#startupsuccess

Total Addressable Market: Startup Market Size and Why It Matters

How much is the magic market share number? It depends on how much the investment ask is: you don't need a $20 billion market share to make a profit; niche companies often succeed with much small shares–they just succeed on a smaller scale.

In this section, we'll cover some basic ways you, as the angel investor, can estimate the addressable market share. We'll also talk about how to drill down in a startup's pitch deck, what to look for when the startup talks market share, and how to protect yourself against poor investments with regard to market.

 

Back-of-the-Napkin Considerations

 

You can do some back-of-the-napkin math to estimate a startup's future share of the market. The more you know about the industry or product type in question, the more accurate your math is likely to be, which is one reason many angel investors choose to operate in fields with which they have experience.

For a solid estimate of total addressable market (TAM), you'll need five pieces of information.

1.  The Total Population of Potential Users

This may be a geographical consideration: There are 100,000 people in the city where a restaurant wants to launch. More likely, this is a more abstract number, since the majority of angel investors are opting for opportunities in Internet, software, e–commerce and other virtual spaces. A total possible population for a mobile app launching in the United States, for example, might be up to 182 million people in 2015, according to Statista's numbers on smartphone users in the nation. The site also forecasts smartphone user population to grow to 220 million in 2018.

2.  Definition of the Market Segment and Estimated Percent of Target Customers

Your product limits the percent of your market segment. Angel investors should ask: Who is this product for? Who is likely to want, need, and purchase this product? Are people already buying similar products, and if so, who are those people?

Consider an app that acts as a virtual storybook for babies. The obvious market for such an app would be new parents with smartphones. There are a total of 318 million people in the US; if 182 million have smartphones, then approximately 57 percent of the population has a smartphone. There are around 4 million babies born each year—applying some dirty math, we can assume that 57 percent, or around 2.28 million, of those babies have at least one parent with a smartphone. That's the target audience for our app.

This back-of-the-napkin math is rough: the population numbers used to arrive at the above percentages counted young children and older individuals, which are less likely to own smartphones. Child–bearing parents are more likely to own the devices, which means the target audience could be as high as 3 million. For ease of estimation, let's assume 2.5 million. Out of 182 million smartphone users, that's approximately 1.4 percent.

3.  How Many of the Products Will Be Purchased At A Time?

If a company is selling software through licenses, businesses can purchase multiple instances of the product. Someone with a hot new cupcake recipe is going to sell in multiples as well; our baby app, however, is most likely to sell once to each user. 

4.  How Often Will The Product Be Purchased?

Does the product lend itself to repeat purchase? Is it a commodity or necessity that will be used up, so consumers must refill or restock? At first glance, a software product is going to be purchased once for each user, but what about new versions and upgrades? Are those free, or monetized?

5.  What is the Intended Selling Price of the Product?

We'll look at two possibilities with our baby app example. First, the startup may charge for its app.  Given app store prices, and depending on how much functionality the startup is going to provide in its app, price might range from 99 cents to $7.99. For the example, assume the startup charges $2.99.

The other possibility is that that startup offers the app free to users, but plans to monetize it through ads, in–app purchases, or professional relationships. In this case, the angel investor needs to see the startup's projections on how much per user the app might generate. For our example, let's assume the startup estimates $5 in revenue per user, per year. 


Possible Market Share Formula

The basic market share formula multiplies all of the data points above. So, for our baby app, basing market share solely on the purchase price of $2.99, maximum market share would be:

182 million smartphone users * 1.4 percent target audience * 1 purchase at a time * 1 purchase (no repeats) * $2.99

The maximum potential market share would be approximately $7,618,520 per year.

 

Drilling down: the Startup's deck

 

That $7.6 million market share number for our imaginary baby app is unrealistic–but some startups are optimistic enough to publish such numbers in their pitch deck. No matter how great the product and timing is, you aren't going to get 100 percent to buy–in from your potential market–and remember, the math we did to get to $7.6 million was all estimates and quick Internet statistics searches. You have to assume the numbers are off a bit.

Startups tend to make sweeping statements about market targets in their pitch deck. They might state, "We're targeting 1 percent of a $20 billion market by 2022." As the angel investor, you have to do your own math, as shown above, to vet the total market claim, and then you have to evaluate whether you think the startup is on point with their target. How likely is the 1 percent goal? At Angel Kings, we like to see startups that provide more specific market definitions, even if that reduces opportunities to $500 million instead of $20 billion. 

 

Is The Startup's Plan Backed By Data?

Startups with specific market definitions have some data to back up claims; as the angel investor, you should vet that data against your own research or knowledge of the market. The statistics we used to create our assumptions for the baby app market share are an example of data that anyone can vet. Startups should source such information, but a quick online search turns up information too.  You should also download the app yourself, try it out, and see if people would care enough to pay for it.

It's harder to tack down the percent of potential market a startup hopes to obtain. Ask how the startup came up with that percent. Did they conduct market surveys? Are they basing the data on comparable products? The startup launching our imaginary baby app might have polled 500 new mothers and mothers–to–be to find out if they would be interested in purchasing an app, and then applied that data to the overall market to determine that 20 percent of possible consumers would make a purchase.

Despite how much data the startup presents, you as the angel investor have to make a judgment call. Do you buy in to the market assumptions the startup makes? Do you think they are probably too optimistic? Even if the startup's assumptions are too optimistic, does the market share potential you see make the investment worthy?

 

tomorrow's market, not today's

 

As an investor, you are worried more about tomorrow's market than today's market. Understanding today's market lets you make evaluations of future market potential. In some industries, you can also use benchmarks, expert guidance on industry trends, and forecasts to estimate future market behavior. With our baby app example, an investor might use the estimated smartphone user growth from several statistical sites to gauge how much the potential market will grow. 

 

primary demand versus secondary demand

 

Numbers and data are important, but investors must also understand the difference between primary and secondary demands. Primary demand references the market size for a specific product or product category–baby apps, cupcakes, virtual hard drives, and point–of–sale software, for example.

Secondary demand refers to the size of the market for a brand.

When dealing with early–stage startups in most industries, angel investors are concerned with primary demand because fledgling startups often tout a single product idea. While concentrating on primary demand, keep secondary demand in mind as it plays a role in growth potential. What are the brand goals and plans for the startup? Will the startup pull its audience through branding more so than product, and does the startup plan to branch out with products that could capture greater shares of the market in the future?

In a few niche industries, secondary demand is the primary evaluation point. This might be true when evaluating biotech or social startups, for example, where audience buy–in to an idea is much more important than the product itself. 


Setting Limitations As An Angel Investor

 

You know the saying about going to the grocery store hungry or without a list? Chances are, you walk out spending more than you wanted and with items you don’t need. As an angel investor, enter evaluation phases with limitations in mind to avoid getting caught up with the people and idea and failing to see the potential market pitfalls.

Some angel investors won't consider a startup that doesn't have a potential minimum market share of $500 million or more. Others won't invest in a company where growth projections can't be reasonably estimated at 10 percent a year or more.  You shouldn’t set targets and ranges like this.

Even more important than arbitrary limitations is your own awareness of earning potential. No investment is 100 percent safe, but by calculating market share, the angel investor has a better understanding of the type of returns that can be expected if the startup is successful.


Want to get information on angel investing and venture capital? Get information from the venture capital expert on startups. And find out if you qualify as an accredited investor, http://AngelKings.com/angel-investing-101

           

Meet The Most Successful Lean Startups

Previously, we discussed the 5 lean startup principles to bootstrap your startups.  Let's recap what those are:

  • Entrepreneurs are everywhere.
  • Entrepreneurship is management.
  • Validated learning.
  • Innovation accounting.
  • Build-Measure-Learn.

So let's meet the startups who've managed to use these principles successfully, starting with:

Aardvark

Aardvark was founded by Max Ventilla, Nathan Stoll, Damon Horowitz and Rob Spiro in 2007.  It's a question-and-answer search engine that allows users to connect with each other and provide technical support and recommendations to other users.  Users connect submitted their queries via the Aardvark website, email, instant messaging or other social networks.  Similar to Pinterest, they tested their product by having beta users for their first release, and having those beta users invite new users.  They publicly released Aardvark in March 2009.

Google acquired Aardvark for $50 million on 2//11/2010 because the product was highly successful at querying users for subjective information and graphing the results.  


Get a copy of our official guide to venture capital and angel investing by becoming a member of Angel Kings.  Learn from the angel investing and venture capital expert, Ross Blankenship.

Lean Startup: 5 Principles to Boostrap Your Startup To Success

New entrepreneurs often buy in to the corporate mantra that cash is king, but many companies over the years have made it on determination, intelligence, strong designs, and a bit of luck. For angel investors, these companies can be a great investment, because buy–in is very small in the beginning. Founders who are willing to bootstrap have a different idea of budget, and they can often get more done with less funding. If the startup succeeds, then investors might even see a generous return on a relatively small cost.

In our article on the hottest software startups, we talk about Apttus, a successful software company that bootstrapped its way through seven years before seeking traditional investor funding. In such a case, investors have an even greater advantage: the startup is generally further along with its research, plans, and products. It might even have products on the market, providing investors with solid data on which to make a decision. Even then, investment asks may be lower than with non–bootstrapped companies.

Eric Ries and the Lean Startup

Bootstrapping isn't a new concept; entrepreneurs have been using their last dimes to launch companies for centuries. Funding a small endeavor on little more than your own sweat and what cash you can scrape together is a risky strategy, though, and most angel investors are likely familiar with statistics about how many of these small businesses fail each year.

Planning and methodology brings a bit more stability to the bootstrapping risk, and one of the more successful methods today is Lean Startup, which was pioneered by Eric Ries. Ries, like many founders featured in our book, began in the technology field. After graduating, he worked for a Silicon Valley company that would fail within a few years. In 2004, Ries cofounded IMVU, a social network company, through which he met investor and mentor Steve Blank.

Blank invested in IMVU, but he required that Ries and his cofounder audit a class he taught on entrepreneurship. Through that relationship and class, Ries would learn about Blank's beliefs on customer development–a strategy he used to quickly deploy IMVU products and later to create the foundation of his lean startup method. Reis's efficient approach to the startup meant that the product launched within six months. By 2011, the company was generating revenue of $40 million with an equal number of users. At that time, Ries had moved on to other things, however, remaining simply a board observer with the company.

Ries's early successes and failures put him in a position to advise other startups, which he did independently and as part of the team at a venture capital firm. He also used his experience, and what he learned from working with other startups, to create his philosophy of Lean Startup.

The 5 Principles of Lean Startup

  1. Entrepreneurs are everywhere.
  2. Entrepreneurship is management.
  3. Validated learning.
  4. Innovation accounting.
  5. Build–Measure–Learn.

Let’s examine the concept behind each step and how it applies to the lean startup. 

1.  Entrepreneurs Are Everywhere

The stereotypical view of an entrepreneur veers between the brilliant college student and the driven scientist, but in reality, entrepreneurs are everywhere and come from all walks of life. By definition, an entrepreneur is a person who organizes and operates a business, sometimes – but not always –– taking on high levels of risk to do so. Entrepreneurs are not restricted to technology startups or cutting–edge biotech.

The importance of this point cannot be overlooked, even though it sounds simple. Opportunities for startups abound in every industry and in every region. When you are looking to fund a startup, you don’t have to be confined to a narrow range of opportunities. Find a sector that intrigues you and focus your attention on startups in that sector.

2.  Entrepreneurship Is Management

Going back to the definition of entrepreneur, we see that a core concept is operating a business. The definition does not include brilliant ideas or wild spending habits or even a degree of coolness. It’s about management, which means harnessing available resources to meet goals or at least to provide the best possible outcome under given circumstances.

Management is about discipline and creating processes that help the organization reach its goals.

To make a startup successful, the entrepreneur needs to impose processes and disciplines on the organization. Management is about making good decisions faster even when based on limited information; it’s about getting the best from a team. Sometimes a manager is a coach and sometimes a manager is a dictator or a friend – or a naysayer. A manager manages, and gets things done. 

This is a fundamentally different view of entrepreneurs, who often exhibit diva–like tendencies and go off on expensive ego trips leaving reality behind. Investing in a lean startup means your cash won’t be wasted on some of the excesses and errors committed by entrepreneurs such as leaders at Pets.com, WebVan, Den.com, Boo.com or Flooz.  These companies all failed.

3.  Validated Learning

Using lean startup principles, companies continually test their vision with the only people who can validate it – potential customers. Most startups take the “Nike” approach. They just do it, working diligently to bring a product or idea to fruition and then springing it as a completed product with no time, resources or room for changes or improvements. Many entrepreneurs are disappointed by this approach when the expected sound of trumpets heralding their vision fails to materialize and instead, all they hear is a resounding thud as the doomed product hits the trash.

The MVP, “Minimally Viable Product,” idea strives to find the product that has the fewest features and requires the least effort to create that will still have appeal to a broad enough market to sustain the company’s goals. The minimally viable product feature set does not spring directly from the entrepreneur’s mind, nor will it ever happen in a vacuum unless it’s a fluke of the universe.

Enlisting early adopters is fundamental to this process. The startup needs the feedback from users to measure the product’s viability. By the time the product is ready for full–scale distribution, it has a built–in user base and a history of solving real customer needs.

4.  Innovation Accounting

Startups have sometimes felt that they were immune to the realities of business that exist in established industries, but startups need to be even more conscious of the mundane metrics. The entrepreneur’s role is to define the process and provide the roadmap including specific milestones and priorities. This is more than project management and far more than standard accounting. It is a new kind of accounting that measures startups on their business imperatives. It’s a fascinating topic that Ries explores in detail in his book, “The Lean Startup.

5.  Build–Measure–Learn

Creating an innovation process is key to the MVP concept and the entire lean startup idea. It involves the product learning cycle: Build–Measure–Learn. The process starts with early prototypes that are shown and tested with multiple customers. Customers provide their feedback on what they like, didn’t like, or what they need to have added before they would be willing to buy the product. The startup measures the product’s current features for acceptability to its target market. The development team takes this learning, adds features that fulfill the identified need and repeats the process until they have come up with a design that meets the need without adding unnecessary cost, extended development cycles or unwanted features.

With Lean Startup, you will eliminate or at least reduce uncertainty in the startup process. Your team will be able to work smarter, not harder as you answer the fundamental question: Should this product be built? Most entrepreneurs ask “What can I build?” or How can I build it?” The lean startup works on the premise that you shouldn’t build a product unless there is a sustainable business to be built. Like the original idea for lean manufacturing, it eliminates waste:

·      Wasted time.

·      Wasted effort.

·      Wasted resources.


Want to get information on angel investing and venture capital? Get information from the venture capital expert on startups. And find out if you qualify as an accredited investor, http://AngelKings.com/angel-investing-101