VCs are interested in firms that have the potential to acquire substantial market share in large markets. 1 They want to know whether the market is large, whether it is growing rapidly, and whether the start-up can capture some of that growth. They also want to know whether the business is scalable. A scalable business model means that the business can shrink or grow very quickly with minor changes in the cost structure. In the best situation, growth should not increase variable costs and fixed costs (perhaps even decrease variable costs). Ideally, growth should not incur large fluctuations in business processes as new customers are added. Remember, however, that scalable growth is usually scalable within a relatively narrow range.
The potential investors will also want to know whether the start-up can acquire customers and keep them. They will also be interested in the market forecast. Savvy investors will question market forecasts that indicate that the firm will garner either 1% or 10% of the market. The 10% share of the market usually means that the market is relatively small and the start-up needs 10% to break even. The 1% usually means that the market is huge and the start-up will be lucky to acquire even 1%. Market forecasts need to be based on realistic assumptions, rather than based on what makes for easy spreadsheet construction. There should be a strong rationale why the start-up will acquire 10% of the market the first year and increase that share by 20% in subsequent years.
Guy Kawasaki has several good ideas for developing market forecasts. His first idea is to develop a forecast from the bottom-up. In this approach, the start-up would try and identify the number of sales outlets and then estimate how many items might be sold at each outlet. Another example would consist of looking at the number of sales contacts each week for each salesperson and then estimate the percentage that will be successful. This approach, admittedly, also relies on percentages and, in some ways, is also seat-of-the-pants as is the 10% solution. The important point in developing forecasts is to examine and test assumptions and to constantly refine the forecasts.
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