"Should this be venture-backed?" (hint: often no), p.1
The subtle and dyeing art of whether a company should be venture-backed
Note: this is not whether a company can be venture-backed? I can microwave metal, but I shouldn’t
I could go blue in the face discussing the subtly of this subject, so let’s discuss
Aspect 1: Will this market narrow into oligopolistic (winners-take-most) or monopolistic (winner-takes-all) dynamics?
VCs make their money on outlier outcomes = outlier multiples
At one point Snowflake traded at over 100x LTM revenue —an insane premium even by SaaS standards, let alone regular business valuations
For the same revenue, a strategic startup with a great business model say sells at 10x Rev, while a regular small business with an average model say sells at 5x EBITDA, for the same revenue, that’s the magic of venture outcomes
Why do some companies get outsized multiples? Because it is a scarce, high-demand asset. By definition, it cannot be one of many, that is no longer scarce
Why does a market narrow? There’s an art to examining this - intense network effects, strong data moats, brand moats, high barriers to entry and exit, etc.
Some markets are highly unlikely to narrow.
An example is a market with low barriers to entry - take nail salons. You or your neighbor can learn this skill and set up shop. Due to such low barriers to entry, this market should not narrow to one or a few winners, thus a VC-backed nail salon startup doesn’t make sense
(Disclaimer: different VCs depending on fund size & structure need different returns to make their math work. Smaller VCs don’t need the same outsized outcomes)