Understanding your market size is crucial when building a startup, especially when attracting venture capital (VC) investment. It’s one of the critical questions VCs will ask early on: “What is your market size?” Not only does market size help outline the potential for growth and success and shows investors that you’ve thought deeply about the opportunity ahead of you. However, market sizing doesn’t have to be complex, and by using simple yet effective approaches, you can present a convincing picture of your business’s potential.

In the world of venture capital, mainly as discussed on the 20VC podcast, one critical viewpoint is that VCs invest in founders, not just ideas. Host Harry Stebbings often emphasises the importance of vision and storytelling in a startup’s journey. Investors, particularly in early-stage companies, are just as interested in the founder's conviction and ambition as in the complex numbers. So, while presenting your market size is vital, weaving it into a compelling narrative about how you’ll navigate and dominate that market is equally crucial.

Why Does Market Size Matter?

In the world of startups, the size of the market you aim to serve sets a boundary for your company’s potential growth. Large companies can only thrive in large markets. This is why estimating your market size early on is essential—especially if you envision building a company that could achieve the scale of businesses like DoorDash or Uber.

From an investor’s perspective, market size is critical because it hints at whether or not your company will generate a sufficient return on investment. VCs, particularly those investing in early-stage startups, want to know that your company can grow into a multi-billion-dollar market and capture a significant portion. For founders, demonstrating a deep understanding of this potential can make the difference between securing funding or walking away empty-handed.

As discussed on the 20VC podcast, VCs want to see more than just a ‘big number’ for your market size. They want to understand *how* you plan to capture this market, what customer segments you’re targeting, and how you’ll expand over time. A straightforward narrative around your go-to-market strategy and a solid market size estimate can build the trust needed to move forward in investment discussions.

Additionally, as discussed in our previous blog on horizontal vs vertical markets, the approach you take in targeting your market—whether it’s broad or niche—will significantly affect your market size estimate. You may have a larger total addressable market (TAM) for horizontal markets, but the competitive landscape might dilute your serviceable obtainable market (SOM). On the other hand, vertical markets often come with more targeted opportunities that allow for higher penetration but within a smaller TAM. Understanding this strategic choice is critical before moving into market sizing calculations.

Bottom-Up vs. Top-Down: The Best Approach for Market Sizing

When estimating market size, there are two common approaches: bottom-up and top-down. While both have their place, investors typically prefer the bottom-up approach as it is grounded in fundamental, testable assumptions. Let’s break them down:

- Top-Down Approach: This involves looking at the broadest market available (Total Addressable Market or TAM) and then narrowing down to a smaller segment that your product or service will target (Serviceable Available Market or SAM). Finally, you estimate what percentage of that market you might capture (Serviceable Obtainable Market or SOM). While easy to understand, the assumptions used in this approach are often vague and unsubstantiated, making it less convincing.

- Bottom-Up Approach: This method builds a more accurate picture by focusing on specifics, such as the number of potential customers and the average revenue per customer. By estimating how many customers you can acquire and the revenue they will generate, this approach links directly to your business model, making it more concrete and more accessible for investors to trust. For example, rather than saying that the entire population of a country could be your customers, you might estimate that your product will appeal to a specific demographic, such as employed people aged 25–40 who order takeout once a week.

Harry Stebbings mentioned in one of his episodes that founders should not rely on grand projections but instead take investors on a journey that connects their market size to actual, executable plans. The bottom-up approach does just that—it breaks down market size into digestible, realistic components, ensuring investors can visualise how you will grow into the larger market.

Ultimately, the bottom-up approach gives investors a clearer picture of your business’s growth potential. It ties the market size estimate to your company’s unique strategy and customer acquisition plans, providing a solid foundation for future revenue projections.

Presenting Market Size: Avoid the Jargon

A common pitfall for early-stage startups is presenting their market size using the TAM/SAM/SOM acronyms without clearly explaining the methodology behind them. While these terms are widely used, their definitions are not universal. Investors often see these estimates presented without much context, leading to confusion.

To avoid this, it’s best to be clear and straightforward when presenting your market size. Instead of relying on acronyms and vague definitions, offer a bottom-up estimate of your total addressable market and expected revenue over the next five years. This kind of transparency will resonate better with investors and demonstrates that you thoroughly understand your market and business model.

For instance, some VCs recommend dropping the distinction between TAM and SAM altogether. Instead, present a strategy that outlines your plan for gradual expansion—starting with one customer segment and eventually moving into others. This approach shows that you understand your market's current size and plan to scale your business over time.

When to Estimate Market Size

Another important consideration is when to estimate your market size. Most investors, especially seed-stage investors, want to see market size projections for the next five years. Extending this timeframe to seven or ten years can be beneficial for startups in rapidly growing industries or those riding long-term trends (like the transition to electric vehicles).

In some cases, it’s also helpful to present both the current market size and the projected size five years from now if your target market is expected to grow significantly shortly, highlighting that growth can further strengthen your case.

Tips for Better Market Sizing

Now that you understand the basics of market sizing, here are a few tips to refine your approach:

1. Focus on a specific customer segment: Targeting a well-defined group of customers will make your market sizing more realistic and convincing. Broad claims of mass-market appeal are rarely effective.

2. Use credible data sources: Support your market size assumptions with reputable research reports, government statistics, and industry bodies.

3. Be realistic about customer acquisition: Based on your sales strategy and the competitive landscape, estimate how many customers you can acquire within 5–10 years.

4. Emphasise future growth: Many successful startups create or change markets. Don’t just focus on current demand—estimate the hypothetical demand for your product five to ten years from now.

By following these guidelines, you can create a compelling market size estimate that reflects your startup's potential and reassures investors that you’ve thought deeply about your business’s future.

Have a great week!