What market sizes VCs want to see

‍Today’s Question: Is my market big enough for VCs? 

Investors and advisors will encourage you to put a market slide in your pitch deck and make sure the ‘total addressable market’ number on that slide is big enough that your company will appeal to venture capitalists. If the market number is too small, you’re not considered ‘venture backable’ and VCs likely won’t invest.

So, how big does your market need to be to raise from VCs? Is $1bn+ big enough? Why do VCs care about market size? Let’s dig in.

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Quick Summary Answer 

• When a venture capitalist raises a fund from limited partners (LPs), the VC is expected to return the money raised with a healthy multiple. Most VCs rely on a few big wins to achieve this, rather than a steady trickle of returns from all their portfolio companies. As a result, VCs are looking for each company they invest in to have the potential to ‘return the fund.’
• For your company to return the fund, you’ll likely need to generate >$100 million in ARR and exit at a $1bn+ valuation.
• As a result, you need at least a $1bn market for you to be venture backable. 
• It’s fairly normal to have a market size in the tens of billions. (See data from YC companies below.) It’s also possible to have a truly gigantic market (e.g., $1 trillion).
• Your market also needs to pass a ‘gut’ check. Is there really a massive money making opportunity here? Are there a bunch of customers willing to pay money for what you’re building, or are you stuck in a small niche?

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Why does your company need to ‘return the fund’?

Jamie (a former YC founder) has a great explanation of how VC fund incentives work: 

When a VC starts a fund, it gets commitments from limited partners (LPs) – typically institutions like pension funds, endowments, or wealthy individuals – for a certain amount of money. For instance, a VC firm might raise a $100 million fund.

So when a VC is evaluation whether they want to invest in you, one thing they have in mind is whether you have the potential to "return the fund."

This means that if you succeed, would you generate enough returns to cover the entire $100 million that the firm initially raised.

This happens because of the power law in startup returns: most startups fail, some give investors a bit of money with modest exits, and some become unicorns that generate TONS AND TONS of money. For example, during Jamie’s YC batch in 2015, YC shared that 97% of their total returns had come from Dropbox and Airbnb (see her post). As a result, VC’s tend to adopt the strategy of making a bunch of bets and hoping for a few big winners. 

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How big should your market be?

In order for you to return the fund, most VCs are looking for companies that can achieve a $1+ billion exit. Rob Go from NextView Ventures summarizes it well here: 

For a VC to generate a great fund-level return, they typically need to invest in at least one company that has billions of dollars of enterprise value. To do that, most VCs decide that each one of their investments needs to have the potential to exit at or above that amount, even if it’s very unlikely to be the reality for every single investment.

At later stages of a startup, you can estimate your valuation by multiplying your revenue by 10. So, to achieve the billion dollar exit valuation VCs are looking for, you’ll want revenue of >$100 million. Startup Stash goes into more depth on this example here. 

Assuming your company can capture 10% of the market you’re in, you’ll need to be operating in at least a $1bn market to achieve $100 million in revenue. Alex Iskold from 2048 explains the 10% number here.

Here are a smattering of other sources that also suggest your market should be at least $1bn+: Hustle Fund, Hyde Park Angels, Alex Iskold from 2048 VC, and Jamie again.

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Do small pre-seed VCs still require a 1bn+ market?

You can estimate the exit valuation you need to return the fund more precisely by looking at the investor’s check size and their fund size. This math typically still suggests even micro VCs are looking for large ($100-500 million+) exit valuations and markets. 

Here’s an example of this calculation from Jamie’s post: 

…[Assuming the $100 million dollar fund described above] If the VC firm invests $10 million for a 10% stake in a startup, that startup would need to be sold or go public (IPO) at a valuation of at least $1 billion (10 times the fund size) for that investment to "return the fund."

Or lets say you are earlier, and you raised 100k from a ‘micro-VC’ that has a $10m fund. If this $100K investment is for a hypothetical 2% stake (at a $5M valuation cap), then for this investment to return the entire $10M fund, the startup would have to reach a valuation of $500M (100 times the $5M valuation cap, as 2% of $500M is $10M).

Important note: it’s a bit more complicated than this, because investors get diluted as you raise. Rob Go has a great post on how to do venture math calculations without any simplifying, which you can check out here. 

Hustle Fund, a great small-check pre-seed VC fund, also shared their criterion for evaluating markets: 

If we invest in Cat’s company at a $1 million post-money valuation, do we believe that she is a founder with the right team and market to support a 100x outcome?

Or in other terms, if we invest at a $1 million valuation, does her business have the potential to exit or IPO for a $100 million valuation?

How much bigger than $1bn+?

There’s a big range of possible valuations above $1BN, so let’s get a bit more specific. What’s a typical market size for a venture-backed startup? Do you want some buffer above $1bn? If your market is looking like $1TN, is it worth double checking your math? 

Markets in the tens of billions are fairly standard, with a few markets that are substantially larger (hundreds of billions):

• Daniel Porras Reyes analyzed 319 YC demo day presentations in 2021 to extract data on their market sizes. He found that the average market size was $29BN.

• Alex Iskold from 2048 shared his view that most VCs love $10BN+ markets. He also notes that there are some legitimately massive markets (e.g., cloud compute = $1.6TN).

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