Investing in pre-revenue companies can be challenging.
Key factors to consider include:
Total Addressable Market (TAM)
Management Team
Total Addressable Market (TAM)
Definition: The total revenue opportunity available for a product or service.
Example from Kleiner Perkins:
They avoid investing in companies with a TAM below $20 billion.
Rationale: A 5% market share of a $20 billion market equates to $1 billion in annual revenue.
How to determine TAM:
Conduct a search for the TAM of the relevant sector.
Utilize reports from consulting firms (e.g., Forrester, Gartner, McKinsey) which provide detailed industry insights.
Alternatively, add up the annual revenues of the top 25 companies in the sector to estimate TAM.
Importance of Management Team
Management team analysis is crucial:
Ideas are easily replicated; execution is unique.
"The jockey is always more important than the horse."
Many business schools focus on business models, but:
A strong management team is essential before analyzing the business model.
Financial Modeling for Pre-Revenue Companies
Once TAM and management team are assessed:
Create a financial model that projects future revenues.
Key Steps in Financial Modeling:
Develop a pro forma financial statement to forecast long-term revenue and earnings.
Analyze a 5-10 year outlook for the company.
Financial modeling will be taught in the MBA program, specifically in the Venture Capital Bootcamp during the third semester.
Conclusion
In summary, successful investment in pre-revenue companies relies heavily on understanding the market size and the capabilities of the management team, followed by careful financial modeling.