"If we can sell one to everyone in China..."
-- Many a hopeful entrepreneur
Entrepreneurs often ask what VC's look for in a business. While simple at first notion, it can be complex in detail. One of the key factors that VC's look at (and which entrepreneurs should seek regardless of funding) is scalability in their business model. This term gets tossed around rather lightly but few people ever take the time to define what they mean by scalability. While different people have different definitions, my basic measure is simple: P * Q.
For all you Economics majors, you know that this is Price * Quantity = Revenue. Why do I say P*Q versus simply Revenue? It probably goes back to my early days at the Boston Consulting Group where you had to break down your analysis to the most relevant atomistic level. VC's need to see businesses that have the ability to get big. They can do this one of three ways...lot of Q, high P or both.
In pitching a VC, never use phrases like "Gartner estimates this market to be $xx billion...". This will get you quickly escorted out of the building. These numbers are often useless and misleading. Top down approaches give very little visibility into the credibility of a business plan. Avoid "all I need is 2% of this market". Again, top down doesn't work. First, you are probably relying on the useless analyst market estimate and multiplying by 0.02. Second, you need to be the market leader in your space to cut through the noise and grow. If you have 2% of the market, either you have defined the market too broadly or your market share is somewhere way out on the tail.
Two phrases to focus on: bottom-up and P*Q. When sizing the market, identify the relevant and believable Q. How many customers are you really going to sell to? It often is useful to identify the first vertical or two that you plan on penetrating (technology usually takes hold a vertical at a time). It is much more believable (or defendable) if you are targeting the 2,000 trade associations than it is to target the Wilshire 2000. You can describe what it is about trade associations (or what other vertical) that need your product.
Once you have defined Q, you then need to demonstrate, realistically, how much each Q/customer is willing to pay (P) annually for your product or service. It should be tied to what customers are currently paying for your product or service. If you are selling something for $5,000 a month, don't model out $200,000 per year per customer. Show that it works at $60,000 a year and that it is gravy when it goes to to $200,000.
Another key factor in gaining credibility with your model and business...visibility. The easiest way to show visibility is to have a credible pipeline. To the degree that the customers in your pipeline look a lot like the customers buying your product, the more credibility your claims will have.
Also, if management has sold to Q in the past and has strong relationships, it enhances credibility that it will work again this time.
So, drive your models to the most basic variables for a bottoms up analysis. Break P & Q down into their sub-components...Q could be visitor traffic times conversion. Each situation has its own drivers. This way, you don't have to sell one to everyone in China...
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