How VCs Assess Market Opportunity

‘Market’ is perhaps the most important variable that many investors consider when evaluating a startup and it is often the most common reason why they pass on investment opportunities. As Andy Rachleff famously said, “when a great team meets a lousy market, market wins. When a lousy team meets a great market, market wins. When a great team meets a great market, something special happens”. But how do you know you’re in a great market? Here are the questions I ask before getting comfortable with a market opportunity:

1. What is the Addressable Market Size?:

a. Size: What is the size of the market you’re after and what is the existing revenue opportunity available for your product or service? A classic exercise is TAM, SAM, and SOM where you look at the total market for your product or service, and then establish a realistic estimate for your market share.

This is often done by using Top-Down Analysis (looking at industry data and categorizing each segment), Bottoms Up Analysis (identifying customer segments you intend to reach, and estimating their size and growth), Value Theory (estimating how much value your product will add to customer and how much it will impact their adoption).

b. Addressability: Aside from “size”, the question of “addressability” or “adoption” is the next factor to consider. It’s not just the question of “are there a lot of potential customers for a given product?” It’s more a matter of, “can you reach lots of people and have them adopt this?” Addressability is how you can reach those customers.

2. If the current proposed solution works, what is the “Potential Market Opportunity”?

a. Tam Expansion: The problem is that almost all category-defining companies don’t seem to operate in a “big enough market” at their time of inception. Great companies (e.g. Uber, Coinbase, Airbnb, etc.) always fundamentally change the market they operate in and materially expand the market by removing friction, improving the overall experience, increasing convenience, lowering prices, and enabling new use cases. Therefore, the conventional TAM, SAM, SOM analysis can sometimes be a poor guide for the future if the future offering is substantially different than the past. As Aaron Levie said “Sizing the market for a disruptor based on an incumbent’s market is like sizing the car industry off how many horses there were in 1910.” Most great markets are nonobvious at first so it’s important to envision what a product could become and see the forest through the trees.

b. Market Growth: When Coinbase raised its Series A in 2013, the total market cap of Bitcoin was less than $1.5 billion. Assuming a 2 percent commission rate, the annual TAM for Coinbase would have been around $30 million! Today, the market cap for cryptocurrencies is around $75 billion with a daily trading volume of more than $40 billion. When assessing market potentials, it’s important to look at the growth of that market and not just how big it is today. Growth tends to fuel great opportunities and successful companies often ride the wave of a new market that is small today, but will be large in the future.

c. Adjacent Market Opportunities: Often the immediate market for a product or service is addressing a niche market, but it is an entry for a much bigger market. Adjacent opportunities are often exploited by leveraging existing skills/capabilities and taking the core competencies to create new value for new customers. Uber started with Limousines’ market. Now they are delivering food. Lyft was a Uber knock off, now it has moved into the scooter market.

3. What is the current Market Dynamics and how will it evolve?

a. Market structure: Many times, the microstructure and the economics of particular markets makes it more attractive because of the defensibility that it creates through its network effect, distribution mechanism, or other barriers. When evaluating a specific opportunity, understand the market forces that can propel you past others, whether it’s new technology, unpacking a crowded space or building on a seemingly niche idea.

Carta is a good example, it started with providing digital cap table to startups, but is now providing various financial products and services and has made cap table and 409A a feature of a “platform”. The more products and services it offers, the more reasons companies have to standardize on Carta’s platform; the more startups that adopt Carta, the more likely investors will start to use it and bring the rest of their portfolios to it and as a result, the network converges faster.

b. Competition: Starting a business in a hypercompetitive (trendy) market might not be as attractive to investors because it increases the risk of having to battle for visibility, users, ad space, and market share which make investors just more cautious. So markets that are “boring” and might not look “appealing” to many, are often the markets that offer the best opportunities. For example, many industries where pen and paper are largely the methodologies for running the business, such as agriculture or legal, create opportunities for tech-enabled businesses to make these industries more efficient. Pagerduty’s market seemed small and boring at first, but it turns out that many companies need it for their ops team.

However, the number of competitors isn’t as important as the quality and scale of them. The key questions are: are the competitors any good? How strong is their brand? Is it a winner-take-all or winner-take-most market? Or is it more of an oligopoly structure? What percentage of the market are they serving and what is the true potential? For example, mental health seems to be a crowded space now, but there aren’t any major players out there and there are many customer pains that aren’t met.

c. Market timing: I’ve written before about market timing and its correlation with finding Product-Market Fit. The question of “why now” is critical to address and think about. Pete Flint says that there are three things he looks for in evaluating startup timing.

1) What is the economic impetus for this product today?

2) What is the technological catalyst that is enabling the new product experience?

3) What is the cultural acceptance of this phenomenon? Is society in a position to accept and embrace your product?

You might have a great product in a great market, but you have to be objective and see if the conditions are there to support it.

If the market isn’t attractive, the startup is in for a very tough battle, even if everything else is in its favor. If it is attractive, then the question is how equipped the team is to capitalize on the opportunity.

I welcome any feedback so feel free to email me at pourya@thinkplus.vc.