Venture Things E05: The Top Down

On the VC side you get confronted with many numbers, assumptions and business cases. Most of them apply a bottom up approach assuming a variety of things. To verify a bottom up you can model a top down approach using own assumptions — this should yield similar results, if not this could be a good reason for a call with the company!

What is the Bottom?

You could say the bottom is the supply of something — e.g. the product and services of a company. Let’s distinguish two perspectives for that: B2C vs B2B. In the B2C case many cases I get on the table are based on different marketing channels — following a logic of “do marketing -> generate demand -> sell product”. Many B2B cases I see are based on the number of leads which are created by ctivity in marketing and sales. There, the logic is focused on “do marketing -> qualify leads -> sell product”. Therefore, the driver of this approach is to create demand through marketing or the activity of sales reps.

Top Down approach

Imagine you worked through the case and have a good overview of how the business will scale over time (based on the very case on your computer screen). Let’s say the Year 5 revenue is 100m. To verify that, I build a top down case which assumes three things 1) a totality of target customers, 2) a conversion rate and 3) a mapping of products to these target customers.

1. Where to get all the target customers? For B2C this is quite hard and requires an estimation of different consumer groups — google, calculate, google, calculate — like the company would do. For B2B this is a little bit simpler — products are often tailored to certain industries or company sizes — try to get the latest statistics on these markets and write down.
2. Conversion rates make the case — this is actually the key metric, which connects a bottom up and top down approach. Here, I also try not to be scientific, but mostly pessimistic. E.g. I assume 1% average conversion in many cases. This puts more emphasis on the assumption 1) and the matter of market size for a VC.
3. Map the products — this is not that trivial at all: Different products of a B2C or B2B company have different prices and lifetimes — I try to be very pessimistic with that, too. E.g. premium products are only for the top 5% of all target customers etc.

Like the company which handed in a sophisticated case the top down version can also become a tricky thing. To keep things simple, I would stop after the 3 assumptions and calculate the resulting size of the case — will it fit to the 100m?

It’s all about assumptions — but you can drill down to very few of them and have a good discussion on that. Additionally, your case can help the company itself very much to get another perspective which is more “market size” driven.