- The Diligent Observer
- Posts
- Market Creation
Market Creation
Lesson learned from passing on Shopify: 1 diligence question to supercharge market analysis
We spend a lot of time doing market diligence.
It’s hard.
But it’s crazy important - no company exists in a vacuum, and without a market for their product/service, a thriving business cannot exist and an investor cannot earn a return on their investment.
Today, I’ll share the question one top VC asks to kickstart and simplify market diligence.
The Observer Express
Don’t have time to read the entire post right now? No worries, here are the main points:
We don’t often hear about huge venture misses.
Breaking down the miss with Shopify.
The key question VC Tomasz Tunguz asks when it comes to market diligence: “Do we believe this company can create the market?”
Announcing the Angel Ops E-Book
How strong is your investor community’s deal management process?
Find out today.
I’m thrilled to announce that “Angel Ops: The 5-Step Framework for World-Class Angel Network Deal Management” is LIVE!
Oops
Investors like to recount their wins. Anyone who wrote a check for Uber, Facebook, Google, or other household names is rarely shy about announcing. And it’s no surprise - these are the bets that make a portfolio and catapult someone to the upper echelon of venture investors.
Less often do we hear about those who had an opportunity to invest, but chose NOT to.
Imagine it - you’re the guy who decided to pass on Google. That’s a miss you’d probably agonize over for the rest of your life - I certainly would.
Let’s look at a real-world example.
Shopify
Tobi Lutke, founder of Shopify ($78B market cap, $7.4B TTM revenue [Yahoo Finance]), recently explained (Click here to watch the video on X) the logic that led to several early VCs passing.
At the time, investors passed because “they thought the addressable market was too small. At the time, there were about 40,000-50,000 online stores, and even if Shopify captured 50% of the market, that still wouldn’t be a venture-scale business.”
Tobi goes on to explain: “You were actually correct, but what you didn’t realize was that Shopify was the solution to the very problem you identified. The reason there was only 40,000 online stores was because it was hard, expensive, and everyone who tried ran into all these brick walls of complexity, which Shopify, one after another, smoothed over and made simple to do.”
The Lesson
Tomasz Tunguz, partner at Theory Ventures, had a chance to invest in Shopify and missed it because of this exact mistake. In a recent blog post (linked here) he owns up to it.
His takeaway from that mistake + a career of watching other companies influence markets?
Instead of asking “Is the market size big enough?” he now asks this question: “Do we believe this company can create the market?”
Final Thoughts
Investors do well to ask themselves this question when considering market diligence. Understanding the current dynamics and size of the market is absolutely important to have as a baseline. But like a potter shapes clay, the companies that truly generate outsized returns ultimately shape the growth of that market by removing/reducing systemic friction.
What Do You Think?
What questions do you tend to focus on when evaluating a startup’s market?
Weekly Observations: 3 Lessons Learned
The hardest part about market research: not getting distracted.🔍This week, I stepped in to help draft one of our 5-page diligence reports. The company I analyzed is developing a new high-performance material for use in 3D printing. So I spent the weekend taking a deep dive, looking at competitors, market size data, and more. The hardest part? Not getting distracted and endlessly researching all the cool similar/related technology.
The diligence lead naturally develops a deeper level of understanding.🧠We realized this week that the depth of understanding available to an analyst or investor who leads a diligence call is a step beyond an analyst/investor who watches a diligence call. The preparation and increased engagement demanded by asking thoughtful questions make a noticeable difference in retention. For example, one of our team members identified several potential competitors after reading the company’s deck and watching the diligence call. And they were great. But after spending several hours with the founder myself and doing my own market analysis, I realized that there were better, more direct competitors worth mentioning instead.
Founders can be a great source of warm leads.🤝We’ve recently come to understand that even though entrepreneurs are not our customers (we exclusively and intentionally offer only buy-side diligence), there is a way we can help. By offering to hop on a phone call with any prospective investor interested in taking a look at the diligence materials we have produced on their company, we’re able to enhance their credibility, help their prospective investor make a better decision, and engage with a warm lead in one 30 minute phone call. Huge win-win-win.
Weekly Links: 3 Things I Found Interesting
Thanks for reading, have a great week.
-Andrew
If you enjoyed this post, please share it with a friend, colleague, or anyone else who may benefit.
P.S. - I recently finished creating The Angel Network Toolkit: 90 Resources for Cultivating a Thriving Community of Pre-Series B Investors, and I’m sharing it with anyone who refers a friend.
How did I do this week?
About Me
I cultivate flourishing.
I'm also the CEO of PitchFact, where our mission is to cultivate flourishing specifically through efficient and collaborative early-stage diligence. I'm a proud husband, grateful father, and honest friend. My love languages include brisket, bourbon, and espresso.