Summer is officially over. Everyone can feel how the activity is ramping up again... Since our , many things have happened, and there are more and more pockets of optimism...
A , notably , Instacart and Arm, have been announced. Most of those businesses are very solid. It will be interesting to see how the market will welcome them. Everyone in the venture world has been waiting for months for . After a record-breaking 2021 (1,035 IPOs, beating the 2022 record of 480), 2022 saw a massive decline (181 IPOs), and 2023 has been a continuation of that trend.
. In line with the stabilisation of software valuations , revenue growth rates have also stabilised in the last three quarters. Growth for best-in-class startups is even accelerating, and new business activity is picking up.
, things continue to head in the right direction. There is no doubt that we are heading towards the end of this downturn and that better days are ahead.
What is your moat?
You can also feel this optimism with founders as deal flow is picking up again. Also interesting, but not surprising, there is a disproportionate share of being launched. Talking to them, I found myself pondering the answer to one question: ‘What is your moat?’
Let me explain: Many of those companies have exciting products coupled with strong early traction. It is easy to get carried away by their initial product ‘wow effect.’ But many of those products are a patchwork of open-source offerings, and, as models are becoming a commodity, it feels like the barriers to entry have never been lower. It is essential to take a step back and understand what differentiates those companies and business models in the mid and long term. Pure commercial execution speed can’t be the sole answer. Or, in other words, what is their moat?
So, what is a moat?
A moat is a term borrowed from medieval castles that had a wide ditch filled with water around them to protect them from invaders. In business, a moat is a competitive advantage that gives you a sustainable edge. Most often, people view moats as an edge over competitors and future trends, meaning the creation of barriers to entry for new entrants or technologies that could make you obsolete. I often look at moats as lock-in effects of your clients, in other words, protectors and drivers of customer retention (see on the topic).
A moat can be based on various factors, such as your tech, your network, your brand, or your customer loyalty. A moat matters because it helps you generate more value for your stakeholders and reduces the risk of disruption or commoditisation. And they usually grow stronger over time.
Building moats is easier said than done. In the early stages, moats are difficult or nearly impossible to demonstrate. The focus is to engage users with a product that works as seamlessly as possible. However, founders and investors must envision how this business will build moats over time.
In the context of GenAI, for example. They are constantly changing, and with them, the open-source models that underpin most of the recently launched GenAI products. As a result, products closely built on top of several open source products quickly need to carve out their ‘own space’ and create a real moat around their offering.
Eight moat drivers
I sat with my colleagues and listed some elements that make a business model sustainable. Your product is, of course, your biggest moat. Here are some economic moats that you can leverage as your business grows:
1. High switching costs for customers are probably the . This can be driven by accumulating customer data and/or work, making it difficult for a customer to leave your products as she/he would lose all the amassed knowledge. The more someone uses your product, the bigger the moat.
2. Technology and/or unique datasets are strong moat drivers. You are in a good spot if your clients love your product and it is difficult to replicate the tech (or not possible due to the existence of patents-protected IP rights) or the underlying dataset. You have the time to focus on growing your business without anyone competing for market share, or they do so with an inferior product that can’t win over time. Conversely, tech disruption is also the most efficient moat destroyer.
3. Intangible assets such as brand or strong client and people relationships are powerful but take a long time to build up.
4. Network effects driving organic customer acquisition or marketplace liquidity are one of the most important drivers of tech companies. They help leverage quickly the significant reach and growth internet products can have.
5. . They are rarer, but sometimes companies have specific online or offline distribution channels or licenses that work very well, either through partnerships (e.g. think about Klaviyo and Shopify) or just because they have figured out something difficult to replicate (e.g. selling a product through small offline merchants built on a network of relationships).
6. Cost advantages can be another moat. The scale of a business is often the driver. This could be because you can do a cost arbitrage (e.g by sourcing your products in one geo and selling to another), you have a more efficient tech infrastructure, access to cheaper but great labor, a sourcing advantage, and so on. The results could be better pricing based on a structural long-term advantage, or more agile company development.
7. Market tailwinds are another moat, but weaker. Sometimes a specific regulation or trend comes about, and a company is uniquely positioned to capture and lock clients (see switching costs). It is a weaker moat as it is only a matter of time until competitors enter the space if it is a lasting opportunity.
8. Efficient scale is another moat driver, but probably the least important one. This is usually the case for smaller markets that can only support one or a few players. It wouldn’t make sense for other companies to join the space as it only supports one player. This driver makes you rely on others to be rational, though, which is not the most comfortable spot to be in…
Did we miss any? Please let us know.
Capital is not a moat
I think there is one thing we can all agree on: The bold experiment of the last years in using capital as a moat to build startups into sustainable businesses has not worked out. While it has worked out for some companies in the end, for most companies it did not. And, while markets are coming back, the hangover of this exuberance will go on for some time. Public markets have dealt or are dealing with this (just think of WeWork or the market caps of so many of the 2020-22 SPACs). But many late-stage private companies still have not, and their cap tables will be turned upside down in the coming months. The decade chasing the ‘capital as a moat’ model is over.
The strongest moats help ensure you have a business that sustains value over the long run, and honing in on these levers early on can help you focus your strategy. Moats often grow by just executing. They are compounding. So, ask yourself this: What is your compounding moat?
This summer has been a special one. My son Gabriel was born on August 12. He is wonderful and an excellent companion to write these posts… He lost patience after some time, so this might be why this post is a bit shorter than usual. But I guess he felt it was long enough and more fun to go outside and enjoy the sun this weekend ! Here is a small gift from my friends at the Kauffman Fellows. Just love it. And I couldn’t agree more--this is a hell of a startup we launched this summer…
Life is awesome.
*Yannick Oswald is a partner at leading European venture capital firm Mangrove Capital Partners, best known for its investments in companies such as Wix, Skype, Walkme and K Health. Oswald supports tech startups across Europe and sits on the board of some of Europe's biggest tech start-ups, such as Flo Health, Sifflet and Red Points. In 2020, he launched his blog , with the tagline Opportunities Everywhere, which has become Europe’s most-read VC blog and a key resource for tech entrepreneurs across the continent. He publishes one article a month, usually on a topic related to venture capital and technology entrepreneurship. Yannick grew up in Luxembourg City, has worked in several European countries and the United States, and graduated in commercial engineering in Belgium and Argentina.