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How do you calculate TAM, SAM and SOM bottom-up?

A vertical SaaS market sized from countable clinics, a real price and a hiring plan, and the test a VC should run against the result.

Julian R. Sterling · from The Venture Capital Associate

Bottom-up, TAM is the number of customers who could buy times what each would pay a year; SAM is the share of them the product can actually serve today; SOM is what the sales team can win in five years, built from reps, deals per rep and churn. For an illustrative scheduling tool sold to 30,000 independent vet clinics at $5,760 a year, TAM is $172.8m, SAM $69.1m and SOM $9.33m of ARR, a fifth of the $45m the founder's top-down slide claims.

Worked in full in The Venture Capital Associate by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →

Top-down sizing starts from an industry report and takes a percentage. It produces large, unfalsifiable numbers. Bottom-up sizing starts from countable units and a price, so every line can be checked in diligence, and it often shows that the market is smaller than the round needs.

The assumptions

An illustrative vertical SaaS company at seed. All counts and prices are illustrative.

Input	Value	How to evidence it
Independent vet clinics in target countries	30,000	Registry or association counts
Vets (paid seats) per clinic	4	Customer interviews, pilot data
Price per seat per month	$120	Current contracts, not the price list
Share of clinics on a compatible practice system	40%	Integration partners' installed base
Quota-carrying reps, years 1 to 5	2, 4, 6, 8, 10	The hiring plan in the model
Clinics closed per rep per year	60	Current reps' actual run rate
Annual logo churn	8%	Cohort data, however short
Founder's top-down claim	1% of $4.5bn	Industry report

The calculation, step by step

Step 1: annual contract value. Four seats at $120 a month is $480 a clinic a month, or $5,760 a year.

Step 2: TAM. Every clinic that could ever buy, at today's price.

Step 3: SAM. Only clinics running a compatible practice management system can use the product now: 40 per cent, or 12,000 clinics.

Step 4: SOM, built from capacity. Rather than assuming a share, count what the team can sell. Each year, customers = last year's customers × (1 − churn) + reps × deals per rep.

Five-year obtainable market from the sales plan.

Year	Reps	New clinics	Churned	Customers	ARR ($m)
1	2	120	0	120	0.69
2	4	240	10	350	2.02
3	6	360	28	682	3.93
4	8	480	55	1,108	6.38
5	10	600	89	1,619	9.33

The result

The three numbers answer three different questions. TAM ($172.8m) says how big the company could become if it won every clinic at today's price. SAM ($69.1m) says how much of that it can address without building anything new. SOM ($9.33m) says what the plan delivers. The founder's slide, 1 per cent of a $4.5bn market, implies $45m: 4.8 times what the sales plan can produce. The gap is not optimism; it is the difference between a share of a report and a count of clinics.

The more useful test for a VC is SAM against the exit the fund needs. If a fund-returning outcome needs about $100m of ARR, SAM covers 69 per cent of it. Getting there would take 145 per cent of the serviceable market, which is not a share anyone can win. The investment case therefore rests on expansion: new countries, group practices, payments revenue or a higher price. That is what diligence should test, not the growth rate of the industry report.

What if: seats and price

TAM, SAM and five-year SOM ($m) by seats per clinic and price per seat per month.

Seats × price	ACV ($)	TAM	SAM	SOM
3 × $90	3,240	97.2	38.9	5.25
3 × $150	5,400	162.0	64.8	8.74
4 × $120	5,760	172.8	69.1	9.33
5 × $120	7,200	216.0	86.4	11.66
5 × $150	9,000	270.0	108.0	14.57

Price and seats move all three numbers in proportion. Sales capacity moves only SOM: at 40 clinics per rep a year, five-year SOM falls to $6.22m (9.0 per cent of serviceable clinics); at 80 it rises to $12.44m (18.0 per cent). When the founder argues about the market, the diligence question is usually the rep productivity line.

The common mistakes

• SOM as a percentage of TAM. "We only need 5 per cent" is an assumption, not a calculation. Build it from reps, ramp and churn, then express it as a share as a check.
• TAM priced at the list price, or at a future price. Use what customers pay now. A price increase is an expansion lever to argue separately.
• Counting users instead of buyers. Vets use the tool; clinics sign the contract. Unit counts must be the unit that pays.
• Ignoring churn in SOM. At 8 per cent a year the plan loses 181 clinics over five years, 10 per cent of the 1,800 it wins.

The exit a fund needs from one company is worked in what exit value a startup needs to return the fund, and how the price of the round then translates into the VC's return in how to value a startup with the VC method.

Takeaway

Count the buyers, price them at today's ACV, restrict to those the product can serve, and build SOM from the sales plan: $172.8m, $69.1m and $9.33m here. Then hold SAM against the outcome the fund needs. The free working documents for this book include the market and product sheet, sized from the bottom up.

Questions readers ask

What is the difference between TAM, SAM and SOM?

TAM is revenue if every possible buyer paid today's price; SAM is the part the current product and channels can serve; SOM is what the company can realistically win within a planning horizon. In the illustrative case they are $172.8m, $69.1m and $9.33m, so SOM is 13.5 per cent of SAM and 5.4 per cent of TAM.

Why do VCs prefer bottom-up market sizing?

Because each input can be checked: buyer counts, price per contract and sales productivity. A top-down claim of 1 per cent of a $4.5bn market implies $45m, while the bottom-up sales plan reaches $9.33m of ARR in five years, 4.8 times less. The disagreement is visible only when the units are counted.

Is the market big enough for a venture return?

Compare SAM with the ARR a fund-returning exit needs. If that is about $100m, a $69.1m SAM covers only 69 per cent of it, so even a 145 per cent share of the serviceable market would be required. The case must rest on expansion levers, which become the core of diligence.

Also on this site

• What exit value does a startup need to return the fund?Fund size divided by the stake left at exit. A 10 per cent seed stake diluted to 4.78 per cent needs a 2.09 billion exit to return a 100 million fund.
• How do you value a startup with the VC method?Post-money = exit value x retention / target multiple. A 200m exit, 10x target and 32 per cent later dilution price a 5m Series A at 8.6m pre-money.
• How do you calculate LTV:CAC when net retention is above 100%?Swap churn for a discount rate: LTV = margin / (r + 1 - NRR). At 115 per cent NRR and 20 per cent, LTV:CAC is 4.00x; at 25 per cent it halves to 2.00x.
• How does broad-based weighted average anti-dilution work?CP2 = CP1 x (A + B) / (A + C). A 40 per cent down round moves a 2.00 Series A conversion price to 1.82: 500,000 extra shares, against 3,333,333 under a full ratchet.
• How does a convertible note convert with interest, cap and discount?Principal plus accrued interest, divided by the lower of the cap price and the discounted round price: 1,090,000 converts at 0.80 into 1,362,500 shares.
• How does a SAFE convert with a valuation cap and a discount?A 1.0m post-money SAFE at a 10.0m cap converts at 0.90 a share into a round priced at 2.16: 1,111,111 shares, 8.0 per cent after the round, worth 2.40x.

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