Marketplace Best Practices
September 5, 2024
As a marketplace operator, getting marketplace funding will be your first order of business — and your first set of challenges. Marketplaces face unique financial challenges right out the gate, including:
Thin margins. Unlike single-seller commerce, marketplaces don’t take home the whole markup of their products or services; they take home a cut and pay out the rest to their sellers. As a result, marketplaces rely on sales volume to generate revenue, which can take time. New operators need funds to keep the business running as they get the flywheel spinning.
Seller payouts. Marketplaces take money in from buyers and payout sellers, creating a working capital problem where you may owe money before you have money. New operators need liquid funds to pay sellers on time — and safeguard their supply.
It’s clear that marketplace operators need to spend money to start making money. But how do you get your hands on the funds to get your marketplace off the ground and keep it off the ground?
To understand how to secure marketplace funding for your start-up, let’s explore:
Marketplaces have the potential to be very lucrative. Just because marketplaces have low margins doesn’t mean they rank low in profitability. In 2023, 35% of global online purchases were made on marketplaces. Companies that have launched a marketplace saw a 42% increase in overall revenue.
What sets marketplaces apart is that they rely on volume to generate revenue. Think of any mega marketplace. Uber, Amazon, and Wayfair's financial success is related to the scale at which they sell: en masse. While all marketplaces rely on volume over margins to generate profit, there are nuances regarding how and who they change.
The most common marketplace revenue models are:
Commission: Commission is the most common marketplace business model. A seller lists their product on the marketplace. When the item sells, the marketplace takes a cut and pays the seller the rest.
Buyer subscription: Buyer subscription models charge the buyer for recurring access to the marketplace. Think Netflix or UpSplash. Subscriptions are beneficial because they provide operators with predictable recurring income and are optimal for digital products.
Seller subscription: Seller subscription models charge the seller for access to the pool of buyers, the technology, or the support sellers receive via the marketplace. This model is also called a ‘membership fee.’
List fee: List fee models charge sellers for listing their product or service on the marketplace. They’re commonly used in marketplaces that rely on single-product transactions or where the buyer could go directly to the seller. At its core, list fee charges the seller for access to more business.
Marketplaces can charge the buyer or the seller. So how do you decide? Choosing who pays comes down to who’s more incentivized to pay. In other words, the side with the bigger problem should foot the bill
Before you can start making money, you have to get your marketplace off the ground. You’ll need funding to pay for the costs of doing business, including your marketplace platform, employees, and marketing, among other fixed and variable costs.
Few will have this capital lying around — and we don’t recommend mortgaging your house to pay for your business. The better route is to seek debt or equity funding.
Debt financing is a way to borrow money from an outside source — like a bank or lender — with a promise to pay back the debt plus interest.
Equity financing, or venture capital, is when you sell a portion of the business to investors to raise capital. Investors make money when the company makes money.
These are not the only funding routes, but they are the most common financial pathways to launching a marketplace.
In a nutshell, there are no mysteries. You agree on the loan’s interest up front. If you sell the business or make profits that exceed the loan, the lender doesn’t receive any additional money. They are only owed the interest and the principal.
It’s worth mentioning that debt financing is non-dilutive. Unlike equity financing, with debt financing, you retain full ownership of the business.
However, if your business does not profit or make money, you are still responsible for the loan’s interest and principal.
Examples: Business loans, business lines of credit, personal loans, business credit cards
Considerations: Debt financing may be hard for start ups to attain because the business is in development and, therefore, risky. The riskier lenders perceive your business, the higher your interest rate will be. Debt financing may become more palatable when your marketplace matures to have a predictable income, and you have the confidence to cover the debt.
With equity funding, funds don’t have to be repaid, and there’s no interest. If the company fails, the marketplace doesn’t have to return the funds raised to shareholders.
What makes equity financing not as appealing to some founders is that itrequires operators to share profits with investors and consult them on decisions as if they are business partners. By agreeing to equity financing, you are essentially taking on another business partner. The only way to remove an equity investor is to buy them out. Equity financing also comes with pressure from investors to be profitable.
Examples: Angel investors, venture capital firms, corporate investors
Considerations: Unlike banks that are motivated by interest, equity investors have a vested interest in your marketplace’s success. They’ve bought in based on a bet that your business will be worth a lot more in the future, which is why they’re a more suitable form of financing in the early stages of a marketplace launch.
There are different investors you can approach at varying stages of your marketplace’s development.
Friends and family: Many first-time entrepreneurs approach friends and family to get their marketplace off the ground. These investors know you and what you stand for. They believe in your vision and abilities. While they may only provide a small amount of capital, their support may be enough to get you started. Always carefully outline the terms of investments. These are not professional investors. If they don’t understand the risks and rewards, you might encounter conflict in the future.
Angel investors: Once you’ve got the bones of your business plan in place, you can approach angel investors. These are investors you don’t know personally but are interested in your space, supporting small businesses, and helping founders. Sometimes, they will be former professional investors who now invest privately.
Institutional investors: Also known as venture capitalists, these are professional investors who take money from outside sources, like pension funds or sovereign wealth funds, and find companies to invest in professionally. They are calculated: They know exactly what risks and rewards they’re taking on. They perform professional due diligence and create a transactional relationship that is focused on one thing: profit.
Strategics: Strategic investors, also known as corporate investors, are corporations that invest in your business when it has matured and needs to expand. Strategics might invest in your business with the intent of eventually buying it.
Now that you know who to approach, let’s review strategies for getting in front of them. While you might be able to call up friends and family to secure a meeting, getting access to an angel investor requires a little elbow grease.
Securing funding early on is all about who you know—and who they know. A warm introduction is a connection facilitated by a contact in your network. You might not have a target investor in your professional circle, but you can work your network to determine who does. Bonus: A warm introduction can also serve as a vote of confidence in you.
Does your target investor go to a specific meet-up? A conference? A corporate event? A pitchathon? Find out where they go — and then make sure you’re there in a memorable way. To find out where they’ll be, pay attention to their personal and business social channels, like LinkedIn or X, to see if they announce their presence at relevant events.
Investors get pitched all the time, so how do you stand out from the herd?
Your pitch is the simplest explanation of your marketplace, how it will make money, and why an investor should give you their money. Your ability to articulate value in a clear, primitive way is step one to positioning your business as a venture-backable marketplace. It’s important to note that your pitch will evolve as you get real-world feedback and should be customized to cater to the interests of the investor you’re approaching.
The more you practice your pitch —to friends, colleagues, in the mirror — the more finessed it will become. Every word matters. Eventually, you want to get to a point where one powerful sentence will communicate your marketplace’s critical value points while wow-ing the investor by changing their worldview. (No pressure.)
Set your target investor up for success.
Remember, your target investor is merely the front lines. If they’re interested in your business, they must secure the buy-in of everyone backing them, including their investment committees, their firm, leadership, and colleagues. Set them up for success with a pitch they can easily reconvey to their team.
Build an bullet-proof business case for your target investor. Arm them with statistics, market research, and proof of product-market fit to prove your marketplace will be a lucrative opportunity. Anticipate risks, questions, and concerns—and then quickly snuff them out.
Venture down the “why” rabbit hole. Why is this a problem? Why does that problem matter? Why would anyone pay for the solution to that problem? Why wouldn’t they choose another solution? Why would they keep paying for that solution? Have an answer for every why. Not only will this help you deal with investor scrutiny, but it will also help you keep your marketplace on task during development.
Attaining marketplace funding will require you to get in the trenches, become a storyteller, and cultivate confidence in your marketplace concept — even when it’s just a twinkle in your eye. Approaching investors will force you to learn how to sell your marketplace from day one, setting the stage for your go-to market. By securing a solid foundation of marketplace funding, you’ll be better positioned to create an amazing product that will wow sellers and buyers alike.
The marketplace start-up journey is not always intuitive—that’s why we’re here to help connect you with insight from experts who have walked the path before you. Learn more about launching a marketplace by signing up for our free Marketplace Bootcamp.