We’re encouraged to think of pitch meetings as a trial by fire: If an entrepreneur can negotiate deadly traps and slay the doubt monsters that bedevil tech investors, they’ll be rewarded with a golden SAFE note at the end of their quest.
Particularly for first-timers, the pitch has become an existential drama, which can lead to poor decisions like overlong slide decks, failing to prepare investors before a meeting, and fatally, exaggerating the size of the total addressable market (TAM) in which they hope to compete.
“With TAM, it is almost guaranteed you’re going to be wrong,” Aydin Senkut, the founder and managing partner of Felicis Ventures, said at TechCrunch Disrupt. “It’s either going to be too large or too small.”
Kara Nortman, a managing partner at Upfront Ventures, said the TAM numbers given in a pitch do not control whether she’s likely to invest. “I would say [it is] more important to be able to articulate how big something can become and to show that you have a thought process around TAM, if it’s early.”
According to Deena Shakir, a partner at Lux Capital, TAM, along with the associated metrics serviceable addressable market (SAM) and serviceable obtainable market (SOM), aren’t meant to be carved in stone. They’re simple planning tools that help founders show investors their company’s upside potential, while SOM and SAM help them offset risk.
“If we’re taking the meeting, we all sensibly think there’s something there that’s interesting enough to be potentially venture-bankable,” she said. “The way it’s calculated and the way the founder is thinking about it tells us not necessarily about the business or its future, but about how the founder thinks about company creation. And that’s much more important at the earliest stage.”
All three panelists said TAM, SAM and SOM numbers offer a window into a founder’s mindset, but they’re not determinative factors, since they already have a general understanding of the sectors in which founders hope to compete.
“When we think about how we make decisions and how we choose funders, I’m not really sure TAM is really like the top three or even top five of the factors,” Senkut said, noting that Shopify’s pitch deck didn’t claim that it would eventually become a $100 billion company. Instead, its founders simply stated the size of the e-commerce market, which encompassed enterprise customers, small businesses and individual entrepreneurs.
“The way it’s calculated and the way the founder is thinking about it tells us not necessarily about the business or its future, but about how the founder thinks about company creation.” Deena Shakir, partner, Lux Capital
“How much have you planned and how articulate is the plan?” he asked. “The plan doesn’t have to be accurate: The plan has to be directionally correct.”
Founders who overestimate TAM to gain investors’ attention haven’t necessarily ruined their shot, but it is a strong signal that they don’t fully understand their market, said Shakir. “What’s much more important is the founder-market fit and the grit and the resilience of that founder that we have to evaluate,” she added. “We can tell if a founder has just done some calculations and got excited about a TAM and thinks it can make a lot of money.”
Although Senkut said he’s tolerant of founders who make mistakes while calculating TAM, he still expects intellectual honesty. “If that number is not correlated to a real calculation or real thinking, I do think that that is a red flag,” he said. “The insight behind it is more important than the absolute calculation.”
Founders use three basic methods to calculate TAM:
- Top-down: often sourced from public data and market research reports.
- Bottom-up: projected and actual pricing, data on current and predicted customer behavior.
- Value theory: the projected value and total anticipated use of your product or service, along with some information about how much of that value can be reflected in its pricing.
Relying on value theory is common when launching a completely new kind of company: Without existing competitors, it’s difficult to triangulate market potential. Nortman, who recently found herself on the other side of the table pitching investors for a National Women’s Soccer League team, said she was turned down more than 100 times.
“The best leading indicator I had at the time was player following on Instagram,” she said. “I got one investor to believe that that was a leading indicator and 99 who didn’t.”
In situations where companies are launching new products and services, Shakir said founders should conduct one-on-one interviews with potential customers to collect intelligence about pricing, customer behavior and other factors that speak to market size.
Senkut said he didn’t appreciate Uber’s potential market size because he enjoys driving so much. If he had it to do over again, he said he would have looked at the size of the overall transportation market for cabs and private cars, then examined factors like Uber’s UI, pricing and the convenience it offered to customers.
“All of a sudden … it becomes like a utility. A lot of times, the markets are limited not because the market is limited, but UI is limited,” said Senkut. “The calculation doesn’t have to be super accurate, but it tells you this is like an important enough market that if you’re brave enough to think of a unique solution that nobody thought about, it’s probably worth going after.”
Nortman said a clear go-to-market strategy can be more compelling than a first-time founder’s “TAM calculations, customer insights [and] segmentation. You can get too far ahead of yourself in the beginning.” Instead of trying to justify a huge potential valuation, founders should focus “on the most important things to figure out: how to build a business that people love, want to pay for right now and will pay more for over time,” she said.
Shakir, who teaches a course at Stanford Business School called “Startup Garage,” said investors understand innately that the TAM founders present is just one signal of many to consider.
“What’s much more important is the founder-market fit, and the ability and the grit and the resilience of that founder that we have to evaluate. If the founder has that deep personal connection and is willing to put what it takes to take it to those next few levels, that’s where the TAM starts to look exciting.”