Mind the Market
Show Your Working: Understanding our DD Process
We all know that venture capital can be a bit of a black box. From opaque processes to complex deal structures to the alphabet soup of acronyms, to, well, our personalities, it is no secret that dealing with investors can be wildly frustrating. So in an effort to lift the veil, we are publishing a multi-part series on our diligence process. Over the course of the series, we will cover customer pain, team, product, competitive positioning, the nuts and bolts, and the overall market. We hope that this will make things easier for founders, help them understand our decision-making, and be better prepared for their own ride on the merry-go-round that is taking investment dollars from a VC.
For Part 5 of our series, we are sharing how we think about - and assess - a founder’s approach to market.
Founders understandably spend a lot of time focused on the things they can control: team, product, execution. Market, however, is a trickier beast because it feels uncontrollable (and if the market doesn’t care, none of the rest matters). That said, there are decisions you can make and ingredients you can bake into your approach to maximize your chances in the ring. Most of them come down to good entrepreneurial instinct. In our diligence process, that’s what we are looking for: the hallmarks of founders who understand market movements, know how to bob and weave as needed, and who are setting themselves up for success.
Know Your Stuff
My first piece of advice is well-trodden ground, but it bears repeating: know your market. We really aren’t going to put much weight on anything else you tell us - your assumptions around TAM, timing, expansion plans - if you can’t convey that you understand the terrain in which you are operating. Learning a market is like learning a new landscape - there are different flora and fauna, weather patterns, new languages, and some pretty big ditches to fall into. The founders who come prepared are infinitely more likely to succeed than those who don’t. All of our Burnt Islanders fit that profile, but John at Daupler is a standout example. When we first met him, it was immediately clear that he knew every angle of the water utility sector, how they procure, how they purchase, what resources they do and don’t have, their incentive structures, all the way down to the language they use. Because of that, he could focus his energy on getting his product into customers’ hands rather than on educating himself about his market. It is the difference between being an explorer (someone we want to back) and being a tourist.
The TAM Trap
When it comes to markets, we are also looking for quality, not quantity. Every pitch deck has the requisite big, scary problem slide. Done well, it creates urgency and sets the stage for your problem-busting solution. But while it’s tempting to think that the bigger the number, the better, that just isn’t true. In fact, we get a little nervous when we see too many zeros. By way of example, founders often tell us about the over 2 billion people who lack access to safe drinking water. But that’s a tragedy, not a TAM. The many many many millions of people who live without clean water deserve better infrastructure and service, but that need is far too vast and complex for any single start-up to fix, no matter how good it is. If you lead with that, it suggests you don’t understand what makes a good market. Good markets have boundaries - they group around shared problems, similar decision-makers, and common buying behavior. CNSRV’s solution is compelling for exactly that reason. It is built for and sold to a very specific group - owners of commercial kitchens - who all face the same issue - mountains of frozen food to defrost. That’s a pretty large group, for sure, but it is also focused. You need clearly defined edges, because if you tell us that too many people are your potential customers, we’ll assume you don’t really have a market.
The Joy of Unsexy Markets
Much like Warren Buffet, we are firm believers that boring businesses are beautiful. And that’s true of markets, too. We get genuinely excited when we see founders going after unsexy markets. Really. The unbelievably arcane, the bureaucratic, the downright dirty - these are the kinds of markets we like hearing about. Unsexy is usually where we find folks with incredible founder-market fit. Because no one dives into sewer inspection videos unless they really know their s*** (pun very much intended) and care deeply about the problem to be solved, like the team at SewerAI. Plus, these markets often come with a built-in layer of defensibility - when it just isn’t all that appealing to follow someone else down the rabbit hole (or manhole), you’ve got yourself a moat.
That said, as our fearless leader Tom Ferguson likes to remind us: there are no extra points for hard. Don’t chase a difficult market just because it’s difficult. The kind of ‘hard’ we love is the one where the pain is deeply felt, the willingness and ability to pay is high, and the price of admission forms its own moat. If you know enough to wade through the messiness to reach the prize on the other side - in the form of high contract values, stable recurring revenues, and dauntingly high switching costs - you can turn that slog into a defensible position.
Timing is Everything
Being early is the same as being wrong - said just about every VC ever. It is a tried and true cliché for a reason. In our diligence process, we need to be able to answer ‘why now?’, and we are looking to you for answers. There aren’t always big, flashing neon signs that a market has reached a tipping point, but there are usually early signals - maturing technology, increasing regulation, changing customer habits, and shifting budgetary priorities are all signs that something could be about to change. But recognize those too late, and you’ve missed the window. Being early is bad, but being late is worse - we’re looking for optimal ripeness here. Take nutrient removal. It has always been important to wastewater operators, but a uniquely diabolical combination of synthetic fertilizer overuse, rising nutrient loads, tightening discharge regulations, costly plant upgrades, and few alternatives has made the need for AlgaFilm’s low-cost, nature-based solution urgent today. We look for leaders who can see the spark before anyone else, build for the moment when change becomes inevitable, and, crucially, articulate that shift so others (we) can see it too. Good timing may look a lot like good luck, but it’s mostly excellent instincts.
Category Creation is a Full-Time Job
What if you are not just competing in a market, but building an entirely new market category? Category creation is all about commanding your own new line item in a budget, and it’s not for the faint-hearted. It means walking the tightrope between novelty and familiarity, telling an incredible story, staying consistent, and often building an entire ecosystem around your product before you’ve sold a single unit. But when it works, the payoff is huge: you define and own your market. And that creates a pretty powerful moat.
In diligence, we’re watching for a few important signals. The mission of market creation needs to be embedded throughout the company - everyone from the C-suite down should understand the job to be done: educating the market and becoming the benchmark. It’s hard, messy, and slow work, so we are also on the lookout for folks with the kind of tenacity and grit to get through the grind. And you need a ruthless bias toward primary data - small wins and early proof points go a long way to validating the vision and showing that your new category is real. Pioneering a step change in membrane technology is no small feat, but that’s exactly what the team at Aqua Membranes is doing. By reimagining a core component, the spacer, that hasn’t seen meaningful innovation in decades, they are creating a new standard for membrane tech. It has taken strong team alignment, the expert leadership of Craig and his team, and a relentless focus on generating real data. That’s the hard work of building a category, not just a company.
Leveling Up
Finally, a good approach to market often involves a sense of proper sequencing, and the right balance between focus and fantasy. We are super excited about hearing your big vision for the future, but make sure your list of ‘where to next’ doesn’t overshadow what you are doing today. Telling us you are going to solve one customer problem, then another, then another, then another - before you have nailed the first - is a major red flag. We want to see you achieve true product-market fit in one place before you jump to something else. And that something else should follow logically - we need to be able to follow the breadcrumbs in your approach. Epoch Blue is a great example. Their supply chain resilience platform could serve several compelling market segments, but what impressed us was their discipline. They were laser-focused on their beachhead first and foremost, and understood that additional markets had to wait until the timing was right. They hinted at where things could go but they also demonstrated that they knew they needed to earn the right to scale. That kind of sequencing discipline speaks volumes.
Think you’ve got the market moves? Then get in touch and tell us all about your approach.