I just passed on a company growing 80% month over month. Instead, I chose one growing more slowly. Have I lost my mind?
Not yet.
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These two companies illustrate one of the most important principles in venture capital: market size matters. Without a large enough Total Addressable Market (TAM), a startup can only grow so big.
Company A
Company A is a fantastic consumer subscription company. It has an awesome product and growth rates you rarely see anywhere.
So they’re scaling like crazy — but for how long? To answer that question, I did a little back of the envelope math.
They have about 25 million potential customers, according to my research. At their average revenue per user of $10/mo, that’s $3 billion a year in potential revenue.
And unfortunately, like many consumer companies, churn is heavy. So the company has to be rebuilt every year or two.
Company B
Company B handles international corporate money flows. And while A has a substantial market, the potential for B is staggering.
Corporations move $23.5 trillion across borders every year. At B’s take rate, that alone is a $60 billion a year revenue opportunity.
Better yet, B also charges SaaS fees! That expands the TAM to around $70 billion.
If B takes even a small slice of the market, it could exceed $1 billion in revenue. At a typical 10x multiple, that means a $10 billion company.
And just because B isn’t growing as fast as A doesn’t mean it’s not growing! Revenues jumped 10x year over year, an amazing performance.
Why We Hunt Elephants
VC’s and angels are obsessed with big markets because the largest outcomes matter most. In venture capital, they drive almost all of our returns.
Let’s look at 3 examples: a company that’s acquired for $100 million, a startup that IPO’s for $1 billion, and another that IPO’s for $10 billion.
Assuming 50% dilution from the time we invest until exit, here’s what our returns look like:
That $100 million outcome, as big as it sounds, accounts for less than 1% of our returns! Meanwhile, the $10 billion Big Kahuna makes up fully 90% of all our gains.
If one type of company gives you 90% of your gains, that’s where you have to focus.
Expanding Your TAM
Let’s say your market is small. But you love your business and you don’t want to shut it down!
Think about how you can sell your product to more customers! Can a product that’s useful for auto garages also work for cleaning services?
There’s nothing wrong with focusing on a small market in the beginning. You have to start somewhere.
But if you want to build a venture scale business, you also have to think big!
Best of luck to all startups, big and small!
How do you think about market size? Leave a comment at the bottom and let me know!
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