Gordon Gekko and Little Jerry Pitch a VC
By Juan Linares
When start-up founders pitch their business to prospective investors, they are tasked with demonstrating that they have created disruptive solutions that are targeting massive markets and that those solutions are perfectly aligned with where those markets are headed. Billion-dollar TAMs (Total Addressable Market) are conjured up from industry research reports, government data and other resources to demonstrate the large addressable opportunity that awaits the savvy investor. Every VC lists large addressable market as part of their overall investment thesis and so every pitch deck presents one as a given.
However, at first glance, it is sometimes hard to grasp two key aspects of the addressable market: the timing and relative scale. It is important for an entrepreneur to clearly lay out why this is an attractive market now and also to anchor the size of the opportunity in a relatable and actionable way to distinguish the company from all the others going after billion dollar markets.
Timing
“Within 45 seconds a microprocessor computes your systolic and diastolic pressure. Got an LCD readout, cost effective – less than one visit to the doctor”
Gordon Gekko understood telehealth and wearables in 1987.
However, it took a global pandemic 33 years later to really drive mass market adoption and acceptance of telehealth. A report put out by Grand View Research in 2016 said that the telehealth hardware, software and services market would reach, and I quote, a “whopping $2.8 billion by 2022”. Recent estimates put the market size at close to $100 billion by 2024.
A lot of timing mismatches can come down to costs taking time to decrease in a particular industry to achieve sustainable economic returns. Think about the first couple of waves of clean tech bubbles that were full of promise but led to minimal returns for VC investors. Thankfully the time for climate tech has arrived and infrastructure, technology and services tailored to the energy transition present a trillion dollar plus market opportunity in the coming years.
Or consider Pets.com, Webvan and Kozmos of the early 2000s – their modern iterations offering online pet supplies, grocery and other daily consumer goods deliveries are multi-billion dollar companies around the world. In the early 2000s the market, technology, Internet/smart phone penetration and infrastructure did not exist to support the same business models which are now thriving.
Sometimes the end consumer doesn’t initially cooperate or embrace the transformative solutions that companies bring to market for a variety of reasons. One is that the technical superiority is not that important (e.g. VHS/Betamax, LaserDiscs/DVDs, Samsung/Apple, etc.) Others are just ahead of their time like Pebble’s smartwatch or LiveJournal which was basically Facebook and launched in 1999. The consumer can be fickle and it is not always clear that the best product is going to capture the market today.
Ultimately, it is important to understand the addressable market as much as possible – this includes focusing on unit economics as discussed in this previous piece. Another essential exercise is getting to know and understand your target customers through numerous interviews, surveys and other constant interactions to ensure that your product is addressing a true pain point and that, importantly, the market is willing to pay for it. Finally, thorough market research and customer discussions should indicate whether the timing is right for your product and that the demand exists to reach significant sales.
Scale Perspective
“Hey, guess what, Little Jerry ran from here to Newman’s in under 30 seconds”
“Is that good?”
“I don’t know.”
Without proper perspective or scale, it can be hard to understand what certain data points mean especially when it comes to things in the billion-dollar plus range. The human brain has a difficult time comprehending large numbers – our brains just did not evolve for that function. So listening to a bunch of companies talk about billion-dollar markets can sometimes become white noise. As the WSJ reported, our lack of comprehension around a bunch of zeros “compromises our ability to judge information about government budgets, scientific findings, the economy and other topics…”
Companies should consider adding an attribute, scaling factor or a reference to help the investor understand the market size and opportunity and make it more relatable. Per Pitching VCs 101, companies will break down their total addressable markets into SAMs (Serviceable Available Market) and SOMs (Serviceable Obtainable Market) which is a good start to demonstrate understanding of the market and how much thought has been given to business development and the ideal target customer.
Additionally, presenting some context around the market size can be impactful. Raj Nathan, a dynamic consultant to start-ups, illustrates the point perfectly. He presents an example slide highlighting the size of the youth sports industry. The generic data point is that the market is a $17B industry. However, the slide also includes the following datum: 20% of families spend more on youth sports than they do on their mortgage.
Now I’m listening and have much better perspective.
Another mistake some companies make is to simply assert that they will obtain x% of a market – usually couched as “even if we just get” some small percentage, it’s still a large opportunity. It is tempting to do this because it is easier to understand percentages, but it is not a good look for entrepreneurs. First, your revenue or market share potential should be a thorough bottoms-up analysis with a fully thought out business development plan incorporating sales channels, marketing, sales teams, etc. Second, keep in mind how difficult it is to capture market share – behemoths like Quicken Loans and Whole Foods are barely 5% of the mortgage lending market and 2% of the U.S. grocery market respectively.
A number of SaaS companies are targeting the SMB (small and medium sized business) marketplace – according to the SBA Office of Advocacy, which defines a small business as a firm with fewer than 500 employees, there are 30.2 million small businesses in the U.S. Is that good? Seem like a pretty good market to try and penetrate, but let’s try to get some perspective.
If you think a $100MM ARR company deserves unicorn status, then if you have a product that costs $10/month ($120/year), you would need to have a customer base of nearly 900K active users to achieve the requisite run rate. That’s a lot of users and would represent almost 3% of the SMB marketplace – looking at it that way, that seems…aggressive. However, if your product provides significant value, or more importantly addresses a large pain point and you can charge $100/month ($1,200/year) then your customer base needs to be around 80K. At the Series A financing round, you would need to have ~800 active customers, which means the investor has to believe you can grow that 10x. A lot of further analysis has to go into getting confidence in that growth, but at least the scale is tangible and well understood.
There are a lot of ways to get to that unicorn run rate and it’s important to understand what that path looks like in a relevant manner. For instance, Palantir, which went public at a $22 billion valuation, has only 125 customers and they have been around since 2003. I imagine that during their early days of fundraising their TAM slide included the U.S. government – annual budget north of $4 trillion. Definitely compelling, but I’m sure Peter Thiel and the team spent more time discussing their business development efforts in terms of sales cycle, sales team and dedicated account representatives and customer success advocates rather than just presenting a slide with Uncle Sam handing over some money.
Final Thoughts
One of my favorite examples of understanding something vast is the cosmic calendar. Imagine that the entire history of the universe (13.8 billion years – is that good?) is compressed into one calendar year with the Big Bang corresponding to the first second of New Year’s Day (January 1st). On this calendar, humans make their debut on the planet at 10:30PM on December 31st, they tame fire at 11:46PM and the Renaissance takes place around 11:59:59 right before Dick Clark or Anderson Cooper drops the ball in Time’s Square to ring in present day. Now that’s perspective…and a killer anecdote for late nights in college with the hacky sack intelligentsia.