How big is too big?

Angel investors and venture capitalists are very attracted to businesses that have large addressable markets. They want their investments to help the company capture a significant share of the market opportunity. It is very important that the potential market size is big enough that the company can achieve a market share position (and therefore valuation) that justifies the investment. However, it is also important that the company achieve a reasonable share of this market (20-30%) to help stave off competition.

Everyone wants “big” but how big is too big? Entrepreneurs sometimes fall into a trap where they take a look at the entire “huge stretch ” market worldwide and then make a claim that if they can just achieve 1% penetration, they can make billions. Apparently professional investors cringe when they hear the 1% number because it means to them that the company has not honestly evaluated their market and the challenges they will face in getting to 1% of “huge”.

I’m in a bit (or two) of a quandry. Natalie and I have been researching the potential size of our market in just North America and we are frankly stunned at what we have discovered. If the statistics from the Canadian and American government agencies are correct, the total spend on club registration fees per year is in excess of $60 billion. This was just for the top sports where we have a strong value proposition. It is our best estimate that a significant number of these clubs (and their members) would find our service attractive.

However, if we quote this number as our addressable target market, I’m sure we are going to get some rolling eyes. Even the 1% approach brings a huge number to the table. One of the quandries is that if we quote a much smaller number, we aren’t hitting the ‘dominant player” level and the investors may fear our market share is subject to risk of being gobbled up by larger competitors before they can cash out their investment.

We’ve taken a look at what other similar services (although not direct competitors) in the market have achieved in new members, etc. By applying similar metrics we estimate at a minimum we can acquire 20,000 clubs and 400,000 members in three years. This would give us annual gross profit from just the spread on the money we process of over $4M. Our hope is that the other three revenue streams would also contribute significantly to our total. Not a bad size business for a three year old given we would be very nicely profitable at that point…

However, the other quandry is that our best estimates of the number of clubs and members we can acquire are probably very, very conservative. It is very possible that we could achieve 10X those numbers in the same period or perhaps within an extra year. Do we bring that up or go with the conservative number? I’m a fan of under-commit and over-deliver but I’m also NOT a fan of giving away too much equity in the beginning because we don’t have the strength of our convictions on the market size. Estimate too low and we give away the farm. Estimate too high and we’ll suffer a “down round” and hurt our early stage investors.

Damn the torpedos – full speed ahead! For now, we’ll use the very conservative estimates for our Friends & Family investment round. After that, I think our approach will be to try to validate the number of clubs and members that we can directly acquire through more hands-on market research. As the research results come in, we’ll use them to adjust our expected growth and therefore valuation prior to going out for the Angel/VC Expansion round. It means that the F&F will probably get a better return i.e. I’ll give away more equity than I should have to in the early stages but that we’ll get the story “fixed” before we have to give away more in the Expansion round.

Feedback on this topic would be greatly appreciated….

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