Size Matters

Time is the entrepreneur's most precious commodity.  For most entrepreneurs, the VC fundraising process is very time-consuming.  Bad combination.

In an attempt to help, I have previously offered tips to entrepreneurs on navigating the VC process -- "The Ten Commandments for Entrepreneurs", as well as some follow-on posts in this blog.

Here's another one.

There are many kinds of VC's.  Some focus on IT, some on healthcare, some on energy, cleantech, etc.  Some focus on early stage investing, some on later stage.  There are, no doubt, other important dimensions on which VC firms also vary.

But, regardless of other differences, one thing almost all VC's look for as the gating item in their investment decisions is market size.  Size matters; bigger is better.

Why is this?

A baseball metaphor is usually employed.  VC's, especially early-stage VC's, get paid to hit grand-slam homeruns (achieve out-sized investment returns).  In order to do this, VC's must "swing for the fences" each time they "step to the plate" (invest).  The bad news: in early-stage VC, as in baseball, if one swings for the fences every at-bat, one strikes out a lot.

One might reasonably ask: why don't VC's just "play it safe" by attempting to hit "singles" and "doubles", with fewer strike-outs?  The reason is perhaps not obvious.  Early-stage VC's don't use the "home-run every time" strategy just because they like high-stakes gambling (though some are high-stakes gamblers outside of work).  They operate this way because, in early-stage investing, it is damn near impossible to tell (with any consistency) which startups will succeed and which will fail.  One strikes out just as often hitting for a single as for a home-run -- so one is better off trying to hit a grand-slam every time.

In the VC business, it is received wisdom that no company can become large and successful unless it's addressing a large market.  In VC land, it's not unusual to hear something like: "Even good teams fail in bad markets; even bad teams have a shot in good markets."  Obviously, there are many other factors that determine success or failure of a startup, but addressing a large market is a necessary (but not sufficient) one.

Finally, most VC's (at least in the good firms, which tend to have the best deal flow) can't pay close attention to more than a small percentage of the deals that come across their desks.  So, like all human beings, VC's use triage strategies to cope.  Given that addressing a large market is a necessary condition of success for any startup, VCs ask the size-of-market question early on as a way to narrow the field of startups to a size they can manage. 

Together, these two factors, (1) necessity of large markets for success and (2) necessity for VC's to efficiently triage their deal flow, show why many VC's use market size (and structure -- see Postscript below) as an important initial filter to decide which startups they spend time on.

A first step on the path to VC funding, therefore, entails making clear to the VC's the size of the market one is addressing.

Postscript:  A useful nuance is probably worth noting here.  Sometimes, the largest opportunities lie with startups that attempt to create new markets (whether through "disrupting" existing markets or otherwise), rather than those who (merely) participate in existing markets by introducing new/improved products and/or services.  Valuable companies can be built in both situations.