PS#097: Market Sizing - Some Rules & Key Considerations (Part 3)

In the last two issues, we kicked off our series on market sizing and discussed my 4-step guide for performing the analysis.

Today, I just want to share some of the things I’ve learned over the course of my career, including a few general rules and some key things to consider.

Without further ado, let’s get started.

Belt & suspenders approach.

The whole purpose of my 4-step process is to force the investor to look at the market from several different angles. We want to take a “belt and suspenders” approach, meaning we are trying to solve the problem from multiple angles. If we are able to determine that there is a venture-size market from several different analyses, then we can be more confident in the opportunity.

As I said, it’s an art as well as a science. We need to be creative in thinking through markets, how they work, and how they will eventually evolve.

The goal is $50M+ in revenue (with room for error).

The whole purpose of venture capital is to create big businesses in a short amount of time.

In order to build a big business, we need a big enough market. When we say “big business”, we’re (at the very least) looking for a market that can support a $50M+ revenue business. In most cases, a company of this size should comfortably meet our target returns.

BUT, there’s one more component… We want there to be some room for error. This means that we want the market to be large enough so that the startup will be able to succeed by capturing a small portion of the total addressable market (“TAM”).

Startups aren’t perfect. They will make mistakes. They will need to learn the right way to sell to their target customers. Therefore, we need to make sure there’s room in the market for them to make those mistakes and learn from them.

If it works, how does it work?

Alright, so we’ve determined that there is a big enough market for a venture-backed company.

If that’s the case, how will this work?

How will the company grow and acquire $50M+ in revenue?

It’s our job as investors to think this through… In the “successful” scenarios, how does the company grow and capture revenue in its target market. What customer segments will the startup target first? For each stage of their lifecycle (i.e., seed, Series A, Series B, etc.), what customer segments will they target? How much revenue will they acquire? How long will it take?

Personally, I look to project the growth journey from the initial investment all the way through the eventual exit opportunity. This gives me a sense for what success looks like and how we might be able to achieve that trajectory.

Product-led growth (“PLG”).

Product-led growth works.

When we think about rapidly growing businesses, capturing new customers is the hardest part. It’s a lot easier to expand within your current customer base. If a startup is able to add new products, features, service, etc. and can sell them to their current customers, that can lead to the type of exponential growth VCs dream about.

As we go through our work, it’s important for us to think through these opportunities. It can change the whole trajectory of the business.

Markets are not stagnant.

I mentioned this before, but it bears repeating… Markets are not stagnant.

In fact, markets are constantly changing. As investors, it’s our responsibility to figure out how they are changing and what is driving that change. If we can uncover these underlying assumptions, we’ll be able to better predict the market opportunity going forward.

Rules of Thumb.

Historically, VCs have leveraged two basic rules of thumb for market sizing…

Vertical Markets: In vertical markets (i.e., markets focused on a specific industry or niche in a particular segment), it tends to be easier to capture more of the value chain. They can more easily expand their product/services for customers, increasing revenue within their customer base. In this case, investors look for markets with $500M+ in revenue potential.

Horizontal Markets: In horizontal markets (i.e., a broad market that services multiple industries or sectors), it’s a bit more complicated. Startups will need to develop multiple go-to-market strategies for the different industries being targeted. Since this approach is generally considered more difficult, investors look for markets with $1B+ in revenue potential.

DISCLAIMER: As with everything in venture capital, both of these rules have been and will be broken. It’s just a simple framework to pair alongside your critical thinking.

Do it yourself.

Finally, do it yourself.

Yes, startups will give you a lot of this information. However, they also know about these rules. They understand the information that needs to be delivered. They know what venture capitalists are looking for and what it takes to receive an investment.

With all the being said, we need to do our own work.

We need to do our own research – speak to current and potential customers, perform the analysis, project the growth, and think through all this information critically.