When it comes to obtaining venture capital, you must have a solid understanding of the market opportunity. The main reason is that a VC firm needs a few deals to generate substantial returns, so as to offset the inevitable losers.
This focus on a large market opportunity has become even more important in recent years, as the the funds have gotten much larger.
“The size of the market is essential for your pitch,” said Kara Sweeney Egan, who is a principal at Emergence. The firm is a leading investor in early stage enterprise companies. Some of its breakout deals include Salesforce.com and Veeva Systems.
To estimate the market size, Kara recommends that you start with a “top-down” approach. Consider that there are numerous research firms, such as IDC, Forrester and Gartner, that publish analysis on markets. From these sources, you can easily come up with the TAM (Total Addressable Market). For example, a quick Google search shows that the CRM category comes to nearly $40 billion (the estimate is from Gartner).
But of course, you should go deeper then this — that is, you need to use a “bottoms-up” approach as will. At the heart of this is calculating the Total Obtainable Market (TOM), which is the total number of target customers multiplied by the average each will pay for your product.
Let’s take an example: Suppose you are targeting accountants in the US. By looking up Labor Department data, you’ll see there are 660,000 CPAs. If your product sells for $1,000 per year, then your TOM would be $660 million.
“Your TOM should range from $500 million to $1 billion,” said Kara. “If it is smaller, then you’ll need a clear plan to expand that market.”
Now there is often lots of tweaking of the numbers. And it will continue over time, as you learn more about your market.
This was the case with NGINX, which offers a suite of technologies for developing and delivering modern applications. “We had the ability to start with a very broad footprint of open source users,” said Gus Robertson, who is the CEO. “When we founded the company, we had about 35 million websites already running the software. We applied assumptions around how many companies those sites represented, and applied some assumptions around the percentage that would buy a commercial offering. As NGINX matured, it became clear exactly what products and solutions our customers valued. We built specific offerings with features that were above and beyond the open source features — a proven open core business model. Some use cases remain adequate for our open source project; other use cases favor moving to our commercial product.”
But what if there is not much data available? This is actually common. But there are creative approaches to deal with this.
Just look at NuORDER, which operates a B2B wholesale ecommerce platform.
“To size the market opportunity,” said Heath Wells, who is the co-founder and co-CEO of the company, “we needed to get a sense of how many brands there are that sell products to retailers. But this is data that isn’t available through 3rd party research or government stats. Instead we used two other data sources to help us size the market.”
First, Health visited the websites of the major retailers in each of the categories his company wanted to target. “From this, we were able to determine the number of brands who wholesale,” he said. “Next, we honed in on the fact that brands have used tradeshows as a major means of finding and engaging lots of retail buyers. Thus, by looking at the number of brands sponsoring and attending major conferences – conferences such as MAGIC, Outdoor Retailer, The Running Event and others – we were able to gather another key data point in sizing the market.”
It definitely worked out. Since 2012, NuORDER has raised about $40 million.
The Big Picture
Just because there is a big market opportunity does not mean VCs will necessarily be interested. They also want to see that there are emerging megatrends, which should allow for the adoption of new technologies.
John Vrionis, a venture capitalist at Unusual Ventures, points out one pitch that did this extremely well. “The co-founder of AppDynamics, Jyoti Bansal, had a simple picture that showed there’s a huge market for making sure apps run right,” he said. “It clearly showed that a tidal wave was approaching. With the growth in virtualization, the traditional approaches of monitoring would simply not work. Jyoti said he knew this because he was the lead architect of one of the top companies in the space. His compelling argument was that there would need to be a re-write of everything.”
It was definitely spot-on. In early 2017, AppDynamics would sell to Cisco for $3.7 billion.
For the most part, VCs want to get a sense of your thinking about the market dynamics, not just the numbers. “A well though-out view of the the market can help build excitement about your company, demonstrate your industry expertise, and highlight your key insights into your customers,” said Kara.