Startup Diligence Guide: Market Sizing in 30 Minutes | Founder's Guide

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

Mistake 2: Not segmenting your bottoms-up market sizing analysis

Why it doesn’t work: Omits go to market (GTM) strategy

Tier 1 = large + urban like LA
Tier 2 = mid-size+suburban like Dallas
Tier 3 = smaller + more rural like Tulsa
Enterprise: 10K+ employees like Google
Midmarket: 1k-10k employees like Datadog
SME: <100 employees such as a startup

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%)

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

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