Early Investing

Three Advantages of Investing in Business-to-Business Startups

Three Advantages of Investing in Business-to-Business Startups

Every investor has preferences and biases that influence which startups they choose to invest in. And some sectors play to an investor’s values more than others.

Whenever anybody asks me which sectors I prefer, I say it doesn’t matter to me. And I mean it. 

I prefer startups led by savvy and determined founders that meet huge needs or wants in uniquely disruptive ways. 

Those qualities help startups endure, grow and prosper — regardless of what sector they’re in. They’re the foundation for success.

But even though I’m a sector-agnostic investor — I’ve recommended dozens of consumer-facing companies through the years — many of my favorite startups are enterprise-facing companies. 

And I’m not alone in this particular predilection. CB Insights reports that enterprise-oriented investment categories “account for the largest proportion of early-stage deals since 2015.”

This may seem odd at first. Enterprise-facing companies aren’t known for having many of the qualities that early-stage investors love most. They usually don’t have fast — or explosive — growth. Or massive adoption. And they typically don’t create excitement and high levels of engagement among their customers.

Yet enterprise-facing companies have their own special appeal. They have attributes that lead to growth and sustainability. And they often grow in a more predictable fashion than consumer-focused companies. 

Here are three reasons why that’s so.

1. Long Sales Cycle

Businesses are far more conservative than individual consumers when it comes to buying stuff. They go through several steps before choosing or changing suppliers. 

Above all else, the product has to work much better than the product it’s replacing. It has to be seamlessly integrated into the company’s operations. And future supply has to be 100% reliable. There’s training, maintenance, scheduled upgrades and more to take into consideration. Hasty purchases can wreak havoc on a company’s operations. 

While selling to companies is neither fast nor easy, it does have a major silver lining. Once a startup has signed up a corporate customer, that customer is likely not going anywhere. That translates to high levels of defensibility, revenue stability and customer stickiness.

2. Stable Demand/Need 

Industrial needs evolve over time… and typically on a far more predictable schedule than fickle consumer tastes. 

The Pokemon Go craze? Here today, gone tomorrow. Same goes for planking, “Jersey Shore” and selfie sticks. 

The cultural zeitgeist means nothing to enterprise-facing startups. They’re not trying to capitalize on fads or short-lived trends.

This is a crucial issue for early-stage startup investors to consider. Companies raising in their seed rounds often take years to reach an exit. It’s important for investors to ask whether the consumer trend that drove a company’s early growth will last long enough for it to exit.  

It’s a hard question to answer — and it only gets more difficult with time. But enterprise-facing companies neatly dodge this issue. The solutions they provide answer needs that are likely to last for many years.

3. Acquisition Optionality 

Successful enterprise-facing startups can choose to IPO if they want. But it likely won’t be their only option. 

These startups often share customers with large and established companies. And those larger companies often look at those startups and ask themselves, “Why can’t we make something like that for our customers?”  

These big companies may not have the company structure, culture or risk-taking incentives to provide the product or services their much smaller peers are offering. But what they usually do have is the money to acquire them. 

I doubt that the drone company I presented to First Stage Investor members (click here to sign up) will reach an IPO. I think it’s much more likely to be bought out by a large on-demand delivery company or even a traditional service like FedEx. 

The heart-monitoring implant company I showed First Stage Investor members should have buyout offers in the next two to three years from a half-dozen large medtech suppliers. 

And another startup I like — which has developed end-to-end field worker management software — will likely be entertaining offers very soon from much bigger legacy companies like Salesforce. 

Buyouts happen all the time with consumer-facing companies. But it’s easier to identify potential buyers on the enterprise side. And these startups don’t have to sell to millions of people or develop household brand names to become an enticing acquisition target. 

Overall, enterprise-serving startups have a more predictable startup journey than consumer-facing startups. 

And understanding this predictability factor gives investors a very valuable edge.

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