Earlier this week Bryce Roberts of O’Reilly AlphaTech Ventures wrote a post about VCs over analysing market size and then passing on deals. His point is that if a VC hasn’t got comfortable on market size within two meetings then they never will and the entrepreneur shouldn’t spend more time with them. The post was titled You Can Never Size a Market in Excel.
There are a couple of important underlying points that I agree with, but I think there is an important subtlety which is ignored, and that is the difference between questioning the market size and questioning how big and valuable a company can get.
First the points of agreement:
- Doing too much work sizing an early stage market is pointless – as I wrote in 50 Questions: How does a VC evaluate market size? there is some analysis that can be done but sizing an early stage market is a very inexact science and you very quickly reach a point where the extra work isn’t bringing any extra insight. I would caution against relying entirely on gut instinct though – there are simple back of the envelope checks that can be done to check the accuracy of the gut feel and it is better for everybody to know sooner rather than later if the market is smaller than one might think.
- Spending time with VCs who are slowly working their way towards a ‘no’ is a waste of time and to be avoided, and for an early stage deal doing too much work on market size is a red flag. In fact doing too much work in any one area is probably a sign of a deep underlying uncertainty that may well get in the way of saying ‘yes’.
There are a tirade of comments to Bryce’s post which echo these two bullets, and I think they are the most important takeaways.
That said, I think it is important to understand the difference between the size of the market and whether there is an opportunity to build a big business. When I first read Bryce’s post I reflected back on the discussions we have had with companies in the last few months, half a dozen of which have lead to investments, some of them (including at least one that ended positively) it has taken us longer to get comfortable answering ‘is there an opportunity to build a big business?’ than Bryce allows for.
In these situations we instinctively knew the market was big, but had concerns about other characteristics of the market which impact the opportunity size. The most common of these are how much of the market is truly addressable, margin structure and pricing (at the point of investment and going forward), and the significance of differentiation with direct competitors and alternative approaches in the market. Due diligencing these issues is often a process of talking to friends in the market, digesting their opinions, and then discussing those with the company raising money. On top of the basic market size analysis this can easily run to more than a couple of meetings.