About a year ago, I wrote a blog post that’s been one of my most-read posts to date. The post was all about why and how startups should define their market size to generate investor interest and excitement.
I still firmly believe this is one of the most important things startups can do.
And yet, Reilly and I continue to turn down company after company that approaches GAN Ventures without a market size large enough for investment.
Rather than keeping all of this feedback internal — sharing it only with founders who approach us for funding — I thought it might be useful to share publicly. What I’m hoping to do is not only help startups better understand what we’re looking for at GAN Ventures (and why) but to understand, as a whole, the type of market that’s generally required for a venture capital-level investment.
Let’s Start with a Bit of VC 101
Here’s a bit of background that might be helpful.
Traditionally, venture funds have been set up with some foundational principles —
- Hunting Unicorns: Venture capital funding has traditionally been designed for high-risk/high-reward investments. VCs have historically invested in moonshot ideas — ideas that, on the surface, don’t seem entirely plausible but, should they take off, would completely transform our lives. These are the mythological creatures — rare and special and you run into them once in a lifetime, if you’re lucky.
- Casting Many Nets: Historically, most VCs also aren’t looking for a return on every investment. They’re looking for just a few companies out of many to make it big. But very, very big. Why? Once VC funds get a big return, they can then return the money raised (and much more) to the individual investors who invested in the firm or fund.
It can seem predatory to expect only one or two companies to make it big and for the others to (likely) go out of business. There are also tons of ways that this model is broken — it means VCs are betting on only high-profitability and not necessarily high-impact, and it’s a model inherently set up to discount a more diverse set of founders, as well as the harm that some companies (even if highly profitable!) do to people, the environment, and so much more.
That’s a blog for another day, but I just want to make sure you understand a very basic level of what most VCs look for. Because if high-reward companies are the ideal investment choice, it means VCs are going to be asking a very specific set of questions to determine whether you fit those criteria.
A Quick Illustration
In case it helps drive the point home even further, here’s a quick run-down of our fund to illustrate the concept —
- We generally invest in startups with around a $4M valuation.
- And we need about two companies in our entire portfolio to grow to 100x of that initial valuation (or about $400M).
- The life of our fund is 10 years.
- So, if our fund is going to get a return in 10 years or fewer, one-to-two companies have to hit that valuation goal.
Again, there are all kinds of things you can say about the VC model. And, there are certainly other HUGE factors that we look for when considering whether to invest. But our reality is that we need to find companies that have a logical path to 10x and a plausible path to 100x because we have to provide returns to our investors. And out of almost ANY criteria we look for, there’s one thing that tells us that you’re a company that’s justifiably positioned to make those leaps and —
It’s Your Market Size
It can be a bit complicated to describe exactly how valuations are set. But, if I were going to describe it in the most simple terms possible:
You get a valuation from two things: Your total potential market size down the road and what you’re doing today.
So, more than any other factor, we have to hear detailed insights into how you think you’re going to reach a massive market because it says something not just about where you are now (including how much revenue you’re currently making), but where you’ll be later.
This means that you can’t just walk into a pitch meeting with a graph on a slide that says you expect to reach one billion people a year because you believe it to be true. You have to actually dictate, through believable research, how you plan to reach a massive market.
What does that look like? Well, let’s say you have a brilliant idea for a new kind of baby bottle. What do we need to hear?
- What’s your total market? (How many babies are there in a particular area of the world?)
- What percentage of that market are you really going to sell to? (How many of those babies will need bottles and how many babies can you expect to reach — obviously, with their parents as your actual customer?)
- What’s the quantity sold per each individual? (How many bottles will you be selling to each of them?)
- And, what’s the price for each unit sold? (How much does each bottle cost?)
These are things you should be able to answer with confidence.
We can’t just hear your pitch and bank on you because you’re a good leader with a good head on your shoulders. If you’re looking for venture capital, you have to be able to show what it will take for you to reach 10–100x and how you’re going to do it soon. Because that’s what helps us to know that you’re an investment worth paying attention to.
My biggest worry here, though, is that everyone thinks that they need VC funding and that couldn’t be further from the truth. VC funding isn’t for everyone, and that’s 100% okay. Maybe you don’t want to grow your company large enough that you have to hit these kinds of returns for an investor. Or maybe you have a specific market you always want to serve and you care about those people and only those people, even if there are only 100 of them and those 100 people will keep you in business for life. Truly, that’s okay. Just know, if you do approach VCs, proving your market is one of the most important things you can do.