Nikhil Gopalani is the Head of Investment at Republic and the Co-Founder and President of Ambition VC. Previously, he worked on leading the deal team at Orange Fab (Orange S.A. corporate accelerator). Over the years, he’s invested in, and partnered with, multiple successful companies, including Samba TV, Equidate, Wonolo, Token.io, Verdigris, Pixlee, VentureBeat, FabFitFun, VidIQ, Drchrono, and many more.
I want to start off by saying that, in my opinion, there aren’t any hard and fast rules for angel investing. Some investors value a startup’s idea, some investors value the market, and some investors value traction. Or maybe they value them all equally. There are so many different data points that you can measure to lower risk profiles, and everyone has a different gauge of what those are. That’s what makes venture capital such an interesting business. I like to think of it as an artisan’s business.
That said, it’s always important to look for signs of traction when you invest in startups. Traction can manifest in a few different ways, and it may mean different things to different investors. It will always look somewhat different for a business-to-consumer startup (B2C) and a business-to-business (B2B) startup. Here are some ways to spot it in an early-stage startup.
The most important thing that matters for B2C businesses in the early stage is retention. This is critical. I'd almost always invest in a company with a great team and a great product that has 200,000 users with 50,000 returning every month over a company that has a million users and only 100,000 coming back every month.
You might think that if a startup has a lot of users or a lot of downloads that means that they’re useful or needed and therefore have good traction. I used to think this too, but after making a not-so-hot investment, I quickly learned that the number of users is ultimately a vanity metric until the business has matured. Once you get to a critical size and can really lock down your retention numbers and also understand what’s naturally bringing people to the product, you can start seeing user volume as a sign of legitimate traction.
A good example of user retention in the early stage is a company that raised here on Republic called Are.na––a social network and collaboration tool for artists. When Are.na came to us, they didn't have a crazy-large user base; they had a few tens of thousands of users. But the thing that really impressed me about Are.na is that they had 20% of their user base as active monthly users, which is pretty high. That means that a fifth of their user base came back every month to use their product, and they were using the product multiple times.
Are.na’s retention paid off in its campaign, too. Many of the people who invested in the campaign were already Are.na users, which shows how passionate the users are about the product. So with B2C businesses, it's about finding that niche and building a base of users who keep coming back based on how the product works and how it interacts with the market. Loyal users will naturally start talking about the product, even if it's a small niche.
That’s another important thing—once you own a niche and you show demand and popularity in that niche you can find ways to expand it into other areas. That’s how Facebook did it. Facebook started out as a social network only on campuses. In fact, in the beginning, you had to have a Harvard email to even get access. It was a tiny market. But then they built that product for other universities, and they had the same virality that they had at Harvard. After that, they were able to expand  it much more broadly. Now, more than a billion people are on Facebook.
Are.na is an example of a consumer app. But there’s also the B2C side of the consumer product or e-commerce.
A great example of a consumer product that’s doing well––and one that I invested in––is FabFitFun. It started as just a box subscription for makeup and wellness products, but exploded after pushing quality content. The founders actually held an entrepreneurship conference recently and shared that they’re creating a Netflix-like subscription service called FabFitFun TV. So people are consuming their content and their brand—the box isn’t why people are subscribing anymore. FabFitFun has moved from the pure e-commerce space into the content & media space.
So with e-commerce, I think the product isn’t as important for the long run as the brand and its content is. The value that those deliver cannot be underestimated. You can gauge a startup’s brand strength by looking at other names in the space. Take Birchbox, for example—a FabFitFun competitor—and see that they aren't building a media business. The founders didn’t design Birchbox to be a part of someone’s life. It’s just a box full of samples that you get once a month. Those kinds of businesses can plateau easily.
With B2B startups, there are a few key metrics to look for. There’s MRR, which is monthly recurring revenue, and then based off that there's ARR, which is annual recurring revenue. There is also month over month growth (MoM). An additional metric that people often forget about, which it’s super important, is churn. Churn is the rate that you lose customers. All of these metrics are key because they signal the health of the business now, and based on those metrics you can somewhat predict how the business is going to grow in the next year or year and a half.
Investors have varying ideas about what the MRR growth should be for a promising startup—usually, it’s between 10% and 20%. A series A investor will look at that number closely when evaluating whether or not to invest in the business. Ideally, churn should not be higher than 5%. So if a startup is making 50K a month and it grows 20% in the next month but loses 5% of its customers, that means it’s growing at around 15% every month. And based on that calculation, you can try and predict if that the startup might be a billion dollar company someday.
I usually try to invest in businesses with around 10%-15% growth a month, but sometimes I’ll veer from that. I once invested in a company that had  8% month over month growth, but I really believed in the team, the products, and the way they were serving their customer (with profitable revenue). I also believed that they could increase those revenues once they found the right feature or nugget to keep people coming back.
It’s important to look at profit as well, but again, this is primarily for B2B companies. For me, I’d prefer a company that's growing revenue at 8 to 10% rather than at 15 or 20% if the business is profitable. For me, profitability is a compelling signal that you’ve not only found the right business angle but that you’re also being smart about your business economics—you’re not just burning money to no end. Maybe you’re growing a little bit less, but I love businesses that build their foundation while being profitable, bringing in little by little.
One of the B2B companies that I invested in because I saw it had great traction was VidIQ, which is basically a HootSuite tool for video. I backed that company because the founder had a multi-million-dollar-a-year video tech company with brand-name customers like Redbull and AOL before. In short, I liked the traction of his previous business. Because the founder built a multi-million dollar a year business with a bunch of big clients before, I knew that he could line up a few million dollars in revenue in the next few years (which he did).Â
There were also top angel investors investing in the company, which is a very important sign of traction. Tod Sacerdoti, Co-Founder of BrightRoll, a huge video tech company, invested; Co-founder of YouTube invested; Ashwin from SambaTV invested; Mark Cuban invested; Chris Sacca, founder of Lowercase Capital, invested—they had a lot of investor traction, and they were growing very well with big clients.
Just as investing doesn’t have hard and fast rules, examining a startup’s traction isn’t limited to one particular facet. In a general sense, traction just means that a startup has interest from people outside of its stakeholders. This can manifest in the ability to recruit good talent, get investments, generating revenue, and achieve user retention.
Traction doesn’t exist in a vacuum, either—team, tech, and traction shape each other. A startup may not have amazing traction without an amazing team, for example. Keep that in mind as you make investment decisions, and remember that you alone get to create your own risk profile. You might make mistakes along the way, but you’ll learn from them. Just be sure not to invest more money than you can afford to lose, and these lessons will be well worth it.
Happy investing!
Hope you enjoyed this deep dive into Traction. Want to get an overview of the 4Ts? Watch the recap of our webinar.
Read more about what is an angel investor.
This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.