Hey guys,

Buck Jordan here.

When I first got out of the military, I launched a venture fund called Canyon Creek Capital.

I was still pretty green, but I trusted my instincts. And luckily, a handful of investors did too.

I deployed $6 million across 11 deals, and the rest is history. Canyon Creek has had some incredible exits over the years – like selling Blue Bottle to Nestle for $800 million – and everything else in the portfolio is doing extremely well, even now.

Since then, I went on to launch Wavemaker Labs with my buddy Eric. Wavemaker is more of a venture studio ­– we build companies from the ground up. But the lessons I learned as a traditional VC stay with me… and I use some of them every single day.

When you’re trying to find the next unicorn, it’s critical to first identify markets that have what it takes to generate a billion-dollar startup in the first place.

And if you’ve never managed a fund yourself, you might not know what to look for.

That’s why I’m here – to make sure you have the same tools at your disposal as someone with millions of dollars to deploy.

Here are the top three things you should look for.

Market Size: Large and Growing

To build a unicorn startup, you have to be going after a large market. You can’t build a unicorn going after a market that is only $100 million or $500 million in size. Think about it: if the market’s worth half a billion dollars, how could one company be worth twice that? It couldn’t.

Typically – as a rule of thumb – to take a company public, it should be generating north of $50-$100 million in annual revenue. Generating that scale of revenue in small markets is incredibly difficult. It entails capturing huge market share, which for a startup with limited resources is very hard to do quickly. In most cases, it might take a decade or longer.

However, if a startup is going after a huge market worth billions of dollars then the chance of generating significant revenue becomes much higher. For example, the U.S. logistics market worth $1 trillion. A startup that could capture even a tiny fraction of that – say, 0.01% – would pull in $100 million in revenue annually. Big companies come out of big markets; it’s as simple as that.

Once you’ve established that a particular market is big enough, you should take a look at the way it’s structured.

Market Structure: Is It Balanced?

The key component of market structure you want to look at is market concentration – essentially a measure of how crowded the playing field is. Markets fall on a spectrum of concentration from completely concentrated (a monopoly) to highly fragmented. Neither of these two extremes are good markets for a startup to go after.

In the case of markets that are monopolies, it can be almost impossible for a startup to capture any meaningful market share. Often monopolies emerge because they have some legal advantage, such as an exclusive charter to a region (think utility and telecom companies) or because they have created moats around their business that are impossible to break through (think the Visa or Mastercard network). Going up against a monopoly is a nearly impossible task because it means challenging a massive brand that’s already well established.

On the other hand, a market that is highly fragmented – such as the market for laundromats – has several disadvantages. Typically, the market is fragmented for a reason. These reasons can range from low product differentiation, thin profit margins, poor economies of scale, and more.

In addition, fragmented markets often have intense competition on price. This makes it hard to build a large sustainable business if you’re always being undercut on price by other competitors.

Most of the time, if a market is highly fragmented, it means that even its best contenders are unable to capture a meaningful share. Unless a new startup comes to the table with a massive differentiating factor – like Uber did with taxicabs – it’s going to be very hard to scale.

The Best Markets Are Rich with Niches

Every huge market has niches: different subsets of customers with slightly different needs to serve. Each of these niches are novel opportunities for a startup to come in and solve a unique problem – which is the number one driver of revenue.

Think about the apparel market, which is worth about $350 billion in the United States. That’s huge – but it’s not a market with many niches. While there is a lot of diversity in product style, color, and materials, there are only so many ways to make money in the apparel industry. The main and primary way is to sell clothes via wholesale and to consumers.

On the other hand, the logistics market – which we discussed earlier – is a market that’s rich with niches. Nearly every industry has a need for logistics software and solutions. You have trucking, air freight, ocean freight, rest stops, tires, fuel, and numerous other products and services that the diverse participants in the logistics industry need and consume on a regular basis.

The benefit of targeting a market rich with niches like the logistics market is that as a startup you can start in one area/product line and focus on building up momentum there.

Then, over time, you can use that initial momentum and the brand value you build to expand into adjacent areas in the market, increasing the size of your addressable market and growing your revenue. It’s much easier to do this in markets with lots of different types of customers with lots of different needs versus markets that are less diverse.

At the end of the day, identifying a hot market comes down to overall opportunity. Is the market big enough to churn out multibillion-dollar startups? Is there enough room for multiple players to win? If the answer is yes, you can move on to assessing a startup’s own unique traits: the founding team, the product itself, the financials, and so forth.

We’ll talk more about how to dig into those factors next time. For now, enjoy the long weekend.

Talk soon.

Buck Jordan