How can you estimate market size in venture capital?

Fairly simply. Price x Volume = Market Price - the value a current customer is paying or will pay for your product Volume - the number of potential customers you could sell your product to. Don't over complicate it.

While TAM->SAM->SOM is widely used, I've always found this approach crude as top-down estimates from market research firms don't have the right context to the product an early-stage founder is building. One way to look at sizing market opportunity for early-stage founders is to understand the replacement value pools available to your product. If you are a vertical SaaS displacing an incumbent service provider, how many such businesses/customers can you sell your product to (with considerations for geo barriers, product features etc.) and at what price point (today, in 12-18 months, in 3-5y)? This gives you a broad initial sense of the size of the opportunity upon which other nuances can be layered to arrive at a more fine-tuned number.

In our market analysis, we begin with a systematic top-down approach, using Total Addressable Market (TAM), Serviceable Available Market (SAM), and Share of Market (SOM). TAM outlines the overall market opportunity, SAM narrows it to the startup's realistic segment, and SOM quantifies the percentage our startup can capture. Specializing in proptech and fintech, our industry knowledge enhances precision in our assessments. This strategic approach goes beyond market sizing, shaping tailored strategies based on a profound understanding of opportunities and challenges. We leverage TAM, SAM, and SOM as tools and strategic instruments, aligning efforts with market intricacies to maximize potential market share for startups.

Top-down analysis offers a broad perspective, useful for understanding the overall market potential. However, it can be overly optimistic, as it often relies on industry averages and macro-level data, which may not accurately reflect the specific niche a startup targets. This approach might overlook unique challenges or opportunities within sub-segments, leading to inflated or unrealistic market size estimates. It's essential to complement top-down analysis with bottom-up insights for a more grounded and realistic assessment.

In my perspective, the top-down approach offers a strategic method for startup evaluation. By initially focusing on the broad market, it allows for a comprehensive understanding. For instance, in a fintech startup targeting online payments, starting with the global e-commerce market provides a solid foundation. Filtering through factors like geography, customer segment, product category, and market share refines the estimate realistically. This method utilizes reliable data from sources like industry reports and government statistics. However, it may be overly optimistic as it overlooks competition and entry barriers. Despite this drawback, the top-down approach provides a structured framework for strategic decision-making.

Many later stage investors will want to see a bottom-up approach, but as this takes a lot more assumptions for early founders, I always suggest using both approaches to triangulate to a good estimate. Then founders should update their assumptions and market size estimates quarterly as new info and learnings become accessible.

Estimating market size in venture capital using a bottom-up approach involves building an understanding from specific data points and scaling up. Start by identifying the base unit of your analysis, like the average revenue per user or unit sales. Then, multiply this by the number of potential customers or units you expect to sell, which can be estimated from target market demographics or sales channels. For instance, if you're selling a software product, calculate how many businesses in your target sector could use your product and the expected revenue per business. This method offers a granular and realistic view of the market potential, grounded in direct data and specific market conditions.

Bottom-up analysis is a meticulous and realistic approach, directly engaging with the product's potential market. It offers a grounded perspective, focusing on tangible data like customer base and pricing. However, its reliance on detailed information can be a double-edged sword. In nascent markets or for innovative products, accurate data might be scarce, leading to underestimation of potential. Also, this method can overlook broader market trends and external factors, which might affect scalability and long-term growth. It's excellent for immediate, tangible projections but may not fully capture the market's dynamism or disruptive potential.

From my perspective, the bottom-up approach is a pragmatic strategy for startup assessment. By commencing with a specific market and gradually expanding to a broader one, it ensures a grounded evaluation. Take a SaaS startup in email marketing, for instance; calculating potential customers, multiplying by average revenue, and factoring in penetration rate builds a realistic estimate. This method relies on the startup's own data, encompassing metrics like customer acquisition cost and retention rate. However, its drawback lies in potential conservatism, potentially overlooking expansion and innovation opportunities. Nevertheless, the bottom-up approach offers a data-driven and nuanced perspective crucial for strategic decision-making.

Bottom-up is an incredible tool as it forces you to look at more data points to quantify the potential number of customers you could serve at 'x' prices, think of ramp-up periods, and definitely helps you anchor more in reality (slightly more grounded than a than a top-down study that is not conscious of constraints like competition or scarcity of resources). What are the downsides? access to data. Bottom-up could provide you with an illusion of accuracy where a lot of assumptions have to be made. The better the quality and volume of data points, the more robust a market sizing in bottom-up could be.

The value-based approach is ideal for assessing startups, especially for unique offerings like a biotech startup developing a drug for a rare disease. It estimates market size by multiplying patient need by the drug's value, capturing societal impact. Yet, its subjectivity and quantification challenges exist. In dynamic venture capital, accurate market size demands judgment, creativity, and validation. Diverse approaches and cross-checking enhance accuracy, acknowledging the evolving nature of market size influenced by customer behavior, technology trends, and competition.

The value based approach is an encompassing method that considers not only the economic potential, but the value of having barriers to entry, demand elasticity, or a unique value proposition. Starts with the willingness to pay and sees that (from a supply chain perspective) spread around different players. It helps in cases where there could be multiple stakeholders benefiting from the same problem/solution fit (e.g., biotech, healthcare, insurance). Can be very similar to a bottom-up approach, yet it's highly subjective and relies on even better and higher quality datapoints.

We can also consider: 1. Market Trends: Use industry forecasts to understand market growth dynamics. 2. Customer Segments: Differentiate between groups to estimate segment-specific market potential. 3. Geographic Factors: Account for regional variations in preferences and purchasing power. 4. Regulatory Environment: Assess how regulations could impact market expansion. 5. Competitive Landscape: Evaluate competitors' strengths and market saturation. 6. Market Saturation: Analyze the potential for new entrants to capture market share. 7. Technological Changes: Stay informed about tech advancements affecting the market. These factors provide a more accurate and realistic market size estimation, considering current and future dynamics.

According to the SEC, for the time period ending on June 30, 2023 (DERA data for the period July 1, 2022, to June 30, 2023): Reg D 506b (no general solicitation) – $2.7 trillion raised (median raise $1.2 million) Reg D 506c (general solicitation) – $169 billion (median raise $750,000) Reg A – $1.5 billion (median raise $1.6 million) Reg CF – $352 million (median raise $100,000) Rule 504 – $258 million (median raise $250,000) Other exempt offerings (Reg S – Rule 144A) $1.3 trillion

The traditional methods and frameworks used to evaluate companies are no longer effective. As a result, mergers, acquisitions, roll-ups, and valuations are becoming increasingly unpredictable, especially with no free money available in the industry. To overcome these challenges, funds should rely heavily on machine learning to analyze open-source alternative data sets and back-test their prior thesis. This analysis should be combined with AI-powered internal cash flow and macro market/industry trend analysis. Some of the tools that can be used are deep learning to categorize tabular data and time series forecasting using tools like Facebook Prophet, instead of relying on insular EMA or DCF.

I recommend that founders look at both bottoms up and top down approaches, when considering market size. However, it is important for founders to do their own examination of their TAM, as opposed to simply quoting industry reports of their relevant markets. A TAM analysis is a great way for founders to share how they think and the relevant domain expertise that they have.

This topic clearly explains top-down, bottom-up, and value-based approaches. It's like looking at a menu without eating. Top-down thinking is like a drone: great for aerial views but lacking in ground details. I see the forest, not trees. Like a street-level tour, the bottom-up approach delivers information but may miss the big picture. With tech and client behavior more variable than ever, this strategy may slip behind. Value-based approaches are admirable but like unicorns—elusive and impossible to define. These methods must be combined with intuition and boldness. VC sometimes demands skating to the puck. Our market size estimator should adapt to trends. See the forest and environment, not just trees!