Big Wednesday
Today was supposed to be the day that I broke my 141 day streak of no surfing. I was supposed to be in L.A. all day in meetings, but they were canceled yesterday and I found myself with a “free” day all of a sudden. I’d been following the reports on Surfline and Wetsand for a week or so and both had been predicting “epic” surf for South Orange County with wave heights in the 7-15 ft range today. In fact, so much attention had been given to the “monster swell” that was rolling in by the experts and my friends that I ultimately decided to take my son to one of my local breaks and watch from the sand rather than put my relative inexperience to the test in DOH (double-over-head) surf all by myself. Turns out, I psyched myself out for nothing. The picture below was taken at Doheny around 9am this morning and raises two points I’d like to discuss. First, I’ll address one of the age-old questions: “Does size matter?”. Finally, I’ll briefly delve into “how big is big enough?” Before you either tune out or turn on, you should remind yourself that I’m writing from a VC’s perspective in The OC and get your mind out of the gutter.
So, does size really matter? If you’re talking about markets, then the answer is unequivocally yes. What do I mean.? I mean that the size of the market (as measured by total available revenue realistically achievable per year) a particular start-up is attempting to sell its product or service to matters a lot for several basic reasons from a VC’s perspective: 1) The targeted market’s margins for operational errata are much bigger (and, therefore, more forgiving) the larger the market is; 2) The larger the market is the more room for competition there is (which will inevitably occur in today’s age); 3) The larger the market is the more revenue any one particular company can aspire towards; and 4) The “law of large numbers”. Why does all of this matter to a VC? Simply put, most VCs are looking for very large returns on their investments (e.g. 10x+) and companies targeting “monster markets” are more apt to realize such returns (all else being equal). To quote a legendary “patriarch of private equity”, Don Valentine, “It’s better to invest in a company in a large market with great demand than to invest in a company that has to create it.”
Okay, okay, so size really does matter for targeted markets…but how big is big enough? It has been my experience that the answer to this question depends on a few primary factors: 1) the size of the VC fund from which you are seeking an investment; 2) the targeted market’s rate of change (in terms of growth / erosion); and 3) the background of the team attempting to penetrate the targeted market. Clarification, please. Sure, since you asked. Generally, the larger the fund the larger the liquidity event needs to be on a per deal basis to achieve the returns most LPs expect (e.g., 2x-3x cash-on-cash) given historical statistics. As an extreme example, and all other things being equal, it is arguably much harder to turn $500M into $1.5B than it is to turn $10M into $30M. Additionally, a “small” market that is growing like wildfire may generally be preferable to a “bigger” market that is quickly shrinking. As an entrepreneur, you should research the size of your intended market and understand not only it’s absolute size, but its underlying growth/erosion dynamics as well. Finally, the less seasoned the team is the greater the margin of error generally required.
A couple of final, parting thoughts come to mind as I stare at the picture… First, don’t generalize size — do your homework and truly understand how big the total addressable market is rather than that of the market generally available. Finally, understand that size is relative. For those of you who know Doheny, you appreciate the fact that while the waves weren’t DOH this morning, the 4′-6′ footers were much nicer than the typical 1′-3′ footers found there. I guess I should have gone surfing afterall…
