Modern Vertical SaaS — Show Me the Money

Traditional Vertical Software

Vertical Software is experiencing a renaissance. While the category has existed since the early days of software, new forces are upending previously held assumptions and creating new categories of vertically focused companies digitizing arcane processes.

Traditionally, companies that succeed in building vertical-specific software, specifically for antiquated industries, go about this by becoming a system of record. David Yuan, the vertical SaaS OG, refers to these as control points. As he so astutely pointed out in one of his many primers —

In the long run, there are no point solutions in Vertical SaaS; there are only platforms.

As he and many others have correctly pointed out, one way to build a large software enterprise in a given vertical is to build a product at the intersection of many data streams to become the proverbial source of truth. For example, as a point-of-sale system, Toast sits at the intersection of payments, customers, and labor. All the truth that you need about your restaurant business lives inside Toast. Once you become this system of record, you become incredibly entrenched, and there is a switching cost when moving to a different provider. Furthermore, additional workflows and upsell opportunities can then built on top of your data. Shopify’s app store allows its content management system (CMS) to become more sticky with merchants as the number of apps used increases.

Modern Vertical Software

However, we at DCM believe a new playbook is emerging for building vertical-specific software companies. After surveying dozens of industries and companies, we believe modern vertical software must be built differently to persuade buyers in 2024. Simply leading by offering a system of record is not enough, as that is likely already table stakes. For vertical software to be adopted in 2024, you must almost always start with software that can drive meaningful expansion of either revenue or profit. Vertical software that will win today is software that sits as close to the money as possible. In other words — show me the money.

Why are things different today?

There are a few observations as to why we believe this:

In many, but not all, industries, digital systems of record already exist. It’s no longer you vs. pen and paper. So, what else do you offer?

These solutions may not be well designed. They may not even be cloud-based. However, these solutions exist and have existed long before your startup existed. The users in the verticals many startups seek to disrupt have been trained on these products for sometimes decades, and simply matching these products feature for feature will not be enough. According to Gartner, 92% of large enterprises have engaged in some digital project, and 62% have invested in cloud.

While the battle cry of many vertical software investors and startups is disrupting pen and paper, very few worthwhile industries are still actually just pen and paper. For example, three generations of software providers are already in the early childcare software space. ProCare began as software that was distributed via floppy disks and has since grown through acquisitions of smaller players. Brightwheel was the first to deliver cloud-based software to disrupt Procare successfully. Now, newer solutions such as Playground, HiMama, and Lineleader are attacking these incumbents with various “show me the money” products such as better enrollment or billing.

In many industries, you are not competing with pen and paper but rather existing software that has already won the hard-fought battle of becoming the system of record. To defeat them, you must bring something more. What’s better than more money? :)

Professional Services Budgets > Software Budgets with AI

In a world where gross margins and repeatability are all else equal, it may be preferable to sell services over software as it drastically expands the total addressable market. Or, as some have coined — sell the work. Traditionally, venture capital has avoided tech-enabled services due to low margins, diseconomies of scale, inconsistent customer experiences, and operational nightmares. However, anyone who has attempted to “digitize” more traditional industries knows how much harder it is to sell software into this market. Why? Because buyers in this category are more accustomed to purchasing professional services or consulting. With AI, entirely new markets and budget pools are up for grabs.

If you can genuinely build a product that delivers the outcome for a customer, such as EvenUp in personal injury law and Revv auto repair. In that case, you are proving immediate ROI and going after a much larger pool of spend in services versus software. Bonus points if that function is traditionally undesirable and low margin (high margin for you, of course). In addition to selling more money, startups can also sell happiness to buyers by allowing those companies to focus on their most pleasurable, high-margin job functions. For many more traditional industries where the owner of the business is also the buyer, we have found that this ability to sell happiness is extremely important.

Our Thesis

We believe that vertical software companies that succeed today will have the following attribute:

Show me the money — Can you do something that helps me drive meaningful top-line or profit?

There are several ways that we’ve seen this executed (non-exhaustive):

• Deliver work product outcomes faster and with better margins— EvenUp, Revv, Dirac, xBuild
• Help fix operational bottlenecks that are limiting top-line growth — Playground, Pallet, Seso Labor
• Offer multi-product day one to collapse existing software spend — Playground, PushPress
• Help reduce risk of any catastrophic costs (mostly compliance) — K-ID, 1breadcrumb, MyPass, Compass Regulatory, Minerva.ai

Our framework for evaluating investments in this space is relatively simple to understand but non-trivial to execute on. To assess whether or not vertical software startups are achieving any of the above, it is important to understand the complete workflow and value chain. Additionally, you must also understand the components that drive the P&L of the end buyer. How does the end buyer define success and generate enterprise value? Internally, we joke that after each diligence process, it should feel like you could work in that particular industry.