Going into a small market where incumbents have large moats as a venture investor
I am evaluating going into a market where large incumbents have significant moats relative to startups, and can typically copy startups once they have one early success. As a result, startups that exit typically get bought at the $200 and change range. There is a separate side to the market that is more infra/tools related where I have expertise and generally does not have the same effect. The cumulative market is around ~$150-$350bn globally depending on how you cut it, so not huge. Most of that revenue resides in ~20 companies globally or so.
I have been burned by being in small markets before, but I hated the products in those markets. In this market, I have a lot of fun, and expect I would continue to have fun, but it is a fairly niche market and I am getting more senior. I am evaluating then the tradeoff behind being in this market vs. not. My background is large cap but when you consider the outcomes for half the market that are pseudo-structurally-capped, it means you need to get in at earlier prices and limit fund size to get the TVPI you're looking for.
I am evaluating the sense of, I have found Ikigai, vs. I am entering a more structurally challenging market willingly. I have to consider both the personal satisfaction alongside expected outcomes and budgeting for the home I want in SF, kids' future tuition, retirement money, etc. I also am evaluating that this is a fairly niche industry where skillsets may not be as transferrable as what I used to be doing, general enterprise software investing.
Based on the most helpful WSO content, navigating investments in markets dominated by large incumbents with significant moats requires a nuanced approach, especially in the context of venture investing. Here are some key considerations and strategies that could guide your decision-making process:
Identify Unique Value Propositions: In markets where large incumbents can easily replicate startup innovations, it's crucial to invest in startups that offer unique value propositions that are difficult to replicate. This could be due to proprietary technology, unique business models, or deep market niches that incumbents are less likely to enter.
Leverage Your Expertise in Infrastructure/Tools: Given your expertise in the infrastructure/tools side of the market, focusing on startups in this area could provide a competitive edge. These segments might be less attractive for incumbents to replicate due to the specialized knowledge and networks required.
Early Entry and Fund Size Management: As you've noted, achieving the desired Total Value to Paid-In (TVPI) ratio in a market with structurally capped outcomes necessitates getting in at earlier prices and potentially limiting fund size. This strategy can allow for more significant equity stakes in startups and higher potential returns, albeit with increased risk.
Consider Personal Satisfaction and Long-Term Goals: Balancing personal satisfaction (finding your Ikigai) with the financial requirements of your future (home in SF, kids' tuition, retirement) is critical. If engaging in this niche market brings you joy and fulfillment, it might be worth the trade-offs, provided you have a clear plan for managing the financial aspects.
Evaluate Transferability of Skills: While the niche industry may limit the transferability of skills to other sectors, it's essential to assess how this specialization might position you as a leading expert in a growing niche. This could open up unique opportunities in the future, even if they are outside traditional enterprise software investing.
Risk Management and Diversification: Finally, consider diversifying your investments within this niche market and beyond to mitigate risks. This could involve spreading investments across different stages of startups, sectors within the niche market, and even considering some investments outside this niche to balance your portfolio.
In summary, entering a market with large incumbents and significant moats presents both challenges and opportunities. By leveraging your expertise, focusing on unique value propositions, and carefully balancing personal satisfaction with financial goals, you can navigate this complex landscape. Remember, the key is to approach this decision with a strategic mindset, considering both the potential rewards and risks involved.
Sources: PE professional, what's your process while judging an investment?, PE professional, what's your process while judging an investment?, Long term, concentrated, deep fundamental investing, PE Firms With an "Moat"
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