Part II: How VCs Test Market Demand
ED ZIMMERMAN: My last WSJ Accelerators piece focused on how successful repeat founders tested their offerings/company prior to their launch. In this installment, we turn to how VCs test market demand for a product when conducting diligence prior to investing. While this is important for founders like those discussed in the last article, without the track record those founders had, diligence on market adoption becomes even more important.
To pull back that particular curtain, I called
Ian Sigalow, co-founder and general partner at
Greycroft Partners, an early stage tech VC. 2012 has been kind to Sigalow and his colleagues, as they’ve
just closed on their third fund ($175M) and scored major exits when portfolio companies
Buddy Media and
Vizu were recently acquired. Greycroft initially invests $500K to $5M and typically increases that position over time. The fund also has a seed program which, Sigalow says, generally focuses on repeat founders re-entering a market in which they’ve proven themselves.
Sigalow would have sat out Rewind.Me, which raised before launching a product. When Greycroft eyes a consumer-focused startup “we need to see user traction — I can’t look at a product and say ‘this will be the next great thing’ because there are elegant products that never get adopted and crappy products that do.”
In fact, when Sigalow looks at a company like
HDTracks, which targets consumers, he fragments the market into two groups: companies charging consumers, and those making money based on large-scale user adoption (for instance, an advertising-based model). “If it’s monetized by advertising, then a few hundred users makes it hard for us to tell whether it will work (because the company will need millions of users). If, alternatively, (users are) paying a subscription each month, a few hundred users is probably adequate for us to determine what works.”
What about B2B companies (called “enterprise” businesses) like LiveIntent? While a fund like Greycroft may need hundreds of paying or 30,000+ free consumer users to feel like there’s sufficient traction, for enterprise companies, the fund may find sufficient traction with only half a dozen large customers using a product for free in beta.
Sigalow explains that for products sold as “freemiums” (the company provides a base product for free and charges for enhanced versions), Greycroft, not surprisingly, looks at whether customers want to pay for it.
Once they’ve decided they like a company enough to commence diligence, the Greycroft team compiles a list of dozens of people in their own network — experts as well as actual and potential customers in addition to references and customer contacts provided by the startup. Each call may take around half an hour to cover whether customers would pay for the service, to whom they’d recommend it and why, and who else they considered (or would consider) using.
Sigalow doesn’t just rely on the phone. Greycroft heavily uses
Instant.ly, an online offering from Los Angeles-based
uSamp. Instant.ly “has a 10 million person panel so we can target by age, geography, relationship status, job title, etc. and get thousands of survey results back in real time as if they were our own contacts.” You can specify how many survey results you want and, because Instant.ly usually has some 4,000+ users on its site, you can begin seeing results almost immediately. A few hundred responses from people Greycroft doesn’t know complement the data gleaned from calling their own network.
Sigalow underscored that “some funds like to risk more capital at an early stage. Seed funds, of course, are often doing pre-product.” Angels too invest pre-product, as I did when I invested in Rewind.Me and
LiveIntent, but Sigalow’s detailed explanation is not far from how other Series A investors approach diligence prior to funding a promising startup.
Intrigued by Instant.ly, I reached out to uSamp founder
Matt Dusig to see how the tester had done his own market testing before launching Instant.ly. “We built an entire business before building Instant.ly” he said, referring to uSamp, which “provides online market research panels and SaaS technology for global market research.” USamp receives inbound requests from corporations looking for market research. Those clients repeatedly told uSamp “we love working with the marketing agencies we use, but sometimes we can’t wait a month or longer for feedback, we want it instantly.” So it was less a question of
Dusi
g testing the market and more of the market shouting at him, which, of course, is a great way to find a hole in the market. Much has been written about “founders in search of a problem” rather than those motivated by an existing problem.
Now that startups have become stylish, there’s a concern that people spend too much time seeking a problem rather than building useful experience and contacts which then would, almost in the ordinary course, reveal problems that desperately demand solving. USamp is definitely in the latter category. In fact, when asked, Dusig explained that prior to founding uSamp, he and his cofounder had built and sold another market research firm and then moved into another online business during the post-sale noncompete period (again, knowing what the market needed trumped testing).
This model of the repeat founder doubling down in a space he or she knows is precisely what VCs crave and, of course, that’s why Sigalow’s fund led the second venture round into USamp, which has now raised approximately $20M from Greycroft,
DFJ Frontier and, more recently,
Adam Marcus at
OpenView Venture Partners.
So are you going to test the market or let the market shout at you? Please post a comment if you have questions or thoughts about the way investors diligence startups or if you have some great ideas and tools for testing the market for consumer or enterprise tech companies. We’ll do our best to answer!
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Juan MC Larrosa
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