4 Common Startup Mistakes Around Market Sizing

"If it's not a $100B market, it's a pass for me. The returns just won't be worth the effort."

A phrase heard all too often from VCs

For a startup CEO, market sizing is fundamental when deciding whether to pursue a market and, importantly, if it can sustain a venture-backable company. However, these day’s TAM feels more like a marketing or justification exercise for a startup or an industry. Part of that is because too many investors use it as a reason to quickly pass on a deal, and not put the time into really thinking about what it could mean.?

TAM is crucial to figure out, especially if done not just to prove that your market is $100B+ so investors can "tick the box". It provides insight into the subsets of a market, the Ideal Customer Profile (ICP), product development and expansion. Most importantly, it makes you think hard about the right monetisation strategy and of course think about the potential scale of your business and exit scenarios. TAM can give you an idea of how large your business can get if you did everything and capture the entire market. That’s why we’ll talk about the SAM and SOM as they're more important than the headline number.

Let’s delve into the four most common mistakes startup CEOs make when sizing their market. And let’s be honest, VCs often perpetuate these mistakes!

1. Confusing TAM, SAM, and SOM

Despite their best intentions, founders often make critical mistakes when it comes to market sizing in a pitch. A common error is confusing TAM, SAM, and SOM. It’s crucial to differentiate these numbers. Your TAM is not the revenue you’ll generate—investors are more interested in your SAM and SOM to determine if the opportunity is substantial and if you have a realistic plan to capture it. Presenting only TAM, or conflating the three, will raise doubts.

More importantly, if you mistakenly assume that TAM equals potential revenue, you might view a $10B market as a $10B revenue opportunity. In reality, your SOM is often a small fraction of TAM, and misunderstanding this can lead to costly mistakes.

2. Assuming Market Size Is Static

Another common misstep is assuming that market size is static. In reality, your product will evolve, and the industry itself will change over time. Some industries may be mature and possibly in decline, while others, like self-driving cars, may be on the rise, making today’s smaller TAM an understatement of future potential. Markets, especially in tech, are always evolving. Your TAM (and SAM) will likely grow as you add products, enter new customer segments, and expand into different geographies. Your initial TAM is just a starting point—regularly update your analysis to reflect growth.

Moreover, your product will likely evolve. A company that starts with an SMB marketplace and a corresponding TAM may build enterprise offerings, before becoming a full-service provider with a much larger TAM.

3. Overstating SOM?

A third pitfall is overstating SOM to justify a high valuation. Claiming a high SOM may help secure a steep valuation in the short term, but it will come back to bite you if you can't deliver that growth. The way that most companies can overstate the SOM is simply by believing they can capture more than a small slither of the total market. Most startups capture only a small fraction of their TAM, and even mature companies rarely exceed 20% market share. Be realistic and base your SOM on hard evidence of customer traction.

Let’s take the examples shown in the image above. In this case, many startups will look at their SOM as a ratio of their TAM to be similar to what incumbents are able to achieve. Look at Levi’s that has taken about 4% market share of the apparel industry worldwide. Now a startup like Spoke London, which creates high-quality men's apparel with more fit permutations, may believe that they could make a similar assumption based on the $500B men’s apparel market. However, their SAM is much smaller as they are only in the UK, and they appeal to a subset of dissatisfied customers looking for better fit without paying for tailoring. Today, their obtainable market has proven to be fairly small. Please note that these numbers are only estimates and a few years old, and sourced from Storplum. They also aren’t actually SOMs they are their current revenues, however, they show you that very often startups will capture <1% of their TAM.

4. Ignoring the market size impact on growth path and exit

One of the most critical mistakes is overlooking the connection between market size and exit potential. The size of your market directly impacts your growth trajectory and exit options. Venture capitalists favour large markets because they’re necessary for delivering outsized returns. If your TAM is too small (e.g., under $1B), an IPO is unlikely, and acquisition may be your only viable exit strategy. It’s essential to consider this when forecasting your business and raising capital.

Consider a scenario where you raise funds based on a TAM you believe to be medium in size. If your assumption is correct, you’ll likely meet expectations. But what if you’ve underestimated the TAM? You might discover that your ICP segment is larger than expected, leading to better-than-anticipated initial results. By regularly reassessing your TAM, you may realise it’s larger than originally thought, enabling you to raise additional capital and outperform your initial plan.

However, the real issue arises when you overestimate your TAM. If the market is smaller than anticipated, you may raise too much capital, miss your growth targets, and find your company struggling to meet the high expectations set by investors. This miscalculation can force you to reset your valuation, growth targets, and exit strategy.

You might wonder why your TAM—and by extension, your SOM—affects your exit strategy. Your SOM represents your short-term revenue potential based on your current products. For example, suppose a company has a small $30M SOM, derived from a $1B TAM. Even if they achieve half of their SOM, they’re looking at $15M in revenue after a few years. Assuming a typical acquisition multiple, this might result in a sale price between $60M and $120M. However, this outcome assumes growth in the SOM, which may not always occur.

This scenario illustrates the limitations on raising funds. If VCs need a 5-7x return on their investment with no dilution, the valuation cap would range between $8M and $24M, placing clear limits on the amount of capital you can realistically raise.

Now you see why VCs would rather see a HUGE TAM, as it means that even a tiny fraction can deliver outsized returns. However, smaller markets can still support venture backable startups, however, they may just need to be more capital efficient and aware of not relying on an unrealistic exit.

In the end, market size right is a key factor that distinguishes successful startups from those that fizzle out. It’s not just an academic exercise but a practical tool to guide your strategy and raise appropriate amounts of capital. By understanding your market opportunity, grounding your analysis in reality, and planning accordingly, you’ll position your company for success. Treat market sizing with the importance it deserves, and avoid the common mistakes that could derail your growth.