Look for white spaces

You hear about it everywhere in the technology industry and it comes in all different colors—the elusive yet hallowed “white space.” For those of you unfamiliar with the concept, white space is a term used to describe a market gap where current needs are not being met by incumbent companies and technologies. When this gap exists, there is opportunity for an innovator to offer products or services that specifically address this unmet market need and fill the blank space. Finding startups that target potentially big white spaces is the key to delivering venture-style returns.

Venture capitalists are constantly searching for innovative startups that target new and emerging markets, or white spaces not yet populated by the tech giants. With giants like Oracle, Microsoft and SAP dominating their respective fields, startups are wisely steering clear and avoiding head-to-head competition with them. These behemoths have such a stranglehold on enterprise software customers that venture investors view enterprise software startups competing for these same dollars as dead on arrival. An entrepreneur could run up and down Sand Hill Road or the 128 corridor with the best idea and team in the world, but if his PowerPoint contains the words “enterprise software,” he won’t get a second look. As markets and sectors mature, there is a natural process of VC investments in those sectors drying up. Today, no one is investing in pure-play enterprise software companies anymore. It’s as black a space as buggy whips and online pet supply stores.

Of course, VCs aren’t ready to abandon software investing altogether. Software entrepreneurs are cleverly creating white spaces by attacking the market from different angles where there is less entrenched competition. You’d be hard pressed to find a VC interested in funding a PC-based word processing suite that takes on Microsoft Word head-to-head. (If you do find one, there’s a bridge we’d like to sell him.) But some VCs would be intrigued by an Ajax-based word processor via a software-as-a-service delivery model. Others may look closely at an open source multilingual word processor for use on mobile phones and PDAs. Startups that can successfully identify uninhabited white spaces have a fair shot at winning investment dollars, customers and market share.

Virgin territory

How does this obsession to find white spaces translate into real returns for venture capitalists? There is compelling evidence that when a VC identifies and invests in a true white space opportunity, the returns can be spectacular. Our definition of a white space company is a first mover in a previously unoccupied market space. See Table 1 for a few of the true white space companies backed by VCs in the past decade or so.

As the London Underground reminds us when we enter the Tube, we must “Mind the Gap” and pay careful attention to emerging white spaces.”

Bart Schachter & George Hoyem, Blueprint Ventures

Most VCs would agree that backing a first mover in a large white space can create outsized returns. Of course, the trick is to find a company targeting a big white space with a viable business model. Does anyone remember Webvan or Kozmo? And it’s critical to identify a space where adoption is imminent. Pioneering products like Apple’s Newton staked out uncharted territory in the PDA space but eventually failed when the market didn’t materialize as planned. The moral of the story: Find a company targeting an unoccupied white space and ensure it has the right business model and near-term market opportunity to go the distance.

The concept of white spaces can be further applied to VC firms’ strategies. It’s becoming increasingly difficult for VC firms—especially newer ones—to compete for the best deals across the entire spectrum of IT and life sciences. Rather than be everything to everybody, many firms are becoming specialists and narrowing their investment strategies by sector, stage, geography and/or deal source. By trading off breadth with depth, they’re able to increase their technical expertise, network and deal flow in a particular niche and better compete for deals in their chosen area. It’s a natural sign and healthy evolution of the maturing venture business.

Not surprisingly, LPs are also searching for white spaces in the VC firms they back. As the venture landscape gets more crowded, LPs are gravitating toward VC firms that have identified gaps in the market and are attacking a different slice of the private equity world. LPs’ interest in differentiated strategies is twofold:

• Opportunity for outsized returns: By definition, VC firms attacking white space opportunities have few if any competing firms hunting in their particular niche. As a result, these white space VC firms can develop proprietary sources of deal flow, are able to invest in attractive deals, and benefit from lower pre-money valuations due to less competitive bidding. These are all key ingredients to finding great investments and generating significant returns for LPs, presuming the VC firm has identified an attractive white space.

• Portfolio diversification: Investment theory states that diversification in and across asset classes is a key driver of long-term performance. Most LPs already have the tried-and-true pieces of the VC investment canvas covered. Rather than invest more dollars in another early stage VC with a substantially similar strategy as its existing portfolio, an LP can diversify by investing in VC firms focused on white spaces.

LPs who invest in only high Roman numeral VC funds risk missing out on the next generation of top-tier VC firms with differentiated strategies.”

Bart Schachter & George Hoyem, Blueprint Ventures

Limited space

These days, most VC firms require a unique strategy to pique LP interest in their new fund offering. They key point to stress in an LP elevator pitch is: How is the firm’s investment deal flow and strategy differentiated? Remember, over-funded deals are a result of LP over-funding of VCs pursuing the same strategies. VC firms that can address this question of differentiation are gaining the most attention from LPs. Just look at recent LP investments in VCs focusing on alternative energy, investments in China and India, and new IP monetization models, to name a few examples. See Table 2 for a list of firms we feel are targeting white space investment strategies.

While our list is not all inclusive, it does lead one to conclude that the pursuit of white spaces is underway in the venture business. Over time we expect to see specialization by private equity firms in search of even more white spaces. And LPs who resonate with a VC firm’s white space strategy—target focus, market opportunity, business model, team, and timing—will be along for the ride.

As the London Underground reminds us when we enter the Tube, we must “Mind the Gap” and pay careful attention to emerging white spaces. History has shown us that forward thinkers generate the lion’s share of private equity returns, whether it’s Benchmark Capital investing in eBay or the Harvard endowment allocating major dollars to private equity in the industry’s early days. We all are guilty of naturally gravitating toward what we know. It is critical to move outside our comfort zones and proactively discover new white space opportunities that will drive future innovation and VC returns. Early stage VCs who insist on investing in enterprise software or telecom only risk becoming dinosaurs. And LPs who invest in only high Roman numeral VC funds risk missing out on the next generation of top-tier VC firms with differentiated strategies.

Stretching and reaching into those Brave New World areas requires taking some calculated risks. As Wayne Gretzky said, skate to where the puck is going—not where it is. We all know investing in both companies and VCs is in large part instinctual. But the best instincts never are realized if you do not act. So get out of your comfort zone and go find your own white space.

Bart Schachter and George Hoyem are managing directors of Blueprint Ventures, which makes seed-stage and early stage investments. Schachter focuses on communications and IT infrastructure, wireless technologies, nanoelectronics, software and communications semiconductors. He may be reached at bart@blueprintventures.com. Hoyem focuses on software, wireless, security and IT and communications infrastructure. He may be reached at george@blueprintventures.com.