Market size determines funding strategy, not vice versa

Market size – or more accurately addressable margin opportunity – determines how valuable a company can be, and the size of the exit in turn determines how much a company should raise. Alex Iskold, MD of Techstars New York put it like this in a recent post:

Venture Capitalists are looking to deploy millions of dollars, and they are looking for multiple times return on that capital. That is why, in addition to founders, VCs focus heavily on the size of the market. If they don’t believe the market is large enough, they won’t invest.

There is nothing wrong with starting a business in a smaller market. You can still get capital, but not necessarily via VCs. Understanding the size of your market before going out to raise money is an important thing to do for every single business.

Simply put, if the exit is £100m and you want to keep £50m for yourself then the investors will get £50m, so if they are going to make 10x+ then the company can have raised a maximum of £5m.

Investors at every stage are doing this maths, and the exit size is a function of the market. That’s why investors with large funds obsess so much over market size. Investments in small or medium sized markets won’t move the needle for them.

A lot of entrepreneurs approach this subject the wrong way round. They figure out how much they want to raise and then they write a deck and writing the market becomes an exercise in selling the investor and justifying the amount of money they are seeking. When the market is genuinely huge that works fine, but often times it isn’t, and investors will walk away if they don’t feel it’s big enough for them to make a meaningful return. Worse, market size can be a difficult topic to give feedback on. If an entrepreneur has claimed the market is worth billions and the investor feels it is worth much less then feeding that back can invite confrontation, particularly if the founder has made a big play about the size of the opportunity. Good investors want to give feedback when they say ‘no’ to investments, but they say ‘no’ a lot and unless they have had meetings they will want to minimise the amount of time they spend giving it – and that means avoiding back and forth debate on questions like market size.

There are plenty of entrepreneurs who have used their sales skills to raise money this way even when the market is small, but that usually doesn’t work out so well in the medium term when the burn rate is high and everyone is disappointed because the market has limited growth.

It’s much better to have a firm view on the opportunity size and build the fundraising strategy from that.

  • Alex Iskold

    Great points Nic, thank you for the link back.

  • I agree on your point about VC’s obsession with market size and how is this related to investment size and potential exists. However, it’s so difficult to put a number in a market size and potential addressable market. We always have this discussion with investors especially since there is no much research been done on our space. Some investors think that having no public data means bigger opportunity because it’s an overlooked market, and others believe its very small that’s why it’s overlooked.

    One thing good startups do, growing the pie or even create a new pie. Most successful startups (marketplaces at least) do is lower the cost, increase transparency and make it more convenient to buyers and sellers. In our case, people are going fishing more with us because it’s more accessible and more affordable. We have customers that went fishing 10X more in the last 9 months than the last 10yrs! Try to explain this to a VC, many don’t get it! They will take you back to a research done by the government about the addressable market and then multiply it by 20% and tell you this is you market!

    The funny thing is when you tell them “Well, Mark Andersson thinks the market is big” then they all have nothing to say. I’m impressed by some VC’s that have their research team doing the market analysis of the market size, we got approached by one top VC that knows more than us on the market size and potential market and very excited about it.

    To sum up, coming up with the market size of a startup is a very difficult task to do and most of the time wrongly estimated. Not saying that putting high weight on market size is the wrong way to estimate a startup fund raising size or valuation, but what I believe is basing your decision on a number that can be wrong most of the time is bad practice. I believe this hold truth until series A stage at least. Probably after that you can have more predictability and clearer view on market size.