Which is a better situation for investors if both markets are at the same size today and the starting share is the same?

1. a market that is shrinking
2. a market that is growing

This is not a trick question. The answer is ‘b’.  A company has to grow quite a bit after it gets investment for the investors to be paid back. Consider an investor that wants to grow his investment by 20 times.  In a market that is fixed in size, then the current market share needs to be less than 5%. It is highly unlikely that the company would get 100% of the market, so they would probably need to have a current share of less than 2.5% to allow for growth that would pay back the investor.  This does not count the actions of companies that are currently in the same space. Overall, a company with a large share in this type of market (>5%) would not be able to hit the investor’s level of return.  With even a small share, a shrinking market would make it even harder for the investor to get there money back.

If the market was growing, then the rate of growth would greatly increase the odds of the investors making money.  This translates into a higher likelihood of getting investment.

So, what happens if the market starts out to be growing but turns into a poor market?  What are the options?

The first option is to continue as before hoping to gain enough market share and exit before the market collapses. This is very unlikely because an exit plan that pays back an investor requires that an outside entity (or group of people) buy the company hoping for an even higher return. In a shrinking market this could happen if the market would rebound or the technology could be applied to another market that is growing.  However, even in those cases, the buyer will try to buy at a lower price because they will feel it is their expertise that brings the most value; they are just avoiding the costs of starting from scratch by buying the existing firm.

The second option is to find another market that is growing.  By translating the technology, infrastructure (and team), and other resources into a growing market the company will now be in a situation to gain enough value to provide the investor with the targeted exist plan.  Buyers will also see that they can make more money with the company and are more likely to purchase at a premium price.

So, if you find yourself in a market that is shrinking you have a choice. Either cut your future losses and find a buyer now that can expand on your existing ideas or transition your company into another market that is more lucrative.  While the second is more desirable, neither option is the absolute correct one as it really depends on the situation.