The Market Size Fallacy for Seed-Stage Startups

Topics: Fundraising

I once showed a company to another VC for an investment we were syndicating. This investor loved the team and thought the solution they were building was compelling. Ultimately, this firm passed because they couldn’t get comfortable with the “market size” given that they were a big fund and only targeted $1B+ opportunities.

Similarly, I remember years ago when I was looking at the series A investment in a company called Lumos Labs. The company is the leader in online brain fitness games and had over 14M members at that time. But these were the early days of the company. I loved the founder but was struggling because this just didn’t seem “big enough” to me. I remember talking to one of their angel investors (and also one of my old mentors) about what the company could become and what it would look like if it ever became a really big business. I wondered if it could potentially be a “platform” for something else (the most meaningless and overused phrase that entrepreneurs and investors try to use to make companies seem more important than they are).

His answer was so simple, and at the time, I kind of dismissed it as the view of an angel investor who didn’t really “think like a VC.” After thinking for a few seconds, he just said: “I just think they can get big by selling lots and lots of games.”

Today, Lumos Labs is better known by their product’s name,, which is used by more than 70M worldwide. The company has raised about $68M in funding as well.

VCs pass because of “market size” all the time. It’s maddening feedback for entrepreneurs, because no one likes to think they are not working on a “big enough” opportunity. Sometimes, it’s true – the market really isn’t big enough. But often, it’s either not really the case or truly impossible to tell. How does one measure the market size of a company creating a completely new market, or one that is trying to unlock non-consumption versus stealing share from existing players?

The problem with the market size feedback is that entrepreneurs end up being stuck. How do I change the size of the market I’m going after? It’s very discouraging. But the reality often is that investors don’t pass because of market size. They pass because of doubts about customer adoption. It’s not a question of “are there a lot of potential customers for this?” It’s more a matter of, “I don’t really believe that lots and lots of customers will buy/adopt this.” The early traction may be interesting, but investors fear that demand is driven by a relatively small niche with idiosyncratic tastes or needs.

In other words, the investors just don’t believe in that scenario my mentor mentioned: that you can simply sell lots and lots of games.

But if this is the case, then there is actually hope! While it may not be possible to change an investor’s mind about a market size, it is possible to change his or her mind about customer adoption.  (And, again, that’s likely the true cause of their hesitation.) And if you can do that, you can probably tell some story about how the company can indeed accomplish more than anyone today thinks is possible. The game plan is then to show accelerating user growth across a variety of user segments and understandable/declining acquisition costs. At some point, investors may start to change their mind about the market size.

Editor’s note: You can hear how one entrepreneur — Jason Robins, the co-founder and CEO of DraftKings, now valued at over $1B — handled this exact pushback around market size and consumer adoption during his early fundraising efforts. In particular, he asked one very clever question of VCs to run a smoother, more effective process, culminating in four term sheets from interested, lead investors. Listen to episode #8 of Traction via iTunes or SoundCloud, or get all links and context via this blog post.