Part 4 in the “Navigating Diligence: The Bling Capital Playbook” Series
This is Exercise 3 in the Bling Capital Diligence Playbook.
Note: This post is an update to a prior version we published in January 2024 on the same topic.
In Exercise 2, (“Segmenting Your Customers for Market Sizing”), you segmented your customers to show who pays, how many of them exist, and how much they’ll pay. In this exercise, we take those inputs and translate them into your market size (total addressable market, or “TAM”) — the number investors care about when they ask, “How big can this get?”
The post below will outline
- why venture investors care about TAM (VCs typically look for “fund returners”)
- common mistakes founders make when sizing their market(s) including examples (over general top-down estimates, non-specific segmentation, unrealistic assumptions)
- the Bling Capital approach (bottoms-up segmentation-based approach)
Why Is Market Sizing Important?
Our goal with market sizing is to understand how big your startup can get if things go well.
Here is a sample mad libs format:
- To get to $100M in gross profit per year, we need X customers paying us $Y per year, where X represents this K% of the market of prospective customers. There are a total of (X / K%) such customers in the US.
- The primary characteristics when doing a segmentation of customers are A, B, C. Our paying customers will have the following characteristics A, B, C.
Here are two examples, in practice:
- To reach $100M in gross profit per year, we need 400 customers paying us $250K per year, where 400 represents 4% of the market of prospective customers. There are 10.6K such customers. The primary characteristics for segmentation are customers’ revenue (between $15M-$50M) and use of the particular software (EHRs: athenahealth and EPIC).
- To get to $100M in gross profit per year, we need 42K users paying us $8K per year, where 42K represents 1% of the market of prospective customers. There are a total of 5M such customers in the US. The primary characteristics when doing a segmentation of users are the type of schooling they receive (homeschooling) and their age (between 8-18)
As we mentioned in the previous exercise, to raise venture capital, you need to be able to tell a credible, bottoms-up GTM plan that shows you can scale to at least $100M in revenue within 7 years. That’s generally considered the minimum bar for being “investible” or “venture scale”.
Here’s why that matters, using simple investor math:
- A seed investor has a $100M fund
- They invest $1M in your company for 10% ownership at seed
- Your company exits for $2B
- After dilution, the investor owns 5% at exit
- They receive $100M (5% of $2B)
- The investment returns the fund
What happens if a venture investor believes your TAM is too small?
- If an investor believes this during your fundraising process, they may pass with the reason: “not enough conviction on the market”.
- If discovered after investing, they may push founders to strategically focus on a venture scale outcome which may be misaligned with the founders’ vision or materially more challenging in a smaller market.
As a startup founder, putting together a clear and concise “back-of-envelope” market sizing that articulates a path to $100M and $500M, respectively, in gross profit will not only help avoid scenarios above but will also be helpful to driving business strategy and go to market approach.
Gross Profit is preferred over revenue to take into account differences in gross margins across different businesses. We use $100M and $500M as shorthand benchmarks for “venture scale” business and a “venture home run” business respectfully.
Company valuations at exit are highly correlated with the quality of revenues and earnings. A $100M gross profit business might be valued at 1x revenue or less, or 10x+ revenue, depending on the market’s perception of the quality and durability of the company’s revenues and other factors.
Common Mistakes and Fixes
Many market-sizing approaches result in numbers that may not resemble the reality of a startup’s current or even future potential market size. Below are four common mistakes we often see founders make when talking about market sizing, and we’ll outline each with relevant examples using two of our portfolio companies: Lyft (Marketplace) and Lucidchart (SaaS). These examples build on each other.
- Lyft is one of the leading ride share companies in the U.S. and is often evaluated as a marketplace.
- Lucidchart is a growth stage SaaS company for diagramming, data visualization and collaboration.
Mistake 1: Focusing on top-down total market size alone
Why it doesn’t work: Too generic, often doesn’t display a deep understanding of the market for this specific product
| Example 1a: Lyft | Example 1b: Lucidchart’s market |
|---|---|
| “Lyft’s market size (“TAM”) is equal to the total spend on taxis and limos in the United States.” | “The total spend on cloud tools is $X billion and Microsoft Vizio’s revenues are $Y millions, so our TAM is $x+$y.” |
| Better Approach: A bottoms-up approach that includes (1) the existing market (2) how Lyft’s approach (convenience, price, customer experience) would expand the current market (3) broader market trends (in this case, gig economy, proliferation of mobile devices) that would expand the current market. | Better Approach: A bottoms up approach that includes (1) your insight into the broader market trend (in this case, the # of SMEs in 2010 will 100x over the next 10 years), (2) your buyer persona, and (3) how Lucidchart is dramatically improving a free product with a product users are willing to pay for (SaaS model). |
Mistake 2: Not segmenting your bottoms-up market sizing analysis
Why it doesn’t work: Omits go to market (GTM) strategy
| Example 2a: Lyft | Example 2b: Lucidchart’s market |
|---|---|
| “There are XX millions of people who can use Lyft. If they spend $Y on rides per year, then our TAM is $XY millions”. | “There are XX millions of people who could use LucidChart. If they pay us $Y per year, then our total addressable market is $XY millions.” |
Better Approach: Segment your markets by city size and key characteristics:
|
Better Approach: Segment your customers based on buyer persona. If the buyer is a company, you should segment the customer by company size:
|
Mistake 3: Static growth and unrealistic penetration numbers
Why it doesn’t work: Doesn’t illustrate your path toward more revenue ($10M, $100M, $500M) with reasonable market penetration (e.g., 1% vs 50%)
| Example 3a: Lyft | Example 3b: Lucidchart’s market |
|---|---|
| “The TAM for Tier 1, Tier 2, and Tier 3 segments is $y. At 75% market penetration we will generate $xB in revenue.” | “The TAM for Enterprise+, Enterprise, and SME segments is $y. At 75% market penetration we will generate $xB in revenue.” |
| Better Approach: Articulate your launch city and reasonable penetration for that launch city. Use that “launch playbook” to articulate expansion to X additional cities that look like your launch city until you reach $100M and then $500M in revenue with reasonable penetration rates (e.g., 5% per city). The idea is to “tell the story” of how your market and business model will unfold over time. [3] | Better Approach: Articulate your ideal buyer and in which segments those buyers exist. Then, articulate reasonable penetration assumptions for those segments, and how you will expand over time until you reach $100M and $500M in revenue. The idea is to “tell the story” of how your market and business model will unfold over time (e.g., # SMEs 10x in 10 years). [4] [5] |
Mistake 4: Using top-line revenue or GMV instead of Gross Profit
Why it doesn’t work: Top-line revenue or GMV leaves out the cost of delivering revenue and over inflates market size
| Example 4a: Lyft | Example 4b: Lucidchart’s market |
|---|---|
| We need x Tier 1 cities with 2% market penetration each to hit $100M in GMV, and x Tier 1 cities and x Tier 2 cities with 1% market penetration to hit $500M in GMV. | We need x enterprise customers, and x SME customers paying us $y ACV, including one-time fees, with 10% market penetration to hit $100M in ARR. We expect ACV to 2x in 5 years and SMEs to 100x in 10 years so our market penetration in 10 years would be 0.1%. |
| Better Approach: Calculate Lyft’s take rate on the GMV as revenue—GMV alone doesn’t reflect the value the company is capturing. Then, subtract the cost of delivering that revenue to calculate Lyft’s gross profit. | Better Approach: Many SaaS business models do not incur a lot of COGS. However, there are some mistakes to correct such as not breaking out annual recurring revenue vs. one-time revenue in your ACV and not including costs such as payment processing, customer support, hosting, etc. |
The Bling Capital Method
At Bling Capital, we believe your market sizing and narrative are interconnected. The exercise we often go through with founders are as follows:
What do we need to believe for ‘Startup A’ to get to $100M and $500M, respectively, in gross profit?
- How many customers (segmented) will you have and how much will they be paying you (annually)?
- What is the margin on your revenue (ideally by customer segment )?
- What percentage of the market does that represent? (essentially market share)*
The output should be (Replace X, Y, K, A, B, C with your answers):
- To get to $100M in gross profit per year, we need X customers paying us $Y per year, where X represents this K% of the market of prospective customers. There are a total of (X / K%) such customers in the US.
- The primary characteristics when doing a segmentation of customers are A, B, C.
Using the examples above, let’s go through market sizing for Lucidchart.
What do we need to believe for Lucidchart to get to $100M and $500M in gross profit?
- We segmented buyers based on company size. We have three tiers of buyers:
a. Tier 1 (Enterprise+) = 1000+ employee companies
b. Tier 2 (Enterprise) = 100-1000 employee companies
c. Tier 3 (SME) = 1-100 employee companies - Across all segments, there are 493K total companies in the US but we will focus on the 470K SME and Enterprise companies:
a. Tier 2: 75K companies (15%) are between 100-1000 employees
b. Tier 3: 395K companies (80%) are between 10-100 employees - We have a SaaS freemium business model with 95% gross margins across segments. Our GTM is a product-led growth, with expansion driven by a sales organization.
a. Our goal average ACV for Tier 2 is $50K ($10K - $100K range), which is an average of 200 licenses per company per year ($250/year/license).
b. Our goal average ACV for Tier 3 is $5K ($100-$20K range), which is an average of 50 licenses per company per year ($100/year). - Our immediate revenue opportunity with our current product is $5.6B and our path to $100M is clear: We need 2K Tier 2 customers paying us $50K per year (~2.6% of market), or 20K Tier 3 customers paying us $5K per year (~5% of market).
a. Tier 2: $3.7B TAM
b. Tier 3 $1.9B TAM - Over time, as we launch more features (e.g., SSO), we will roll out to Tier 1 (Enterprise +) and implement playbooks to increase ACV across all segments. With just ~14% market penetration in this $9B TAM, we can reach $500M per year.
a. Tier 1: 23K * $150K = $3.4B (3.3K companies, or ~14%)
b. Tier 2: 75K * $50K = $3.7B (10K companies, or ~12.5%)
c. Tier 3: 395K * $5K = $1.9B (100K companies, or ~25%) - As extra credit, further segmenting their customer tiers based on actual or projected data points (e.g., engineering, product, design, marketing teams are core users for Lucidchart) shows an even deeper understanding of your market.
Applying The Bling Capital Method
Step 1. Plug-in the outputs from your “Hair-on-Fire + 10x Better” and “Customer Segmentation” exercises into our Market Sizing Template. As a reminder, these exercises answer:
- Who is the customer (or title of customer, or buyer), today AND tomorrow? These can be customers you serve today or, if you have not launched, customers you intend to serve.
- What are the segments in your market where this customer exists? Divide your market into segments and define them.
- How many of these customers exist per segment? What are the number of customers that are model customers in each segment? Does that change over time?
- What is their “hair-on-fire” problem?
- What are they doing today?
- What will they do tomorrow with your product?
- How is this 10x better?
- How do you get them to pay you?
- How much are they paying you / will they pay you? This should be your GMV, average order value (AOV), or average contract value (ACV) per customer per year.
- What is the cost of delivering that revenue? Does that change over time?
- What is the gross profit total for each segment? Does that change over time?
- How many customers do you need to get to $100M and $500M in gross profit, and what percentage of the market (per segment) does that represent?
- Then, show the path to do that (In one sentence, clearly summarize how big of a revenue opportunity we believe this to be for us in Year 1, 2, 3, 4, 5). How many customers in your market do you already have as customers or are currently talking to? How do you plan to get your first 10-100, 100-1000 customers (or 10x, 100x or 1000x your current customer base) at the current or future GMV, AOV, ACV?
Step 2: Use the outputs to “fill in” the mad libs market sizing output format, for example:
- To get to $100M in gross profit per year within our target customers, we need approximately 100K SMBs (20% of 500K) paying us $1K, 17K mid-sized customers (9% of 200K) paying us $6K, or 2.8K large customers (14% of 20K) paying us $38K per year.
- The penetration rate within each target customer by segment: SMBs, 10% penetration or 5 licenses; mid-sized, 20% penetration or 30 licenses; large, 30% penetration or 200 licenses. Our path to $500M in gross profit includes increasing penetration rates and ACVs among mid-sized and large customers.
We’re excited to see what you produce!
Final Takeaway
Market sizing helps you create a holistic and compelling narrative about your business, one that will resonate with investors and help you sharpen how you talk and think about your product evolution. Taking the time to deeply evaluate your market size with a solid methodology can be a key part of crafting a strong narrative.
Next Up: The D+ Financial Model
In Exercise 4, we’ll walk through what we look for in a financial model:
- Why it matters
- How to tie burn, headcount, and GTM spend together
- A framework and template you can use to build your own model
Footnotes
[1] Consider these questions when segmenting your markets for a location-based GTM strategy: Is it by city or metro area? What is the characteristic of cities in each segment? How many cities exist in each segment? How much market penetration do you think you can realistically achieve in every market? When do you consider a city “activated” or “unlocked”?What is the TAM per city? How many cities in each segment do we need to unlock in order to achieve $100M and $500M in gross profit?
[2] Consider these questions when segmenting your customers for a subscription product: Do you sell top-down to businesses or through a bottoms-up product-led-growth (PLG) motion? Who is your ideal customer profile? Is it different from the buyer? At what size company does your buyer differ? What is the size of the company by number of employees? Can we organize these companies by segment? How many companies exist per segment? How much will they pay us and does it differ by segment? How will sales and marketing differ per segment? How much market penetration do you think you can realistically achieve in every logo per segment to achieve $100M and $500M in gross profit?
[3] Consider these questions when thinking about location-based GTM expansion and penetration: Which tier(s) will you focus on first? What is the hypothetical cost to launch a model city in each tier? How long would it take to hypothetically payback a model city in each tier? What is the reasonable goal penetration per model city in each tier? How many cities in each tier do you need to achieve $100M and $500M in gross profit? How do you anticipate growth over the next few years? Is this a small or large percentage of the total market? Is there room for more than one winner?
[4] Consider these questions when thinking about subscription GTM expansion and penetration: Which segment(s) will you focus on first? Will you be using a sales team and if so for which segments? How will sales and marketing channels differ per segment? What is the hypothetical cost to close a model logo in each segment? How long would it take to hypothetically payback a model logo in each segment? What is the goal penetration per model logo in each segment (e.g., x employees / seats per logo)? What is the path to achieving $100M and $500M in gross profit? How do you anticipate growth over the next few years towards these revenue goals? is this a small or large percentage of the total market? Is there room for more than one winner?
[5] Consider these segmentations for subscription businesses: Segment customers into logo size segments of SME (<10 employees), Enterprise (11-1000 employees), and Enterprise + (1000+ employees). Then, each segment’s logos should be assigned an ACV based on some reasonable assumptions; calculate total ACV per segment type as $xy, with x being the number of companies in the segment.