How to Prove Your Market Is “Big Enough” to VCs?

It's not about showing trillion-dollar market size numbers on the pitch deck……

The second most common reason why VCs pass on an investment is some version
of “it’s not big enough.” For a VC to generate a great fund-level return, they
typically needs to invest in at least one company that has billions of dollars of
enterprise value.

To do that, most VCs decide that each one of their investments needs to have the
potential to exit at or above that amount, even if it’s very unlikely to be the reality
for every single investment.

The problem is, that most really exciting companies seem “not big enough” to a lot
of investors, especially really early on. These startups are often going after markets
that don’t currently exist or seem like a niche opportunity (but in reality, are much
bigger).

“So if you’re a founder choosing to take the VC path,

How Can You Counter Investors’ Objections About Market Size?”

By The Venture Crew Team

Below are some different approaches. Keep in mind that some of these are
left-brain sort of approaches and others are more right-brain.

Both are important and could be effective for different sorts of investors (and
different sorts of founders). And if you gravitate towards one, keep in mind that
investors who make team decisions will come at this question from multiple
angles.

1. Top Down, But Brick By Brick

Most market sizes are top-down. “The market for marketing software is $XB
dollars so it’s big enough to support some really big companies.” It’s the simplest
way to think about market size, so most investors will gravitate that way, especially
if you are building a company that is going after an EXISTING market.

One way to augment this is to essentially take the same approach but show
brick-by-brick how your market opportunity may be bigger than it seems.
This means showing:

● geographic expansion
● pricing/upsell potential
● market growth
● very logical expansion into verticals or complementary products etc.

You will still need to be going after a pretty large core business for this to resonate
in any way. But doing a build-up like this can be effective when a prospective
investor does believe that the market is somewhat big but would love to see more
upside to get fully comfortable.

2. Bottoms-Up Market Demand

The previous approach completely fails when you’re talking about markets that
don’t quite exist yet or when an investor is not at least on the fence about market
size.
By The Venture Crew Team
Another approach is to do a bottoms-up analysis to demonstrate the scale of market
demand for a service like yours. Start with the total number of potential end-users,
and use reasonable estimates around customer demand, pricing, market share, etc.

The key things that you’ll be pushed on with this sort of analysis are -

a) how do you define the reasonable scope and segmentation of the potential
customers,
b) how realistic your market share assumptions are, and
c) the fact that this is all conjecture.

One way to address d) is to include solid data points that lend credibility to your
assumptions (like a reasonable estimate of how much customers already spend to
solve a similar problem or some ROI analysis on your product/service that can be
used to estimate reasonable pricing and the “no-brainer-ness” of what you are
proposing).

Also, keep in mind the “vitamin vs. pain-killer” analogy.

Bottoms-up approaches tend to work better for “painkillers” than “vitamins,” even
if the ROI of the vitamin seems to hold together.

3. Attaching To Mega-Trends–

Being in lock-step with a broad mega-trend is another way that investors get over a
seemingly small market. This means that the investor (consciously or not) believes
that the mega-trend will either -

● drive massive market growth or

● drive the new company to have an unusually high market share.

A simple example of this was the shift from simple tools to advanced tech. Once
investors believed this was happening, it became more reasonable to think that a
new software product in a specific vertical might enjoy extremely rapid adoption
By The Venture Crew Team
and enough market share to build to $100M+ in revenue and $1B+ in enterprise
value reasonably quickly.

Without this mega-trend, it’s harder to believe this because the pace of adoption
may be too slow and it would be too difficult to dislodge existing players with a
similar approach without being 10X better, faster, or cheaper.

4. Using Analogies

Using analogies can be tricky because they may not land. But if they do, I find that
a lot of investors often get fixated on an analogy that can sufficiently build
conviction. When doing this though, it’s important to not just list out similar
companies or big exits in the space, but internalize what those analogies
communicate.

For example, if there have been some large exits in a seemingly small market, this
can be a blessing or a curse. Yes, those analogies exist, but how well do investors
know the comp that you are citing? Was it a teeny business bought for purely
strategic reasons?

Are there only one or two buyers who would pay that kind of premium? How
many investors would take that bet?

Productivity software is in this category. One could point to companies like

Evernote, Sunrise, Acompli, etc. as examples of companies with really nice exits or
private market valuations. But looking at this another way, one could say, “Wow,
outside of Microsoft, who will pay a premium?

The best companies only exited for at most a couple hundred million. Wow,
doesn’t Evernote show that it’s really tough to be a truly venture-scale, independent
company in this category?”

I find that the best analogies are ones that tend to connect to one of two things.
Either, it is tied to a mega-trend. For example, “Just like the shift to the cloud
allowed for the rise of great companies in different categories, the shift to mobile
By The Venture Crew Team
computing in the enterprise will do the same. So this application that does X is the
beginning of a mobile-first HR product that will be like Workday but for mobile.”

The second analogy is to connect yourself to a company with a similar ethos or

founders with the same superpower. This is a lot harder to do and probably
happens by inception more than through direct argument.

You would probably not say “We are just like the Airbnb founders, so you should
believe we can make this work.” But I have heard investors who have gotten to
know founders over some time say something like “Wow, these founders are
unbelievably obsessed with design and user experience in a way I haven’t seen
since (person X). Maybe they really can pull it off!”

5. Scope expansion

This is some version of “Today we are doing X, but that just puts us in a great
position to do Y, which is obviously huge.” There are a couple of flavours of this.

The first is the bank shot. This is where X is actually not the foundation of a great
sustainable business but could be a gateway to more. A lot of VCs have a hard time
with bank shots unless you are already demonstrating some really remarkable
traction. Usually, the right approach here is to focus on growth and scale as
quickly and efficiently as possible when accomplishing X, and make most of your
money doing Y down the road when you have a network effect, customer lock-in,
or can provide a valuable service that no one else could provide without your scale.

The second version of this is when X is actually pretty decent. Maybe it won’t be
“the next Facebook,” but it could certainly get you to a pretty attractive place.
Usually, this works well when the underlying business is profitable and decently
large without being too capital-intensive, which gives you more freedom to pursue
the bigger opportunity as a next step.

This allows an investor to say to themselves, “I could reasonably get a 5–10X on

the core business, and there is some small probability that this could actually be a
20X or more.” Usually, this means that the company is in a market that has decent
By The Venture Crew Team
prospects for future funding or M&A, such that if the business hits a double but not
a home run, it still could be a good outcome.

6. Betting On The Future

One additional approach that most founders use quite successfully is what I’ll call
“the future bet.” The approach here is to deflect discussions about current market
size and focus the discussion on a single, simple bet about the future.

For example, this can be used in almost any rental or sharing economy company
(clothing, transportation, equipment, etc). Even though most rental markets aren’t
very large, the bet goes something like “Do you really believe that people are going
to continue spending thousands of money on products that are not utilized 90+% of
the time? Our bet is that consumers are rapidly moving away from ownership
towards sharing and renting, and those multiple billions of dollars are going to shift
towards the companies that get this right.

Two Final Thoughts and Reminders

First, don’t forget about what margins mean for market potential.

High-margin businesses like software or marketplaces (when revenue is correctly

accounted for) can support 10X+ revenue multiples. So the bar for a large-scale
opportunity is the potential to generate hundreds of millions of dollars in revenue
to be worth billions of dollars down the road.

For low-margin businesses, the revenue bar for a larger-scale opportunity is

higher. So when you are talking about how your business can build using a
bottoms-up analysis or comparatives, make sure you keep this in mind.

Second, the landscape of potential acquirers plays into this discussion as well.
Generally, don’t spend too much time talking about buyers and M&A
opportunities. But when you are a company that may very well find that the market
opportunity is not as big as one thought or hoped, it’s comforting to be in a
category with a strong set of folks who would buy you for a reasonable amount.
By The Venture Crew Team
Most investors don’t focus on downside protection. But psychologically, this could
make a difference when one is on the fence because of market size or the risk
associated with a bank shot/scope expansion strategy.

Written By The Venture Crew Team

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By The Venture Crew Team