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Evaluating Market Size
The other aspect of an investment opportunity that can sway an investor is the sheer size of the market opportunity presented. Angels and venture capital investors frequently focus on the size of the market for the company’s product to evaluate the potential return on investment.
important It is important that the company can convince you that they can be a $100M-revenue company while owning only a small fraction of their target market. That suggests that the company needs to be targeting a $1B market or larger. Angel investors typically do not want to invest in a lifestyle business* that tops out at less than $10M in revenue, because there are fewer exit possibilities, and it is hard to achieve the levels of returns that VCs and angels seek if the company is going after a small market.
A typical scenario for a startup is that they are targeting a large market, but are starting with a very focused market entry strategy. This is a smart approach: create a beachhead and initial traction with a very focused product in a very specific market and then expand to the broader market as their resources for engineering and sales grow. So while the initial market may be small, the total addressable market (TAM) in which they believe their product, service, or approach will be superior, should be large.
Evaluating the Idea
Angel investors will often categorize an idea as a painkiller or a vitamin. A vitamin is something that makes the customer’s life a little easier or a little better, whereas a painkiller is something that solves a real pain point for the customer. The assumption is that if you are addressing an actual problem a customer has, they will have a greater urgency to purchase your product or service and will more readily take on the risk of buying and using a product or service from a startup.
B2B startups have a particular challenge in that they are asking their customers to take a chance on the product and the company. If a customer buys a startup’s product, invests in setting it up and training their employees on it, and then the company disappears in a year because they ran out of money or pivoted, then the customer is up a creek, and that purchasing manager has some explaining to do to his or her boss. The product has to be really compelling for the buyer to take that chance. It is often not enough that it has better features than existing products or that it saves the customer 10%-20% on their costs.
Even for B2C companies, it can be challenging to get consumers to change their behavior. The product has to be significantly better than the alternatives to get consumers to switch and stick around.