Venky Ganesan
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The end of 2020 will be marked by a series of high-profile consumer technology IPOs. Among the companies on file are several marketplace businesses including home rental giant Airbnb, food delivery service DoorDash, grocery delivery company Instacart and the online shopping platform Wish.
Poshmark, a social commerce platform in which Menlo Ventures invested early, has also filed to go public. While the public market will soon assign value to these marketplace businesses, the dominance of these businesses underscores the strength of the marketplace business model. It’s interesting then, to dig into the numbers to understand the state of marketplace businesses today.
What to make of 2020?
Typically, we’d spend most of our time analyzing the most recent data. But, it will surprise no one that 2020 is an outlier. Thankfully, we don’t need to throw the data out. There are some interesting insights. The pandemic impacted businesses broadly, some boomed while others went bust. How the marketplace category fared varied from business to business, depending on the category.
The large public marketplaces continued to perform. If we look at the top 20 publicly traded marketplaces, we see that their combined market cap increased ~63% in 2020. This growth rate is lower than the ~99% growth of the 20 public SaaS leaders.
Not surprisingly companies like the video meeting platform Zoom and Shopify, a commerce platform that allows anyone to set up an online store and sell their products, benefitted from new dynamics introduced by the pandemic.
Similarly, some of the largest public marketplaces, like Amazon, Etsy and Delivery Hero were boosted by changes in consumer behavior including spikes in online shopping and delivery.
Acquisition efficiencies increased with increased demand from consumers and merchants that resulted in favorable growth plus EBITDA pairing.
Take Etsy as an example: In the last quarter, it grew at a whopping 128% YoY compared to 32% the year before with EBITDA margin of 30% versus 15% from the year before.
But where some marketplace categories were propelled by COVID-19 tailwinds, categories like travel and fitness struggled against the headwinds created by the pandemic. This is where we saw some exciting innovation from startups — which tend to be more nimble than their public counterparts — adapted to the new normal. Take Classpass, which was originally conceived as a platform to connect gym goers with the right studio/fitness classes.
With gyms and studios shuttered, the company launched live-streamed workout classes for fitness enthusiasts confined to their homes. While travel suddenly stalled, after months in lockdown Airbnb soon noticed a spike in demand for driving-distance rentals. The company smartly adjusted their algorithm to surface destinations within 300 miles, saving the sanity of stir-crazy customers who just needed a change of scenery after months in lockdown.
What we might see is that these companies follow a similar trajectory to the one we saw in enterprise SaaS: Projects stalled in Q1 and Q2, then demand picked up in Q3 and Q4. Perhaps the stall will be longer, but there is an argument to be made that these companies will rebound much faster, as pent-up demand is unlocked and people can once again travel, exercise, etc. Cautious startups may hold off on plans to go public, staying private longer as they ride out any COVID downturn.
Where are VCs directing their dollars?
A substantial amount of VC funding continues to flow to private marketplaces here in the U.S. In 2020, VCs directed $4.9 billion in funding to American businesses built with a marketplace model. But again, 2020 was a strange year. If we look to 2019, we see that VCs invested $6.7 billion in private marketplace companies.
The majority of this funding was captured in later-stage rounds by a few select companies. It was the category leaders Uber (in which we were early investors), Airbnb, Lyft and DoorDash. (When we strip out these outsized funding rounds, funding is up and down. There is no consistent trend.)
This demonstrates what, at Menlo Ventures, we refer to as the rule of marketplace businesses: It’s a winner-take-all (or winner-take-most in cases like Uber and Lyft) game. Marketplaces are one of the few business models that demonstrate true network effects: Supply and demand follow each other.
When one company controls a market with strong network effects, it can absorb the majority of supply and demand, generate huge profits, retain customers and keep competitors at bay. Category leaders capture a lot of value and with that comes a significant advantage when it comes to raising capital. Nobody wants to invest in the third runner-up. The game is already over.
For investors, this means that it’s important to pick a category winner. Money flows into later-stage companies because the leaders are obvious. The investments are less risky. (Though, when we invested in Uber’s 2011 Series B round, the company was not yet leading the ride-share category, in fact that wasn’t even a category yet. Uber was challenging black cars and taxi cabs. But the risk we took in making that investment was greatly rewarded.)
Does this mean that the love affair investors had with marketplaces has ended? Not at all. In fact, public marketplaces are very profitable in the long run. They earn more than double the average enterprise value of public companies offering SaaS (another VC darling).
This would surprise anyone who thumbed their noses at previous marketplace IPOs because companies going public showed negative profit margins. But lest we forget, some of the largest and most respected internet companies were built as marketplaces: Alibaba, Google, PayPal, Amazon and more.
What does it take to go public?
It’s hard for most startups to get to IPO. Today, In order to make it to the public market as a marketplace, companies must have $150 million+ in net revenue and be growing at about 50%. It’s gotten harder: The rule of thumb in the past used to be that if a company reached $100 million in net revenue and was growing at 30% to 40% YoY they could expect a good IPO.
But, with so much capital in the private markets, expectations have ratcheted up. Marketplaces need to keep growing at a larger scale for longer. The public market must believe that your company could hit $2 billion or $3 billion in net revenue opportunity, which means tens of billions of dollars of GMV. So a company with $200 million in net revenue explains that this is just a tiny fraction, maybe 10%, of the actual market opportunity it can reach as a public company.
Profitability is no longer a requirement for going public. This is a symptom of the capital that’s available in the private markets. Companies can keep raising capital without the need to be profitable. They can use that money to go after supply and demand. We saw that as Uber and Lyft both prepared to go public, offering incentives to riders and drivers to use their platform.
In terms of take rate, most public marketplaces cluster around 10%-15%. At Menlo Ventures, we use 10% as a rough benchmark. That number reflects a core take rate of 20%, minus incentives and additional line items. Of course, there are outliers, companies like Shutterstock and FarFetch have much higher take rates, but they aren’t the norm.
Going public is just one step in the journey. Being rewarded by the public markets is another. When we ran the numbers to see what the public market rewards in a marketplace business, we got one answer: growth. If you look at the relationship between forward revenue multiple and year-over-year growth, it becomes clear that ~50% of the multiple that companies receive is explained by their growth rate.
Naturally, the economic model is important. Profitability is important. TAM is important. But right now, the markets are hot. Growth trumps all.
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