Why VCs Will (and Won’t) Fund Niche Startups

Lydia Hudgens
Lover.ly CEO and founder Kellee Khalil

Most venture capitalists and entrepreneurs brag about the largest potential market for their companies’ offerings. But some founders are thinking smaller on purpose.

Instead of promising to become the next Google Inc. or Amazon.com Inc., niche startups create products for influential, high-value audiences outside of the mainstream-say, tens of thousands of people with a rare disease, or a few hundred thousand professionals working in the world’s scientific research labs.

Kellee Khalil, founder and chief executive of a “bridal search engine” called Lover.ly, says that a narrow focus is better than trying to be “all things to all people.” Lover.ly (operated by Dubblee Media Inc.) recently raised more than $500,000 in seed funding. Lover.ly’s target audience is comprised of about 2.3 million women planning their weddings each year in the U.S.

If that sounds like a large group, consider that Netflix has about 38 million paying subscribers, Open Table Inc. seats over 12 million diners at restaurant tables each month, and Facebook Inc. has more than 101 million daily mobile app users in the U.S. alone.

Annual wedding spending-driven by a modest audience of 2.3 million brides-to-be reaches around $99 billion in the U.S., Ms. Khalil said. That’s money spent on rings and services like stylists, chefs or entertainment, as well as wedding venues and wedding-related travel.

The New York startup generates revenue through sales of keywords and other search or display advertising (via Lover.ly and a network of wedding blogs) to brands that want to reach brides-to-be in their decision-making moments, Ms. Khalil said.

Another startups targeting a niche audience is Quartzy Inc., which raised $6.7 million to bring its lab inventory management software to the world’s two million research scientists.

Edimer Pharmaceuticals Inc., meanwhile, raised $18 million to develop a therapy for a rare, genetic disease known as XLHED (which stands for X-linked hypohidrotic ectodermal dysplasia) that affects an estimated one to two people out of every 100,000 according to a recent Danish study.

And Quantopian Inc. also raised $8.8 million to bring a browser-based, algorithmic trading platform to “hundreds of thousands” of programmers in financial services. The company recently hit a 10,000-user mark.

Why invest in a company when its market, by nature, feels limited in size?

Khosla Ventures’ Partner Keith Rabois said his firm backed Quartzy because of its potential to improve the quality and speed of life-saving research conducted in labs. He also emphasized: “The size of a market is measured by dollars spent, not the number of participants in it.”

As VentureWire previously reported, lab managers and scientists spend about $35 billion a year on supplies.

Niche startups face unique hurdles like recruiting from a narrower pool of talent, says Quartzy CEO Jayant Kulkarni: “It’s hard to find people who are great developers, and who are passionate about accelerating the pace of scientific discovery in life sciences.”

Signing on early users also proved difficult for Quartzy, compared to peer startups. “Groupon had millions of small businesses to approach when it was getting started, but we had to keep going back to people who said ‘no’ earlier,” the CEO said.

Today 6,000 labs use Quartzy, with about 60% of users logging in at least twice a week.

One positive for niche businesses is a dearth of competition in their respective markets, Mr. Kulkarni said. “How many crowdfunding sites or dating and photo apps are there?” he asked.

Several investors who wished to remain unnamed said they aren’t fans of niche businesses, especially those seeking to address a narrow slice of the so-called sharing economy. Recently funded ventures in this space offer peer-to-peer and hourly rentals of boats (Cruzin, Boatbound), music equipment (GearLode Inc.) and scooters (Scoot Network), for example.

Bain Capital Ventures’ Matt Harris said certain investors will back niche players or me-too companies when they “missed a bigger opportunity, [and still] want a piece of a newly established market.” His firm generally frowns on this approach.

Founders or teams with a great track record can attain funding even if their ideas seem too niche at the start, he said.

A French startup called Dronestagr.am is currently seeking seed funding to build what founding CEO Eric Dupin calls “Instagram for drones.” It’s an app and online community for photographers who do their work with unmanned aerial vehicles (UAVs or “drones”) and are willing to share their images.

Mr. Dupin–who is also founder of a successful media startup in France, Bloobox.net (d.b.a. Presse-Citron)-thinks Dronestagram will grow along with the sales and increased use of “civilian, or personal leisure drones.”

“In the U.S., they sell about a thousand [drones outside of defense] per week,” Mr. Dupin said, “and what is the main purpose of these flying machines? [Taking] pictures, stills and videos.”

While the company closed 80,000 euros ($107,900) of initial seed funding already, the CEO is confident he can attain more capital and support for Dronestagr.am, in part because of his own track record at Presse-Citron. He insists the business is not a “me-too” play in photosharing. Like mobile phone cameras, “the drone view is a new paradigm, a new visual language,” Mr. Dupin said.

Peter Nieh, a founding partner of Lightspeed Venture Partners, says apparently niche companies in search of funding should show a clear path into adjacent markets, or a way to grow a niche market into a massive opportunity.

Mr. Nieh backed OpenWave Systems Ltd., which “put browsers on cellphones,” long before the advent of iPhones and touchscreens. The company “seemed niche at the time, but our return on investment was close to 100X,” he said.

A more famous example is Facebook. The social network targeted just college students at Harvard early on, then moved to Ivy League students only, and eventually the world. Now, of course, Facebook is a public company with a market cap over $120 billion.

For its part, Lover.ly plans to “control the search bar for wedding information,” Ms. Khalil said, attracting users in a bride’s extended network of friends, family and service providers.

And Quartzy plans to develop a full-blown platform for research, where scientists can upload and share their data, discuss protocols, buy and review products securely. “When you have two million researchers and managers collaborating, communicating and buying stuff you will…bring the future of health care three years closer. We’re not Facebook, but we could be just as influential,” Mr. Kulkarni said.

Write to Lora Kolodny at [email protected] Follow her on Twitter at @lorakolodny