Changing my tune about Vertical SaaS?
Don't shoot the messenger
I recently had a discussion with an investor about vertical SaaS, and to his surprise I sounded less enthusiastic than usual. And reflecting on it, it's true that my stance on vertical SaaS has evolved a bit. Through many discussions with VSaaS founders the past 18 months, a couple of elements have crystallized in my mind:
Market: Fewer big verticals than I thought? The market is obviously a crucial factor in building a substantial SaaS company. My current feeling (it might change) is that fewer verticals are large enough to support the growth of massive SaaS businesses than I initially thought. The most successful vertical SaaS companies tend to operate in the same large industries (construction, restaurant, healthcare, real estate…). And now I even argue that companies like Shopify or ServiceTitan are not really vertical SaaS because they address so many different verticals under the umbrella of eCommerce or field service providers.
Product: Most VSaaS customers want Swiss Army knives. Most vertical markets require a Swiss Army knife type of product –a.k.a a product with a ton of features. This is because users in many verticals prefer an all-around tool over using multiple separate applications. And developing and maintaining such complex products is challenging and time-consuming.
Sales and Marketing: A unique playbook: The vast majority of pre-seed/seed vertical SaaS founders I've spoken with struggle with sales and marketing. And 99% of the time it is a pure execution problem as the sales and marketing playbook of most VSaaS relies on automated lead generation at scale paired with high velocity direct sales to close customers. It seems to me that there are far fewer options available than with horizontal SaaS. HSaaS can, for example, target enterprise customers (fewer but bigger deals), leverage plenty of existing software marketplaces (Salesforce or Shopify marketplaces), adopt a freemium approach etc. They just have more options when it comes to acquiring customers.
Pricing: Low ACV and price sensitive customers. ACV in vertical SaaS is often low, with customers being price-sensitive. Significant revenue expansion usually occurs only at later stages, making efficient lead generation critical from the outset.
Importance of Service Departments: Most successful vertical SaaS companies have a substantial service component. However, establishing a robust service department is challenging in the early stages, even though it’s increasingly common.
The couple of points above explain why I believe:
There’s limited room for VSaaS founders to improvise at early stage: Vertical SaaS founders face more constraints in product development, sales, marketing, and pricing compared to their fellow founders in horizontal markets. Success in vertical SaaS is heavily reliant on precise execution and less on creativity.
VSaaS founders need early stage investors that can support them financially for a longer time: For VSaaS founders who raise pre-seed or seed rounds, it seems to me that it’s crucial to raise with VCs capable of doing bridge rounds and even doing the Series A. Ticking all the boxes I mentioned above (product, sales and marketing, services…) takes time, so if you don’t have an early stage investor who is ready (and can) invest in your company over a longer period of time, it can get messy.
Not taking VC money early can be a good option: The past couple of months I saw an increasing number of VSaaS that raise money after spending +6 years self funding their company. Once they have ticked all the boxes (product, sales and marketing organization, and service department) they directly raise a Series A. So if you cannot find a VC that can follow you from seed to series A, then self funding your company is probably an option to consider.
Conclusion: A more nuanced view
In conclusion it’s not that I don’t believe in VSaaS anymore, but more that my view on the industry is more nuanced:
There are probably fewer verticals than I thought that are large enough to support “VC backed” types of companies.
A corollary is that plenty of VSaaS are probably better suited for “PE style” trajectories than for “VC backed” trajectories.
From a VC perspective, it can make sense to invest mainly in vertical SaaS companies at Series A once they have ticked all the boxes.
And if you do invest in a VSaaS at pre-seed / seed, then you need to be ready to be on board for a long time and to financially support the company from seed to series A (included).