Whether a company is actually investable is a debate I routinely have both with myself and other people.
There are a couple of companies which end up being part of this debate. The first are companies run by their founders on the basis of their lives rather than the needs of the market.
The so-called 'lifestyle company' is used as an utter term of abuse in the world of investors as an excuse not to invest.
(For the record, my view on people who are able to run companies in a manner which is completely balanced with the rest of their lives should be celebrated and studied intensely rather than ridiculed. I aspire to run a lifestyle company one day.)
The other type of company which often gets rejected is done so on the basis that 'the opportunity is too niche'.
Niches are challenging for investors. Anyone who's investing from a fund is constantly looking for very large outcomes because of the nature of portfolio failure (most of a VC's returns will come from a third of their investments). On the surface, a lot of niche markets are rejected because they don't appear to be capable of supporting a company which fits that profile. Typically companies often end up being marginal players in marginal markets.
However the alternative to this, and one of the reasons why I'm so attracted to niche opportunities, is extremely interesting.
Niche markets can be monopolised and the average spend per customer gradually increased (eg subscription box services or Apple).
Niche markets can also be leveraged to open up related markets and products (eg Nike and Amazon).
The video games, e-sports, online dating, craft beer, organic food and DIY furniture markets all started as extremely niche sectors.
Don't confuse small markets today with necessarily small dollar values tomorrow. Today I'm certain that niche opportunities are (still) being undervalued by almost every investor. There are three reasons for this.
1 Information efficiency. In our hyper-connected world, it's far easier to reach 100pc of a niche audience than at any time in history.
Look at the crowd-funding campaign for a game called Star Citizen. Over $75m raised for a game which would struggle to raise finance from a mainstream publisher on the grounds of 'lack of mainstream appeal'.
2 Niche audiences overvalue tailored products. I will pay $40 to get a 'Run The Jewels' T-shirt. And I will be extremely pleased about it. So will they with their 40pc net margin.
3 Longevity. I'm not exactly sure why this is happening (although it may possibly relate to reason 1, above) but I suspect the lifetime of niche audiences is increasing.
One of the other reasons I love niche markets is that you can learn EVERYTHING about your customer. And I do mean everything.
In a sub-$100m market, it is entirely possible to map out org charts, budgets, internal politics and internal relationships of your entire customer base.
You shouldn't just know who the competitors are, you should be able to know precisely how much is being spent with them.
Here are a few effective techniques I've seen;
1 Interviewing senior candidates from competitors or clients.
2 Just asking. You'd be amazed at how forthcoming people can be over lunch.
3 If there are sector-specific investors, take them for lunch as well
4 If you're lucky enough for one of your competitors to be public, their filings should be a goldmine. Find their institutional shareholders and quiz them.
5 Hire interns to do 'end of year projects' with all of the main companies. Never underestimate how open people get around students.
It's difficult to scale this out in already large markets. But if you're dealing with an industry which has fewer than five competitors and fewer than 200 customers, it's absolutely manageable. Inside data is always important in a market, but in niche sectors, it arguably ranks on par with the quality of your product or service.
One of the biggest failings I see from niche market pitches is founders thinking about them in the same way they would a multi-billion dollar market.
Nobody is going to be interested in you taking 5pc of a tiny market. Show me that you understand how to completely monopolise it.
Explain to me how you get to 100pc.
In my world, niche is fine, but show me how you become the gorilla if you're seeking venture money.