What I Obsess About as an Early Stage Investor

Last night I was invited as a guest to a networking event, hosted by Tablecrowd and attended by about 20 people. The format is more intimate than other networking dues I get to attend, consisting of drinks, followed by a proper dinner, closing off with a quick speech by the guest and Q&A. Given most of the audience was made of entrepreneurs, I talked about what I look for in entrepreneurs.

Here is a quick summary of what I talked about.

When investing at the early stages of a company there are two factors that matter more than anything else in my view: people and market. So in evaluating investment opportunities, I end up spending the large majority of my time thinking about them.

The reason I am obsessed with people and market is that if you get one of them wrong, or worst you get both wrong, you have limited scope for manoeuvring. While a team may be able to fix a product, or improve unit economics, it’s incredibly disruptive to replace founders when an early stage business has 12–18 months of runway, and it’s obviously inconceivable to change a market. Of course a company can pivot to address a different audience, or to a new business model or pricing strategy, we often expect them to do so. It’s rare that a company successfully pivots to a different market. It can happen, but as an investor I’d rather not take that risk.

People

So, what do I look for in founders? The answer is very subjective, a different investor will have a very different answer to that question. I found the answers to the following three questions to be highly correlated to ultimate outcomes:

  1. Would I work for this founder(s)? I find that it’s almost always a great sign when I am tempted to drop everything and join them in their journey, regardless of what they are working on. It’s a way to set the bar very high. Founders I would have worked for all had similar traits:
    • ability to inspire smart people to join by selling them a dream, a vision, and making it look achievable
    • ability to lead employees towards realising that vision, with all that leadership entails (e.g. long term strategic thinking coupled with attention to details, delegation skills, hustle, relentlessness, honesty, trustworthiness, ethics etc )
    • ability to raise capital, a necessary ingredient until the business is cashflow positive
  2. Does the founder posses proprietary knowledge? Does the founder know something that others don’t or does she understand something better than anyone else?
    • The answer to this question often revolves around the founder’s personal history and what brought her to start that business in the first place. What I am looking for is an obsessive passion for solving a specific problem. Passion often derives from a deep, visceral understanding of the problem, the market, the customers. The stronger the passion, the more proprietary the knowledge.
    • Passion is critical because when the going gets tough entrepreneurs only keep hustling through it if they are deeply passionate about what they are working on. That’s why I am typically less keen on what I would call a management-consultant approach to startup: a numerical exercise to picking an opportunity. Again, this is just a personal framework, there are plenty of successful founders who used that very approach.
  3. Are the founders working on a problem I understand? I need believe I can play a role in helping the founders achieve their vision, beyond just providing the capital. Have I got other investments in the space? Do I know people in my network who can help? Do I know potential customers?

Market

What do I look for in a market? I have narrowed it down to three tests:

  1. Is the addressable market large enough to sustain at least a £50m revenue business in a capital efficient way and in a sensible time frame, without having to make absurd assumptions on long term market share? By absurd market share I generally mean > 10% and by sensible timeframe I mean 5-10 years. Again this is completely subjective and highly dependent on the size of the fund under management and stage of investing.
  2. Is the market addressable right now? Is the timing right? One can be too early, and with limited runway the market can “remain irrational longer than you can remain solvent” (J. M. Keynes); or too late, in which case it will take much more capital to catch up with the market leaders.
  3. Has the company got a good shot at becoming the market leader? The rationale behind this is that value tends to accrue disproportionately to the #1 in a market, so as a VC you really want to back the leader, rather than #2 or#3.

 


The Investment Thesis Behind Opendesk

Over the summer of 2014 I personally invested in Opendesk, a three-sided online marketplace for locally made office furniture. The marketplace connects furniture designers (who can upload their designs to the platform and get paid in the form of royalties), with a network of local furniture workshops (who get commissioned work from the platform) and companies (who are in the market for office furniture).
The business is a spin-out of Project 00, a highly creative design-oriented studio.
Opendesk successfully raised an over-subscribed seed round on Crowdcube over the summer, with further participation for Telefonica incubator Wayra and a number of high profile angels. I was then asked to joined the board of the company as a non-executive director and we recently had our first board meeting.
I thought it would be a good time to share my investment thesis for future record:
  1. An underlying trend supporting the rise of digital fabrication
    • The downward spiral in entry costs for small-scale digital fabrication (i.e. 3D printing, CNC milling, laser cutting), coupled with the improved output quality and the widespread adoption of digital design softwares, have revolutionized the economics of batch manufacturing. As these machines become widely available at local small-scale workshops, it is now possible to leverage a network of makers that can manufacture high quality products, on demand and in small batches, while being close to the end customers and without having to rely on economies of scale to drive their economics.
    • We are still only at the dawn of this trend, and OD is well positioned to ride along it.
  2. A compelling user proposition for all 3 sides of the marketplace
    • For designers: OD aims to be a remunerative route-to-market for both up and coming and established product designers who normally struggle to bring commercially viable product designs to market via the traditional routes. Stuck in a vicious cycle of needing strong retail appetite in order to secure financing for the manufacturing, while not being able to test retailers’ appetite for their product designs unless they have resources to manufacture them, they can only hope that a brand discovers them and gives them access to their infrastructure. On OD furniture designers can upload their digital creations and connect directly with end customers: OD will act as the curator/moderator who ensures the designs are commercially viable and uploaded in the right format, ready to be manufactured by the local manufacturers that are plugged into OD. Designers will ultimately earn royalties, as well as gain visibility in a community of like-minded professionals.
    • For makers: OD aims to be a source of highly qualified, validated and paying customers for furniture workshops, who welcome a no-risk way to fill up surplus capacity (similarly to what Just-Eat does for takeaway restaurants) by accessing both quality designs and end customers on OD.
    • For customers:
      • Quality at affordable prices: on OD they can find real wood, customisable design furniture at only 2-3x the price of equivalent mass produced furniture (which, by the way, is often made of pulp rather than actual wood) and well below the more expensive alternatives of buying wooden designer branded furniture (generally 10-20x more expensive than anything on OD), or commissioning custom made furniture.
      • Short lead times: since OD furniture is manufactured locally by leveraging a network of furniture workshops, lead times from purchase to delivery tend to be significantly shorter than the alternatives offered by traditional design furniture distribution companies that often rely on sea shipping from the Far-East and are generally are not able to cope efficiently and economically with small order quantities.
      • Emotional appeal: I believe there is an increasingly evident demand among consumers and companies for unique products and experiences, handmade goods, craft and artisan-ship, locally made and sourced a products and a wider movement away from the mass-produced, the commodity shopping establishment, the Ikeas and Tescos of the world. Consumers ascribe an emotional premium to the experience of having a direct connection with the makers (think Esty), the hosts (think airbnb), the drivers (think Uber/Lyft) or whoever is crafting the experience for the end user. OD, by connecting the customers with the makers and the designers, provides a much more engaging, transparent and responsible way to buy furniture that the alternatives out there.
  3. An elegant “asset-light” business model
    • The OD marketplace is built on top of the pre-existing digital fabrication supply chain, and as such it does not require investment in the hard assets that a traditional retailer or brand would need in order to operate, such as warehouses, inventory, working capital, manufacturing equipment, raw materials, logistics network etc. OD simply enables the existing supply chain to function more efficiently by removing the frictions and the intermediaries that exist in the traditional retail or manufacturing value chains, and in doing that is able to capture (and defend in the long term) a large share of the incremental value it unlocks along the way.
  4. A big and compelling vision executed by a team with deep domain knowledge
    • Office furniture is clearly only the first step for OD, although it in itself represents a large opportunity to build a valuable business. Once the machine is well oiled though, there is nothing stopping OD from moving into home furniture and home decor more broadly and, eventually, into any product category that can be digitally fabricated. The idea of of ultimately taking on Ikea, a €30B revenue business, is not that far fetched.
    • I am confident that a team with deep domain knowledge in industrial design and crowd-sourcing, such as the one that Tim is leading up, is best placed to execute on this compelling vision.

I am excited to see the business grow and validate my investment thesis over the next few years!


8 Areas of Internet & Digital Media I Will Pay Closer Attention to in 2014

(1) Vertical integration in retail. I refer to the process of brands cutting out the intermediaries and selling own products directly to their end consumers, primarily via the web. The intermediary share of the value normally created along the value chain gets split between the end customers and the brands, as higher customer satisfaction (higher quality at lower price) also results in higher gross margins. The enablers have been the web channel at the front end, which allows for effective and scalable direct to consumer distribution without the need to add more brick & mortar stores, and the emergence of rapid designing, prototyping and manufacturing technologies at the back end, which have shortened production cycles significantly. Despite what Oliver Samwer thinks, I believe the offline channel will still play an important role, not necessarily as a sales channel though but more as part of a multi-channel approach to retail. Services such as Appear Here will provide online brands the ability to access the high street “on demand”, at the right time and location. I will watch particularly closely for businesses embracing scalable manufacturing technologies, such as 3D printing, in their processes and leveraging flexible offline presence at the front end.
Examples: Makie Lab, Align Tech, Shoesofprey, Rapha, Walker & Company, Harry’sBonobos, Warby Parker, Shapeways, Intelligent Beauty.
(2) Mobile as the main delivery platform. As obvious as it sounds in 2014, any business not putting mobile at its core is soon going to be obsolete. I believe in 2-3 years the large majority of our digital interactions will occur via mobile or tablets, including commerce (mobile commerce is still only 25% of ecommerce). Some of this shift will be just desktop-replacement, but a large portion will be incremental as mobile makes us all ubiquitously connected, always a click away from another purchase or booking. Some services are also just better delivered via the mobile (think Hailo, Uber, Instagram, Snapchat, Citymapper, Yplan etc). Marketplaces are an example of a business model that mobile has enhanced, since it makes it “vastly quicker and cheaper than ever before to ‘wire up’ both sides” as Matt Cohler noted recently. Opportunities will be plenty for businesses delivering beautifully simple mobile experiences.
Examples: Hailo*, Uber, Depop, Bizzby, Hotel Tonight, Citymapper, yplan, Osom.
(3) Image-led ecommerce: the trend of commerce and content converging has been in the headlines for a long time already, with publishers getting closer and closer to the transaction (e.g. Mail Online, Conde Naste) and online retailers investing heavily in curation and content (e.g. Asos, Farfetch, Net-a-Porter etc). I expect more companies attempting to bridge the gap between rich media (photos/videos) and commerce as users attention span gets lower and lower (as Biz Stone, co-founder of Twitter and Jelly puts it: “In a world where 140 characters is considered a maximum length, a picture really is worth a thousand words”) and mobile and tablets, with their constrained screen real estate, made the economic model of traditional advertising inefficient.
Examples: Houzz, Osom, Asap54Pinterest, Fancy, WireWAX, Olapic.
(4) C2C economies: it is about the emergence of online (often mobile-only) vertical marketplaces that allow any individual with excess capacity of an asset (e.g. skills, know-how, money, time, car, taxi, couch, bed, room, house etc) to efficiently monetise it. An interesting trend that has emerged from the resulting over-fragmentation (and thus expansion) of supply is that hard ownership has become redundant for certain asset classes that can be now available on demand: it’s happening to transportation, apparel, music and even server space. Watch this happen to other verticals.
Examples: Airbnbuber, lyft, blablacarboatboundStylebee, Vestiare Collective, Lending Club, Zopa*.
(5) Offline to online shift in large and ripe industries: while most industries and product/service categories have already transitioned online, there are still a few large industries that are resilient to moving online, but inevitably doomed to (e.g. commercial real estate, healthcare, education, law, financial services, automotive).
Examples: Zesty, zocdocAppear Here*, nutmeg, covestor, Shake, LawPivot, LawpalWealthFront, Carwow.
(6) Twitter ecosystem. I am long Twitter as an interest-based advertising AND ecommerce platform in the making. To the extent that “interest” is more strongly correlated to purchase intent than just “friendship”, I believe Twitter has the potential to become an effective platform for commerce, where Facebook effectively failed. I believe the userbase gap with Facebook will slim significantly in the next few years.
Examples: socialbro, Driftrock*, Buffer, Hootsuite.
(7) Online education. I think in 2014 we will start to see the pace of investing and consolidation accelerating in the space as the new learning/teaching formats become increasingly accepted and incumbents realise they have missed the boat and decide to up their digital exposure. Opportunities remain as an enormous industry is changing fast and new value chains become clearer. I continue to believe the value captured by the online educational content producer will diminish as competition intensifies (there are countless sites already where I can learn the basics of coding for example) and therefore businesses building tools and services that sit on top the content providers to create better online learning environments (ultimately improving outcomes) will thrive.
Examples: Clever, Blikbook*, TopHat, Piazza.
(8) Pervasive computing. I include in this area the entire ecosystem created around the ability of any device, from wearables to connected home appliances and drones, to capture, analyse and act upon data. The technology is now available for this to happen. As this is a new area for me, I will aim to learn as much as possible about it in 2014.
Examples: Cyberhawk, SkycatchStrava, Alert Me, 3D Robotics.
* Forward’s investments

The Investment Thesis Behind Appear Here

As I think it is a good practice for investors to make investment thesis publicly available, this post will be about the investment thesis that led Forward Investment Partners to invest in Appear Here back in November 2012.

As a backgrounder on the company, Appear Here aims to be THE online marketplace where commercial property is rented out, irrespective of lease length. The investment thesis can be summarised as backing a compelling entrepreneur to disrupt a large, ripe market via a proven and attractive business model.

Market

Commercial property is a large sector (between retail and office rentals, the UK market is worth well in excess of £30B a year), currently undergoing rapid and significant structural changes:

1) Landlords are under pressure as an ever larger portion of their portfolio becomes vacant and occupied lease lengths keep falling year after year.

  • Vacancy rates up. This is driven by the weak economy, and online sales growing as a portion of total retail sales. This has meant UK retail vacancy rate (i.e. readily available retail units as a % of total available retail units) has surpassed 16% towards the end of 2012. This is likely to grow even further, possibly double, driven by ongoing growth of e-commerce and the large number of long-term leases coming up for renewal in the next 2-3 years which are unlikely to be renewed. It is also worth noting that vacancies have a double-whammy impact on landlords: not only do they generate no rental income (opportunity cost), they still incur in business rates which the landlords have to front (actual cost). This cost UK landlords £1.1B in 2011/12;

commercial property vacancy rate

  • Lease lengths down: the average length of new signed leases continues to shorten, from over 20 years in 1991 to c. 9 years in 1999 to below 5 years now, with terms now often including long rent-free periods and short break clauses. There is no sign of this trend inverting any time soon;

commercial lease length

  • Conclusion: landlords know they need to adapt to a new environment where their inventory gets rented out on extremely flexible and standardized terms (e.g. rolling weekly/monthly leases). What they are looking for is a platform that will help them to optimize this inventory so the total net value of the yield is the same.

2) Secondly, on the demand side, brands are increasingly trying to build direct relationships with their customers, cutting the intermediaries out of the equation as Paul Fisher has elegantly illustrated in one of his recent blog post.

  • In the long-term the dis-intermediation of the retail world is inevitable and brands will establish more direct relationships with their customers;
  • Retailers, particularly online ones, are starting to value bricks & mortar as an extension of their brand: much more about the touchy-feely customer experience rather than product revenue. What companies like Rapha, Warby Parker, Moo, Etsy etc. have done offline are good examples;
  • As online cost of customer acquisition keeps increasing month on month and return from online marketing dollars is maxed out, offline becomes an attractive complement as another touch point in the customer purchase cycle. This requires a shift to viewing a square foot of space as media rather than as potential revenue generator;
  • Conclusion: brands need flexible and easily accessible physical retail.

3) Last, dis-intermediation in the property marketplace is inevitable: timing is not clear, but the web WILL disrupt as it has done already in other sectors:

  • the transparency brought by the internet makes it increasingly difficult for middle-men to justify their share of the value created along the entire value chain, leaving buyers and sellers to retain the margin that would otherwise go to the market intermediaries;
  • the compensation model under which commercial property agents are remunerated is still the same as it was when lease length averaged > 10 years, with short-term leases not generating enough commission to be worth their while;
  • Conclusion: the web will enable dis-intermediation in the commercial property market.

Business Model

An online transactional marketplace is a proven business model that is very attractive because of its economics and its defensibility, at scale.

  • Attractive economics: marketplaces generates a fee without taking the cost of inventory and incurring in the risk of not being able to shift it; in the case of Appear Here, the inventory is owned and held by the landlords, and Appear Here valuably facilitates the transaction via its website;
  • Defensibility: marketplaces also tend to be highly defensible, once they reach a certain level of liquidity; this is because buyers/sellers tend to naturally gravitate (and stick) to highly liquid marketplaces where they have the highest chance of being able to find a large number of seller/buyers.

Entrepreneur

Ross Bailey is a charismatic and energetic entrepreneur with a grand vision and the courage to go after it. We, at Forward Investment Partners, love backing entrepreneurs like Ross.