Startup general interestVenture Capital

The perils of aiming too big too early

By July 16, 2012 One Comment

I’ve been advising startups for a long time now to make sure their fundraising is consistent with the size of their opportunity. Unfortunately, it is in the nature of startups that the opportunity size is usually unclear at the early stages. For the lucky few that have found an obviously large opportunity with a relatively benign competitive environment they should go all out and raise as much money as they can. Wonga springs to mind as an example of such a company at the moment, as does our portfolio company Neul, albeit at an earlier stage. The rest of startups should size their fundraisings to allow their investors to make a decent return at an exit valuation commensurate with the opportunity size which can be credibly defended at the time of investment. (Note, opportunity size shouldn’t be the only driver of round size, Nicholas Lovell wrote more about this as part of our 50 Questions Series: How much money should I raise?, and Why too much money will kill your company )

This advice isn’t always terribly popular. Taking a pragmatic and realistic view of the opportunity size today is sometimes mistaken for a lack of ambition or a lack of belief in the entrepreneur/company vision. This is a particular problem when other VCs are routinely advising companies to shoot for the moon, but it is crystal clear in my mind that for many companies raising a couple of million and preserving the possibility of a profitable $30-50m exit is the right strategy. By all means plan to step up the ambition once the opportunity size is proven, but don’t lose site of the fact that exiting at that level is a great success that only a few entrepreneurs pull off, and will most likely be very lucrative for founders if they haven’t raised too much money.

So I was pleased to see this morning that Dave McClure thinks about things in a similar way. In a post titled Niche 2 Win, Baby Dave wrote the following:

Most startups think they have to be AWESOME to succeed.

Actually, this is quite far from the truth – in fact, you can be incredibly mediocre and still be quite successful. (sounds inspirational, i know, but stick with me for a minute.)

The secret is to find your Niche – that is, the initial customer segmentation / product differentiation combo that enables you to beat your more established, mature competition with a much crappier product.

This strategy is called “Niche to Win”.

Most VCs (especially those with limited operational marketing experience, or in a few cases, those with too much good fortune with big wins) have no understanding of this. They commonly and foolishly advise founders: a) “You’re thinking way too small”, or b) “Your market isn’t big enough for us”, or (sorry Vinod i know you mean well but i don’t agree) c) “We only fund Ambitious Entrepreneurs who want to Change The World”.

While this perspective isn’t completely irrational coming from large-fund VCs (>$250M+) who need big exits & returns to satisfy their LP investors, it’s incredibly unhelpful in the short-term for entrepreneurs just getting started, who may be a year or three from understanding their mature market opportunity.

I think this is a really important point and one that is not widely understood. Whether it is ‘niche to win’ or matching the ambition with the opportunity the key is that success comes in many guises and it isn’t always appropriate to be shooting for a $1bn outcome.