Why Market Sizing Is Critical for Hyperlocal Founders Seeking Investment

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Businessman removing a wooden card reading Start up from his pocBecause of my longstanding participation in the entrepreneurial community, I have the good fortune of speaking with hundreds of founders each year and reading their pitch decks.

These pitch decks usually include a great amount of detail about how a product will be built, how it will be used, and how it will affect change with consumers or businesses. Good presentations would also describe the amount of money that a founder is seeking, what they intend to do with the money, and how much revenue they expect to generate over the next several years.

But far too many pitch decks completely ignore a vital section that can make or break the whole presentation: market sizing. The market size is the total amount of goods or services expected to be sold in the vertical area in which a business intends to operate. Skipping this section is usually reason enough for a pitch deck to end up in an investor’s rejected pile.

In fact, an entrepreneur’s projections about the total amount of revenue to be generated in the entire market for their vertical can be even more important than the projections they make for their individual business. I’ve always found that the best way to judge an opportunity is by first examining the projected market sizing.

Consider two companies: the first company dominates the competition and projects to generate $5 million in revenue in a vertical with a total market size of $7 million. The second company, a player of such a minor size that competitors in its space may not have heard of it, projects to generate only $1 million in a vertical where the market size is projected to be $1 billion.

When it comes to venture investment, investors would not consider the first company a very compelling candidate. Yet if the second company has a solid strategy to gain market share, it may be incredibly interesting to investors.

The economics of venture investment dictate that professional venture investors only invest in businesses that have the potential to massively scale. This is because the majority of investments in early-stage technology businesses fail. In order for a venture capitalist to make money, they need a few of their investments to generate sufficient returns to compensate for all the businesses that generate no returns. The only way this is possible is if every business they invest in is at least pursuing a very large opportunity.

From the entrepreneur’s perspective, this also means that the best way to tell a story about the future of their vertical is to talk about its inevitability. If I’m presenting to a group of venture capitalists, I usually pause after describing the vertical opportunity to see if I can get agreement from my audience before delving into the particulars of my business. “Do you agree that someone in this vertical will build something huge?” I ask.

When I pitched investors on sixdegrees, I said: “It’s inevitable that millions (now billions) of people will index their relationships in a single database and be able to see the people they don’t know through the people they do know.”

When I pitched MeetMoi, I said: “It’s inevitable that the majority of online dating will be done on a smartphone, and someone will introduce a new dating experience that will be uniquely suited for a mobile device.”

Once we had convinced investors that the market opportunity was huge, we then had an opportunity to tell our story about why our online dating experience would reinvent the online dating experience. And while our dating company did not live up to the hopes we had articulated in our pitch deck, our predictions about the disruption were compelling when articulated and ultimately came to fruition, albeit alongside our competitors.

Predicting market size can be easy when there exists third-party research from a company like Forrester or Jupiter, for example, that publishes projections about revenue in a specific vertical. The tougher question is what entrepreneurs should do when no credible projections exist for a vertical. More complicated still is what they should do when the vertical itself exists only in their vision of the future.

The best approach in this situation is to create your own projections and, in doing so clearly describe your methodology.

Here’s how entrepreneurs can step-by-step create their own projections for market sizing:

Portable Expenditures
Imagine a company that is building an application for Google Glass that allows users to view local businesses in a new way. The business model is based on local advertising. Let’s imagine that, in spite of the founder’s best efforts to find credible research predicting the size of the advertising market for Google Glass, she can find no meaningful projections. But there are plenty of projections available about the amount of local advertising and online local advertising from small businesses. And there are projections about the number of Google Glass units that will be sold over the next five years. This founder could take the projections about the Google Glass units and project what percentage of users will be searching for information from their devices instead of from desktop or mobile devices. Then she could further project the total number of searches or page views resulting from Google Glass. If advertising budgets don’t grow beyond the amount that online advertising is already projected to grow, then our founder could simply project a portion of revenue from one type of device to another.

Available Budgets
Let’s use a second example where a business analytics startup is focused exclusively on big businesses that want to calculate ROI using their marketing expenditures. There may not exist easily accessible studies showing what amounts corporations spend on business analytics solutions explicitly focused on ROI calculations, but there are studies that show what they will spend on big data and business analytics generally. And surveying a few large enterprise companies would likely reveal the percentage of business analytics expenditures that are spent on understanding marketing efforts. While applying an approximate percentage for marketing expenditures against big data expenditures wouldn’t reveal exact market sizing, it would certainly provide useful context for how this founder could approach the total market opportunity that he is pursuing.

Bottom Up
If an entrepreneur is selling to small and medium-sized businesses, there also exists a bottoms-up methodology for market sizing. For example, if there were no studies available for projected expenditures on web hosting, a founder could derive their own market sizing by first looking at the total number of websites in existence and then examining the growth in projected websites being created over time. If the founder had some idea of the average cost structure associated with hosting, he or she could multiply that cost structure by the number of websites they’re projecting that will require hosting and then derive a projected market size.

While all of these market sizing methodologies have holes, it’s crucial that startup founders don’t bypass this exercise if they are going to provide investors with solid projections about their companies and verticals.

If a founder’s pitch falls short, they might be forgiven by a prospective investor who believes that they’ll iterate their way to a better product or service. But if their market sizing doesn’t exist or is poorly sketched out, founders run the risk of being viewed as pursuing opportunities that simply aren’t big enough to attract venture capital.

Andrew WeinreichAndrew Weinreich is a serial entrepreneur. He has founded seven startups and has been awarded two software patents. He is currently the co-founder and chairman of Indicative, a data analytics startup. He has also created the comprehensive Andrew’s Roadmaps program, a two-day bootcamp that walks founders through eight critical entrepreneurial disciplines over a series of 30 lectures.