Backing a growth market

By Matthew Cushen

Over the last 10 years, two things have defined my professional life – being a prolific investor in start-ups and being an innovation consultant working with the leadership teams of some of the world’s largest consumer brands.

The second has of course informed the first. And no more so than in crystallising the relative importance of insight over idea. When most people think of innovation they think it is all about having ideas.  But I’ve learnt that that is the easy bit. The harder and most useful effort should be expended on mining for fresh, new, inspirational insight that is the fuel for differentiated ideas and the source of confidence that the ideas are solving a need or exploiting an opportunity that the many people will actually care about.

It is frustrating in the seed investing world to see so many seemingly marvellous solutions desperately searching around for a problem to solve or for a market that is large enough within which to scale. For us at Worth Capital, the market, and the insight into it, are our most important criteria when assessing our deal flow.

We look for:

1. real empathy with the consumers in the market and an understanding of exactly what is being solved for. For example, we invested in a business looking to provide an online platform to landlords. There are many start-ups in the same space, and many with much better tech building capability than our investment. But our guy is a landlord with multiple rental properties. He has first-hand experience of all the gripes and niggles that landlords talk about and has identified a clear opportunity for tenants (having their rent payments contribute to their credit score) that creates the potential for them to recruit landlords (who love the thought of tenants that are motivated to pay on time and in full each month). We expect his cost of customer acquisition to be very much less than others in the space.
2. evidence that the UK (and/or other country markets) are lagging behind a benchmark set elsewhere. For example, we are just about to invest in a building material. It is Canadian and has been around for 20 years – not a sexy innovation. But there are some legislative and attitudinal changes in the UK that lead us to believe that this material can grow from less than 0.5% market share in this country towards the 10% market share that its equivalents enjoy in North America.
3. a fragmented market. It’s tough for any start-up to go up against incumbent competitors with high market share. They can use their distribution and marketing clout to wipe out the upstart – at a time of their choosing, usually when the start-up has done the hard job of establishing the market need. Other things being equal, we’ll go for a market with companies that are already peddling hard to maintain their share. For example, we’ve invested in a brand with equipment to help parents provide convenient but healthy meals to toddlers. The market has no dominant brand and it is easy to define and relatively easy to zero in on the target customer.
4. sustainable growth with volume. I was struck the other day sitting on a panel of food & drink investors when we were asked about trends. All four before me talked about veganism. Yes it is a real trend, will drive significant growth and is interesting. But it’s too easy to be captivated by growth and forget when it is from a low base. Instead, I talked about sugar tax (on soft drinks) – this is a seismic change, already driving a difference in consumer behaviour and attitudes and, most critically, in a mainstream, huge, category. We have an investment in a soft drinks brand – it has a sophistication that takes it into the ‘adult’ space and away from the big incumbent brands, along with a strong differentiated taste despite being naturally low in sugar and therefore below the range of the sugar levy.
5. trends not fads. Sometimes is hard to spot without the benefit of hindsight, but we are alive to whether a market is benefiting from a real long-term trend or just a short-term fad. Exploiting a fad might throw off a lot of short-term cash but rarely does that generate real value for investors. A start-up needs to generate long-term sustainable growth to create a high exit multiple. We’ve invested in a drinks brand that provides an alternative to alcohol – with the taste and rituals associated with wine, beer and cider, but appealing to the 20% and growing of the population that are teetotal, plus the 5 million UK drinkers that have regular and lengthy periods of abstinence, such as for Dry January or Sober October.

It is not always possible to hit all 5 of these market characteristics, and different ones are more and less important in different circumstances. But they work for us as useful first considerations to assess a market before being beguiled by a shiny new product or service.