Calculating a market size using a top-down & bottom-up approach

Hi! I’m glad you’re here. You’ve made it to issue #7 of VC Demystified🪄.

My name’s Nicole - I’m a Principal at an early stage venture fund, and I know firsthand that VC can often be a black box. Breaking into the industry may feel daunting and resources can seem scarce and inaccessible. I wanted to put together a newsletter to give others the playbook I wish I had when I first started.

Given it’s lucky #7 newsletter this Sunday, I thought it was a great time to ask for your feedback. Please take <2 minutes to fill out this form telling me what you’re liking (and not liking) about VC Demystified🪄. I’m here to help you and in order to do that well, I need your feedback!

Today’s deep dive: How to calculate a market size using a top-down & bottom-up approach

My personal mission is to open as many doors as possible for other people and this newsletter is just one avenue to do that. As always, I will continue to post VC insights daily across my socials for those of you who prefer those channels.

How to calculate a market size using a top-down & bottom-up approach

Market size is typically one of the first things VCs consider when evaluating a new investment. The reason is because VC-backed businesses need to reach a certain scale in order for investors to return capital back to their Limited Partners (LPs). Often times you’ll hear the golden valuation is $1 billion (aka unicorn valuation). Not all businesses need to reach that valuation for investors to be successful, but they do have to reach large scale. I’d say $500M+ valuation to truly be a game-changing exit for VCs.

Given the scale required, you can start to see why VCs care so much about the market size. It’s because big businesses can only be built in big markets, as PearVC once said.

So how do you calculate market size?

There are two methods: 1) Top-down approach 2) Bottom-up approach

Bottom-up approach is more widely used by VCs because it takes into account a startup’s business model, meaning it’s more tailored specifically for that business. Top-down is less useful because it starts with an overall industry size and then takes a percentage of the overall size to estimate the startup’s total addressable market (TAM).

Whether you’re a VC or a founder, understanding how to calculate a market size using these two approaches will be critical in evaluating the exit potential of a particular business.

In this issue, I will take you through a hypothetical example of how to evaluate the market size of an eCommerce software company using both top-down and bottom-up approaches.

Let’s get into it!

Subscribe to Premium to read the rest.