Market sizing. It’s something I have always struggled with, despite being analytical and knowing the theoretical fundamentals. To me it is sort of intuitive; the market is either big or not. Trying to quantify it has always been a little like either, 1/ trying to put lipstick on a pig, or 2/ so obvious, do I really need to explain?
I posit that if you are in camp 1, you have an issue you need to address quite quickly, and if you are in camp 2, you don’t really need to explain it. Only if you are in camp one, you are highly unlikely to get funded unless it is dealt with deftly.
I know it when I see it
I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description [“hard-core pornography”], and perhaps I could never succeed in intelligibly doing so. But I know it when I see it, and the motion picture involved in this case is not that.
In 1964 US Supreme Court Justice Potter Stewart described his threshold test for obscenity in Jacobellis v. Ohio, explaining why the alleged ‘pornographic’ material at issue in the case was not obscene under the Roth test, and therefore was protected speech that could not be censored. The famous remark was “I know it when I see it.” I believe the same applies with market sizing.
Market sizing is the greatest litmus test. It is the only factor upon which if all other variables are positive, a company is either viable or not. Think of market viability as the denominator – a null value always results in a null outcome. Why?
- It doesn’t matter how good the team is and your strategic partnership with hippies inc.
- It doesn’t matter how good the product is if your market is 20 hippies
- It doesn’t matter how good your traction is if you have 50% of the 20 hippies in a commune in a day
- It doesn’t matter how good your unit economics are if your 20 hippies will only pay $50 a month at 99% margin and $1 CAC
The market always wins. As Andy Rachleff, formerly of Benchmark Capital puts it:
When a great team meets a lousy market, market wins.
When a lousy team meets a great market, market wins.
When a great team meets a great market, something special happens.
VC math needs big market sizing
VC math works different to startup math. As I blogged previously A meaningful founder exit is not the same thing for venture capital. You can’t have a strategy of Shrinking a market and owning it if you don’t have a big market either. VCs need a big market to get big returns. The only thing that matters is you can be big enough and that means headroom to grow, as well as the story to tell for future growth.
So simply put you aren’t getting funded without a market that can facilitate a large exit. If you need a small market to get a big exit, the VCs would be happy with that too, but that’s not the way the world works.
How big can this get?
‘How big can this get‘ is one of the absolute first and fundamental questions an investor will think to themselves. Maybe they will pause and question if the market is small now, will it grow larger in time (They read about how some VCs passed on Uber, so they won’t make this mistake)? If they can’t reconcile this in their head rapidly, they will as you “how big can this get?”
Oh crap. The fact they need to ask this question is a big flag, per se. Why do they have to ask? Something must be missing right? You can say your market is fashion as an ecommerce provider. Everyone wears clothes. The question is therefore more ‘why you‘, why do shoppers need another seller, can you acquire customers cheaply? There are a lot of related questions to a big obvious market. But the question is not about the market size, more the share you can profitably acquire.
An investor might ask this question if the starting market is small, but the potential is large due to some trends. Think SaaS software and Salesforce.com. Think ecommerce in the world of 56k dial up modems; it would be reasonable to ask of this from Boo.com with their Flash heavy site. But there is a story of why the market will get big in future.
How long does it take to answer this question is correlated to your funding conversion rate
If the question of ‘how big this can get‘ is raised, your time to comforting the investor will determine your likelihood of closing the investor.
If this question stands out like a sore thumb, festers, and dominates any meeting starting with a “sorry I have to bring this up again but” you are not going to get funded. No startup survives contact with an investor for more than two interactions if the market question is not resolved.
Market sizing cannot be modeled in excel
When an investor is unsure of the market size, it’s a little like cheating on your girlfriend, and after getting caught, trying to convince her you won’t do it again. She listens to your logical reasoning, but instinctively she doesn’t believe you and can’t reconcile the cognitive dissonance. To her it’s simpler to move on and find another to invest time into.
Comfort on market size is something that is either instinctually obvious, or is reconcilable due to the connection the investor and founder have due to charisma, belief in product and the vision. If there are some concerns on the market size and the investor believes in the founder, then they will find a way to buy into it.
If investors don’t get the market and they don’t get the founder, than no amount of excel models and Goldman Sachs research reports will prove to the contrary. Simply put, you can’t logic an investor into believing the market with excel.
Growth stage deals are different. It’s much more about the math. The market likely needs to be modeled in the cold light of excel. If you are kicking ass then, what headroom is left may be a realistic question! Salesforce has pretty much saturated the market already.
‘The market is too small’ is a hell of a lot easier to say than ‘you, the founder are not backable’
Early stage, what I have written in this blog applied. Early stage is all about hope and a song. It’s intuitive. Investors get the opportunity or they don’t. Truth is, the market is too small is a hell of a lot easier to say than you, the founder are not backable. I wrote about this previously at length.
If investors decide they don’t get the market, it’s pretty impossible to convince them otherwise. Ensure that you communicate the size of the market to investors and ensure that they get it. You need to know the top down sizing (list the reports) and do your own bottom up calculations (ideally be able to do the math on a whiteboard). Furthermore, have a story with all the underlying drivers that will lead to the market expanding and you riding that wave to the top of the market.
But at the end of the day, if investors don’t get the market opportunity, you won’t get their money. Sell the market size.