One of the toughest things about analyzing companies is figuring out if they are tools or platforms. In B2B Fin Tech, one of the things we are seeing is the unbundling of big entrenched vertical silos. Bloomberg, FIS, Fiserv, Envestnet, the banks, exchanges and insurance companies all have walled gardens they want customers to play in.
In many cases, it’s possible to unbundle one small thing out of their service and create a new platform company that can get big. The new platform company brings new customers into the market that were previously going through distribution. That can decrease costs, and bring efficiency. It can increase throughput, making the market bigger than it was.
It’s not Fin Tech, but think about Uber. It was a tool at first. It hailed a black car. You could circumvent limo services and potentially taxi services. But, it’s developing into a transportation/logistics platform. Or, think about Ebay at the founding of the company. It looked like a potential platform from the get go.
The trick is to figure out where a company can go. Often, it starts out as a tool. But, an ecosystem forms around it and it can evolve into a platform. Sometimes, it just starts as a platform and goes to town.
As a seed fund, it’s pretty critical that we figure out the difference. We invest at the same stage as angel investors. But, we can’t think like angel investors. Angel investors can play for singles and doubles. Funds can’t.
Tools solve one problem. They don’t disintermediate a layer of distribution. They just offer the customer a choice. Or, they offer the choice at a discount to what the customer is paying on the platform. In many cases, entrepreneurs should build these businesses but they shouldn’t take any venture money to build them. If they build enough mass, a behemoth will buy them. Usually the buyout is less then $50M. It’s a great outcome for the founders and people that work at the company. It’s a great outcome for angel investors. It’s not a great outcome for a fund investor.
In many cases, it might be better for the entrepreneur to just sell the tool to a potential acquirer early for a small amount of money rather than take the risk and go through the brain damage of building a company.
Platforms solve multiple problems and have network effects. They are sticky. Customers return there again and again. They start to suggest add-ons and they are willing to pay for it. Platforms can also streamline previously hard problems-like adhering to regulatory requirements. Platforms can get big. They can start to invade adjacent areas of business. It’s like a tank going into battle. Shoot this enemy over here, turn the turret and blow up that one over there.
Sometimes a fund will make an investment based on their prediction that a tool can become a platform. They have ascended the proverbial mountaintop and seen what the entrepreneur sees. But, often times it doesn’t happen. The tool can’t break through to platform scale and the outcome is less than optimal.
Entrepreneurs know this. They always sell their idea as a platform. But, platforms are rare.