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Imagine this scenario. You’re preparing to go fundraising. You’ve done your bottoms-up analysis multiple times but you keep coming up with $500m - a number that you know is too small for the VCs you want money from. You know you need to present something much larger to get funding, something that conveys ambition and tells investors that billion dollar outcomes are within your reach. At the same time you know that presenting something investors don’t find convincing will torpedo your pitch.
Whilst advising founders with fundraising I come across this problem frequently. Founders who know that their number needs to be bigger but don’t know how to do that while remaining convincing. Typically, founders fall into two camps - those who inflate their market size to the point of ludicrousness and those who are overly conservative when defining their markets. This post is for founders in the latter camp.
When calculating and presenting their market’s revenue potential, founders often forget two things.
Keeping the former in mind will stop you from being paralyzed by conservatism - if your logic is coherent and your calculations plausible, you can present it. While grasping the latter gives you licence to inject some optimism into your calculations.
With a bit of care - it’s often possible to more than double your market size without damaging plausibility or doing anything dishonest. In this article I’m going to run through some tricks of the trade you can use to do this. This post focuses on rooting out hyper conservatism from your numbers, while its sister post teaches you how to get VCs to believe in your long term vision - allowing you to present a market size that includes customers that you don’t yet serve and products that you don’t yet make.
As I’ve mentioned elsewhere VCs care about market size because they are trying to understand whether relevant customers will spend enough annually for your business to amass significant revenue. Startups are extremely risky so investors focus on how much your business will ‘win’ if it is successful.
In a bid to be ‘conservative’, founders often shoot themselves in the foot. They will often only include a percentage of their market size for no good reason. Here’s an example of this:
This well executed bottoms-up market size is ruined by the last sentence. $173m is not the market size - $864m is! As long as all 120k plumbing companies are relevant and have the problem that the product solves, then all $864m should be included in the market size. There is no good reason to exclude 80% of the number.
This damages your fundraising chances in a few ways
Make sure you are presenting the entire relevant market as the opportunity space.
Many founders present market sizes that are geographically constrained in a bid to make their estimates seem more reasonable. Too often, I hear founders whose stated aim is to build a global product present their market size like this, “the market for our software in France is $300m”. The problem is, they omit any indication of how big the market is worldwide.
It’s understandable why founder’s do this - your business is in France and you’ve only been selling to customers in the French market, so how can you talk confidently about what the appetite for your product is going to be like in Australia. Surely investors will put more faith in your French market size than your global calculations.
While it’s true that investors will put more credence in your local market knowledge, it doesn’t actually make that much of a difference. VCs tend to see the business world as global and will largely believe that if you can sell a product to businesses in one developed country, you will probably be able to sell it in all similar economies.
Moreover, as stated above, startup investors are explicitly looking to invest in outliers. Yes, most companies fail to expand outside of their home markets, but the one’s VCs are looking to invest to take over the world. This means that they have a bias towards taking the challenges of geographic expansion for granted. They believe that the winners will make it internationally, thus if they like your team and think the problem you are solving is both painful and widespread they are primed to accept that you can take over the whole Western world, not just France.
This has two effects.
Nine times out of ten being conservative about the geographies that make up your relevant market is a disadvantage, so even if you aren’t struggling to produce a number large enough for VC interest, it is still a good idea to take an ambitious stance on geography.
A third way that founders are overly cautious is when their market sizing focuses on the current revenue available for the taking in industries that are growing very quickly. In nascent markets, this static view of markets hampers founders unnecessarily.
VCs care about market size because they use revenue as a proxy for how much a company can be valued at exit. Large markets equal more potential revenue at exit which in turns means larger outcomes for the fund. The thing to notice here is that they care about all of these things (market size, revenue, etc.) at exit.
Since early stage investors aren’t expecting you to exit your company for 7+ years, they are perfectly happy to accept an estimate of your market size in 2030 (I’m writing in 2023) as long as they agree that your industry is actually growing.
If your company sells software to drone operators and you have a plausible argument that the number of drone operators will grow from one million now to five million in 7 years, investors will be willing to accept the implications of having 5 times as many customers in your market size. Assuming that these customers would pay $1k p.a., this transforms your $1bn market size into a $5bn one.
In scenarios like this, not taking into account how your industry is expected to grow is the equivalent of fighting with one hand tied behind your back.
Now that you know how to eliminate unnecessary conservatism from your market sizing - check out our sister article which shows you how to get VCs to believe in your long term vision. Something which is fundamental if the market for your initial product is small.
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