What Investors Want to Know About Market Attractiveness In Macro-Terms

Not every entrepreneur wants or needs investors. Some investors – like the three Fs: family, friends and fools – don’t really need returns on their investments, although they’ll be happy if they get them. While they hope for returns, the real motivation for most of this group is to support someone they love. Aspiring entrepreneurs should not mistake such expressions of love for confidence in the venture, nor should they treat them as affirmation of their opportunity’s merit!

Most other investors – business angels and venture capital investors – invest in order to achieve returns on their investments. Knowing that most new ventures fail, they expect spectacular returns in order to make it worth their while to bear the significant risks they know are involved. What sort of returns do such investors require?

A successful venture capital portfolio might, at the end of its life, have one or two in ten of its investments hit the jackpot, returning ten times their investment or more. Three or four more – the living dead, as they are called in the trade – may return their capital, but little more. The remaining deals – lemons – lose the firm’s entire investment. It’s not a pretty picture. On the other hand, if the one or two good deals are good enough, then the fund earns an overall 25 or 30 per cent annual return over the five-to-ten-year life of the fund, enough to reward the partners handsomely and to make the pension funds and others who provide their capital happy indeed.

Given this picture, what sort of return do you suppose a venture capital firm seeks from each deal it invests in? A typical rule of thumb is ten times their investment over, say, five years, a figure that amounts to something like a 60 per cent annual return on their investment. Angel investors might invest in deals with returns projected at only half this level. But what does all this have to do with market attractiveness at the macro-level?

Do you know any (legal) business that returns that kind of money year after year? Invest ten pounds or ten dollars, return six, again and again? No, neither do I. The only way venture capital investors can get the kind of returns they require is for the business to grow so fast that it becomes worth far more tomorrow than it is worth today. They then sell the business, either to another company or to the public in an initial public offering. This kind of growth doesn’t happen in niche markets, for there simply isn’t the market potential to make it happen. Large markets are required. Nike did well in running shoes, but the overall athletic shoe market provided the scale that enabled Phil Knight and his team to grow the business substantially.

Thus, if you are a would-be entrepreneur seeking venture capital to start your company, market attractiveness – in macro-terms – is a big deal indeed.

We need to know whether the opportunity has the potential to be big – in other words, scale.
RJ, UK

A large and growing market is not the entire story, by any means, but an opportunity lacking such a market is unlikely to get funded by professional investors. Why? Large and growing markets offer two things that investors like. First and foremost, large and growing markets offer the opportunity to build a large company, one worth much more tomorrow than today. That’s good for returns. Equally important, large markets offer the chance for multiple players to be successful, each serving a different segment perhaps in a different way. That’s good for reducing risk, because it offers multiple pathways to success.