“SaaS is boring, but lucrative.”
When I started getting into startups two years ago, this was the consensus of most VCs and founders I talked to: All the “interesting” companies were being built in web3 or American Dynamism/hardtech. Following the well-known trope of “the smartest people in the world are optimizing ad clicks for money” from 2010-2017, the narrative was “venture dollars keep going into incremental SaaS companies rather than anything that resembles innovation.”
Even people who introduced themselves as SaaS VCs would caveat it by semi-apologizing for the business model they invested heavily in. I met founders who would pitch their frontier tech startup by aggressively labeling themselves as a non-SaaS company. SaaS founders sheepishly stayed mum compared to their friends building in other areas.
I have to admit that I had the same opinion coming into VC at Susa. I knew I would be investing in SaaS because that was a Susa specialty, but my interests skewed heavily towards areas like crypto, space, defense, education, etc. I would say boastfully, “I want to invest in startups that touch the real world,” “atoms, not bits,” “they promised us flying cars,” or other VC catchphrases that regurgitate whatever Peter Thiel said in a podcast recently.
However, I recently went down a rabbit hole that proved me completely wrong. Or at the very least, reframed how I think about opportunities in SaaS.
Let’s talk about Vertical SaaS, specifically related to SMBs.
Many vertical SaaS companies sell software solutions into SMBs like gyms, barbershops, restaurants, and car washes. It’s everything VCs hate: low ACVs and difficult monetization, fragmented GTM, and low customer quality with high churn.
With all these negative points, why would anyone be interested in funding these companies?
Vertical SaaS companies touch every aspect of businesses from finance to customer relationships to employee management, creating an opportunity for an inherently multi-product “compound company” with a correspondingly higher ARPU, LTV, and NRR.
They are a natural “system of record” or “operating system” for the customers they serve. They can capture large market share as customers look for a single point of accountability rather than multiple point solutions. The buyer and user are very closely tied (or often the same person!) rather than separated by several layers of bureaucracy.
As a VC, I get pitches every week where a founder has identified a so-called “wedge” into an industry. Their pitch usually explains why they think that wedge is interesting and then ends with a grand vision of how they’re going to take over the entire industry with their array of products and services.
However, what’s usually missing is an explanation of why their company will have a “right-to-win” in adjacent categories or products. It’s usually a story about cross-selling, user expansion, or “customer experience/branding.” But in large enterprises, there’s a variety of different stakeholders and users. If there’s no clear incentive to use your product in a new org, they will often prefer the best available situation, regardless of whether that’s made by you or someone else.
And guess what? The other company’s point solution for the problem is probably better than yours because they’ve identified that as the wedge they want to tackle and then try to get into YOUR business. What ends up happening is these myriad of point solutions competing with each other and selling stories of expansion into other areas that usually fail to materialize.
This view heavily impacted Parker Conrad’s view on how to build Rippling and why he chose to build it as a “compound” company from the outset:
However, vertical SaaS companies selling to SMBs usually don’t face the same issues. Once you capture a control point (usually in the front office or back office) in the business, it becomes the most important software the SMB owner interacts with. Unlike the spread-out organization that is buying point SaaS solutions, the SMB owner is looking for a single point of accountability that simplifies their vendor management process. The buyer and user are very closely tied (or often the same person!) rather than separated by several layers of bureaucracy.
Once a vertical SaaS company hooks into some aspect of the SMB’s management, there’s a natural extension into other products. For example, if the startup starts by managing payments and reconciling the general ledger, it can expand into products like instant deposits, lending, or payroll and benefits. It could also start in the front office, with a CRM that eventually adds marketing products, e-commerce tools, etc. The ambitious founder might start with both at the same time.
Ever since the publishing of Zero to One, founders are more comfortable pitching themselves as potential monopolies that escape competition. For most SaaS companies, this will simply never be the case across multiple products. There will always be a better point solution out there attracting funding from VCs and attention from customers. However, despite the difficult GTM, vertical SaaS has supported winners with monopolistic market share like Veeva, ServiceTitan, Mindbody, etc. Customers in these markets prefer software that’s built for their specific industry and use cases. As a company becomes the runaway winner and preferred vendor-of-choice, they can actually become the dominant solution across multiple products.
The challenges and opportunities in building vertical SaaS is much better covered in other places like Tidemark’s Vertical Knowledge Project so I’m not going to rehash them here. What struck me more while going down the rabbit hole was how much these companies touched the real world of “atoms” in an incredibly meaningful way, but would never attract plaudits from tech Twitter for the real-world impact they had.
The phrase “vertical SMB SaaS” like a lot of VC nomenclature hides something real underneath. Someone who operates a gym in Topeka, Kansas or a barbershop in Buford, Georgia, doesn’t think of themselves operating in a “vertical.” They’re just a small business owner who’s providing a service for customers, while trying to make ends meet for their families and their employees. The very-same razor-thin margins that VCs shy away from are the very ones they must make work so their kids have food on their table.
Even though I don’t think this is necessarily what Katherine Boyle intended when she coined the phrase “American Dynamism” is usually associated colloquially with space, defense, and other startups that either sell to the government or attempt to circumvent its failure with a private solution. It’s trying to recapture the spirit of 1969, when Americans still had a positive and optimistic vision of their future.
I think that’s great. It’s awesome that we are seeing so much interest in building in these areas that have long been neglected or avoided by VCs in Silicon Valley.
But I would argue (and I think Katherine would agree), what makes America dynamic is its people.
When Warren Buffett or Lee Kuan Yew say to never bet against America, they’re talking about its people. It’s that barber in Georgia or that gym owner in Kansas, trying to scrape out a living and provide a better future for their kids. To coastal elites, these businesses are “shitty businesses” that they would never bother to run. WhErE’s ThE OpERaTinG LeVERaGe? But that can-do attitude, the frontier spirit, the American work ethic, and the desire to make something of your own is what makes America special. People often chide Americans for their narcissism and belief they are special snowflakes who can escape the law of averages, but if it wasn’t for that self-belief, we wouldn’t produce nearly as many great companies, athletes, musicians, actors, scientists, doctors, etc. as we do. The world’s best in almost every field are either born here or come here to prove it.
Our biggest weakness is on the other side of our biggest strength.
America is a country uniquely good at producing outliers, but it comes from a culture where even the median person is ambitious, hard-working, and believes they have a unique gift to offer the world.
Hot take: vertical SaaS companies who service entrepreneurs building the backbone of our economy and small businesses all across the country are every bit as heroic as the flashy startups raising boatloads of venture capital to explore space.
Importantly, it’s not either/or, it’s both/and.
SMB verticals are radically underserved and it is an incredibly important mission to equip these businesses with modern tooling so their lives can be easier and their businesses can be run better and more efficiently. Significant tailwinds around increased SMB adoption of technology during the pandemic buoy the opportunity available to founders.
We need to increase the pie and expand the frontier of humanity, while also creating solid middle-class jobs and opportunities for people who don’t want to move to the coasts and work at a startup or Big Tech. I love watching companies like Rinsed, PushPress, and Toast enable small businesses all over the country and world to operate more efficiently.
It’s a noble mission.
When I wrote “It’s Time To Lead” two years ago, I would’ve been skeptical of the importance in investing in SaaS companies. I wanted to “invest in the future.” However, the future is not just about science fiction, but about supporting people and their dreams. The rebirth of America will be led by people across walks of life and all sectors: yes, the proverbial startup founder building a VC-backed defense tech company in Southern California, but also that barber in Georgia and gym owner in Kansas.
Never bet against America.
We’re going to build this country brick by brick from the smallest business to the largest enterprise. Software will be a part of every layer, creating leverage and freeing up humans to do what they do best.
Thanks to Michael Tan, Blake Eastman, and Leo Polovets for looking over drafts of this essay. Special thanks also to the folks at Tidemark Capital whose research was instrumental in writing this piece.
And if you’re a founder building a vertical SaaS company, SMB or otherwise, reach out to me at firstname.lastname@example.org
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@Pratyush - This article so succinctly illustrates so many points I've long and passionately felt about Vertical SMB SaaS, but never was so eloquently able to express. Thank you! Our mission at PushPress is just as meaningful as it was yesterday for US....but I think now others can start to understand better the power and meaning behind our mission and those that we support!
Let me check if I understood this right: is it like how square and stripe targeted small retailers and startups respectively, rather than large enterprise? And doing this 'bottoms up' approach is a good strategy to prove out a SaaS idea?