As a freshly minted VC in 2011, one of the first things I was taught to look for while evaluating new deals was a large total addressable market (TAM). It was pretty much a necessary, though not sufficient, condition for generating outlier venture returns.

After many years of venture investing now, I would agree that startups need to go after large markets to be VC-fundable. However, I have also seen a common VC fallacy, especially at the seed stage, where a startup gets prematurely filtered out simply because the immediately visible market doesn’t seem large enough.

In my experience, the best founders either create new markets or expand to adjacent markets over time. So the TAM keeps growing. I remember when Peyush Bansal of Lenskart (the Warby Parker of India) was pitching for Series A, investors thought that the Indian eyewear market wasn’t large enough. In hindsight, everyone underestimated 3 things: (1) the overall market would grow at a much faster rate than expected, (2) in addition to online, Lenskart would also go offline and (3) it would expand the market by launching private labels, as well as increase its gross margins by in-house manufacturing. Lenskart’s last valuation: $4.5Bn!

Same with FirstCry, where most investors viewed the TAM as mostly Diapers because that was the majority of its GMV in the early stages. FirstCry is IPO-bound, likely at $3-4Bn valuation!

In the enterprise space, I remember Amagi’s initial flagship offering was the ability to insert vernacular TV ads in national programming. Investors pretty much checked out when they sized up this niche. What they underestimated was Amagi’s ability to go global, expand its product offering to an end-to-end cloud platform, and serve the rising OTT market. Amagi’s last valuation: $1.4Bn!

Airbnb was a similar case. Paul Graham has shared the now-legendary email thread where Fred Wilson of USV felt its addressable market wasn’t big enough.

The entire thread is super-insightful, wherein PG is repeatedly trying to explain to Fred that the eventual market will include hotel accommodations and therefore, will be large enough.

In fact, one of the strategies that is highly recommended for seed-stage startups is to identify a wedge in the market, usually a very sharp pain point or job-to-be-done, and focus on solving that in a differentiated way. By definition, these early wedges often create an illusion that the addressable market is limited to just that.

This is where the role of imagination comes in. Seed investors should spend adequate time with the founders to understand the eventual end-state of the world they are imagining. If this end-state is large enough and ambitious enough, usually that’s a leading signal that the company will continue to expand its TAM.

Turning the tables around, I also believe that founders should spend time crafting a strong narrative around this end-state and paint a picture that investors find easier to buy into. If this can include even a broad outline of what the path from the present wedge to the eventual end-state potentially looks like, even better.

I hesitate to call this picture a “vision” as this word is just thrown around a lot and frankly, is now considered faff. Instead, trying to visualize what the world will look like with your product in it, is much more tangible and real.

So, if not TAM, what aspects should seed investors evaluate instead? I recommend the following two:

1/ Founder-market fit – this is critical for the startup to go from the wedge to the end-state, and should be in place even at the earliest stages of company building.

2/ Competitive differentiation/ right to win – as I mentioned in my post ‘How To Differentiate As An AI Applications Startup?‘, for a startup to be viable, it’s not enough to just build cool tech. It has to be able to create significant competitive differentiation, especially against incumbent solutions. I call it “non-incrementality”.

A strong hypothesis around competitive differentiation, and eventual right to win, should exist in the founders’ strategy from Day 0. The edge will get gradually built out over time, but both the intent to create it as well as the building blocks for it need to exist from the earliest stages.

Looking back on the many startups I have seen or invested in across geographies, one thing I have learned is that if a startup remains sub-scale, in most cases it tends to be due to founder motivation, quality of execution, and team/culture issues, rather than the available market being small.

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