Size of Market and Expanding Quickly are over-rated

The two most over-rated factors in startups are market size and speed of expansion, and placing too much emphasis on them could put your business at unnecessary risk and dramatically increase the chance of failure.  I’ll address each separately below. 

 

Yesterday I had a founder whose business was in the wedding industry lament to me about market size.  Her business was focused on a niche in the wedding space, and as such, many VC were telling her that the market size for her offering was just too small.  In response, I shared a few things with her: i) she’s good at wwaht she does, her business is what it is, and the size of her market is outside of her control, so stop worrying about it; ii) expanding into other product lines to artificially increase the market size takes the business out of its competency/focus thereby creating more risk and taking more cash; and iii) if a VC really likes your deal, they’ll just adjust the valuation downward to account for a smaller market.  For instance, if a business’ most likely outcome is a $10mm exit, a VC can still make plenty of money investing at a pre of $1mm.  Any VC that tells you market size is an issue is either using it as an excuse to pass, or more likely has too large of a fund for you.  VC’s with large funds ($500mm+) have to put a lot of money to work in each deal in order for successful investments to have a meaningful impact, so doing smaller deals doesn’t make sense for them.  We actually love small niche businesses because they don’t take a lot of capital to get to an acquirable size, they’re generally attractive to acquirers as a feature or add-on, and they don’t attract competition.  Come one, come all. 

 

Another over-rated factor is the speed at which startups gain meaningful share.  We see many startups, especially those on the B2C side that focus on speed at the expense of profitability.  For instance, they try to expand to their 10th city before even being profitable in their first city.   Not only is this overly capital intensive and puts the business at undue risk by burning cash too quickly, but it’s not attractive to an acquirer.  Working off the same example, an acquirer would prefer to see you be very big and profitable in 3 cities versus very small and unprofitable in 10 cities.  From an acquirer perspective, they’ll look at those profitable cities and markets as proof that the business really works.  The acquirer can then be the one to scale the business from city 3 to city 100, and that’s indeed why they’ll buy you. 

 

Furthermore speed doesn’t work: it’s silly to think you can outpace the competition, when what you should really focus on is outperforming them.  Remember the story of eBay: at the time it was still young and Benchmark had invested $6mm in it, The Economist estimated that there were more than 150 online auction sites on the Web.  One of those was far ahead of the rest, backed by Kleiner Perkins, and was already a public company with a market capitalization of about $175 million.  As we know, eBay beat everyone else because they outperformed the competition, building a profitable business that outlasted the rest as opposed to speeding to every market burning through cash in the process. 

 

In summary, size of market and speed should not be the most pressing concerns and emphasizing them can actually put the business at undue risk.  Focus instead on building a great business profitably. 

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