A few weeks ago, Tom Shields of Woodside Fund contributed a post to VentureBeat listing his criteria for investment in a Web 2.0 company. Rather than comment on that post, I thought I would offer an alternative version. In researching the key success factors for 20+ successful Internet start-ups on my blog, Startup Review, several recurring themes have emerged. I wouldn’t so much call these investment criteria, as much as I would describe them as leading indicators for potential success. A consumer Internet service that offers a convincing story along one (or multiple) of the below indicators may just be the next big Internet success story. If I were working at a VC firm or contemplating pursuing an entrepreneurial idea, these would be the things I would look for in an Internet company.
Product that fits the needs of an underserved niche
Conceptually this is pretty easy to understand, so I’m probably not providing an earth-shaking insight here. However, a company that has truly unearthed a market need that isn’t being met by other services and delivers upon that need with the right feature set and value proposition represents the best opportunity for an Internet start-up today. I think that the venture community tends to underestimate the potential of niches to transform themselves into the mainstream plays, which explains why companies like eHarmony, Newegg, Zappos, and Betfair were not backed by top tier VC firms until after they had proven their success.
Strong ability to leverage natural search as the primary means of user acquisition
I think this is probably the most under recognized opportunity area for Internet entrepreneurs and investors today. It is no secret that search engines, and Google in particular, have become the gateway to the Internet. Search query volumes continue to grow at a fantastic clip, and as such offer one of the best ways to acquire users at no cost. It is particularly appealing to start-ups, because search neutralizes the need for brand recognition.
Any company that can demonstrate an ability to achieve high natural search rankings for a high volume of search terms stands a good chance to become a success on some level. Recent examples here include Yelp and Digg, both of whom owe a great part of their success to natural search. In the case of Digg it was inbound linking from tech bloggers and for Yelp the production of a massive amount of searchable, local user-generated content that did not exist before.
Service that empowers people to make a living
Every Internet service needs power users, and I would argue that the best type of power users are those that have a vested personal financial interest in the success of that Internet service. There is probably no better example of this than eBay and the legion of people who earn either a full or partial salary from their eBay activities. iStockphoto is another good example, enabling semi-professional photographers access to the stock photography market, and some supplemental income for themselves. An emerging example is uShip, a company that is transforming the freight services market by leveling the playing field for sole proprietors.
Free (or near free) alternative for a previously high cost service
Again, not an amazing insight, but one that has been time tested on the Internet and hence I feel is worth re-iterating. Really this is just another way of framing the value proposition. Some good examples of this include Greenfield Online, the pioneer in online market research, Craigslist as a free alternative to classifieds, and iStockphoto for near-free expensive stock photography.
True viral distribution potential
A viral Internet service is one where each new user must involve friends to derive personal value from the service. This is best exhibited by communication and hyper-social services. Telling a friend is not an option; it is a necessity in order for the user to derive value from the service. Although it is easy to incorporate viral feature sets into any Internet service, actually getting users to utilize these features is quite hard unless they recognize the value they personally and immediately will receive by involving friends. Thus, while many Internet start-ups will claim to rely on viral marketing, only a select few will actually qualify as truly viral services.
Ability to jumpstart user acquisition through distribution partnerships
Having a distribution channel to jumpstart user acquisition isn’t a requirement, but it does increase the likelihood of success. Skype was able to acquire its first 500,000 users by being bundled with Kazaa. MySpace migrated users over from a dating service (CupidJunction) and made heavy use of database marketing. Bebo marketed to the install base of its established, sister property BirthdayAlarm.com. Even Digg launched via a TV show that reached 100,000+ of its target users (tech enthusiasts). As a counterpoint, successful services like Flickr, Craigslist, Piczo, RockYou, Xfire, and countless others did not benefit from proprietary distribution.
Story that lends itself to mainstream PR
Although many will claim the death of mainstream PR in Web 2.0, I would claim that it is still a key ingredient to achieving scale and mainstream adoption. Thus, companies that have the potential to be good PR stories after achieving some initial success, have a much greater likelihood of being break-away successes. The truth is, some services are sexy and make for good stories, whereas others do not. Companies like Hotornot and Craigslist made for great stories, and thus received massive amounts of press attention. More recent examples include MySpace, YouTube, and Zillow. Mainstream PR cannot provide the spark, but it can fuel the fire in a big way.