In the old days of enterprise software, common wisdom had it that only companies that reached $1 million in annual revenues per customer could grow into large companies. As a result, enterprise software focused on the largest corporates while mid-sized businesses fell by the wayside.
The emergence of the cloud and inside sales has changed all that. The cloud allowed software to be delivered cheaply, and inside sales enabled the marketing of this software efficiently. That gave rise to a host of companies that cater to mid-sized businesses and leave the enterprise and SMB segments to others. HubSpot, who has built an empire around its marketing and customer relationship software for mid-sized businesses, is one of the most notable examples of this trend.
The first time I met a mid-market SaaS company was in 2015. Samanage, the IT service desk software that was later acquired by SolarWinds, introduced me to the notion that you can build a moat around your enterprise software business by differentiating based on customer size.
Since then, I’ve had the privilege of observing from up close several mid-market focused companies: Israel Growth Partners (IGP) portfolio companies DealHub, Dot Compliance, Hibob and SysAid, my former portfolio company Guesty, and a few others I considered for investment over the last few years. Here are a few insights I thought worth sharing on how to successfully navigate the mid-market terrain.
For simplicity, SaaS companies that focus on the mid-market segment are referred to here as mid-market companies, and their customers are mid-sized businesses. Similarly, enterprise-focused SaaS companies are referred to as enterprise players, while SMB-focused SaaS companies are referred to as SMB players.
What makes the mid-market attractive?
The beauty of the mid-market is that it combines the best of enterprise and SMB. The mid-market supports inside sales, shorter sales cycles and lower customer acquisition costs (CAC). Mid-market companies get to build a high-velocity sales machine from day one and take the edge off issues like choppiness and customer concentration that characterize enterprise players. The inherent predictability of this model is one of the main reasons I like it so much as no single customer can make or break the company.
In contrast to SMB players, mid-market companies benefit from inherently stable and fast-growing customers and can expect churn and net revenue retention (NRR) rates that admirably rival those of enterprise players (discussed below).
Furthermore, software markets tend to leave the mid-market underserved. Enterprises tend to buy dedicated, broad solutions, while SMBs generally settle for narrow point solutions. Mid-sized businesses are left choosing between an unsuitable enterprise solution or combining several point solutions or no solution at all. All this means that mid-market companies can unlock a large greenfield opportunity or trigger a rip-and-replace cycle in a large market segment that is ripe for disruption. DealHub, the quote-to-cash platform for sales teams at mid-sized businesses, began by selling to spreadsheet users and expanded over time to replace heavy enterprise deployments as well.
As to the addressable universe, what the mid-market lacks in annual contract values (ACV), it compensates for in the number of businesses. The total addressable market (TAM) of the mid-market can therefore rival — and in some cases eclipse — that of the enterprise segment.
Market: mid-market is about behavior and then size
The first question that arises is how best to define the mid-market. This is not just a matter of sizing but rather of identifying the fault lines where businesses exhibit different behaviors. In some markets, there may not be a distinct mid-market segment at all, even if there is an active mid-sized customer base.
It’s fairly common for startups to begin sales with smaller customers and work their way up to larger ones. Selling to mid-sized businesses doesn’t make a startup a mid-market player. There’s a simple rule here: if your vision is to sell $1 million ACVs, you’re not a pure-play mid-market player. I once met a company that said it was focused on the mid-market but derived a meaningful part of its revenues from a single large enterprise customer. That made me question the assertions that there was a distinct mid-market segment in that market and that the company was truly committed to that segment.
In addition, the defining metrics can greatly vary across products and markets. At SysAid, the IT service management (ITSM) solution for mid-sized businesses, the leading indicator is the number of IT administrators. However, such metrics aren’t easily observable from the outside.
The mid-market can be defined as businesses with 50 to 5,000 employees. That can be further segmented into core mid-market (50–500) and upper mid-market (500–5,000). While there are markets with higher or lower floors and ceilings, this is the range addressed overall by the companies I worked with. This range is wide because the characteristics vary significantly across industries (e.g. tech vs. manufacturing), so it’s difficult to come up with blanket headcount numbers.
Businesses in the mid-market share similar needs and can be reasonably supported by the same product platform and sales motion. Some adjustments might be required when addressing the upper mid-market (discussed below), but the core should ultimately remain the same.
The mid-market is sometimes confused with the SMB segment which is known for its infinite universe of businesses and perennial churn issues. Yet it’s far from that small fry bunch. According to the US Census Bureau, in 2020 there were 378,000 mid-sized firms in the US with 50–4,999 employees, of which 92,000 were upper mid-market firms with 500–4,999 employees. In comparison, there were 5.9 million SMBs with less than 50 employees and 47,000 enterprises with more than 5,000 employees.
SMBs (firms with less than 50 employees or small teams within larger businesses) are better addressed by SMB players with self-serve or product-led growth (PLG) motions. Otherwise, the balance between CAC and churn will not be sustainable.
Product: mid-market is about value proposition and then cost
Mid-market offering is not just about high functionality at a lower cost than enterprise offerings. While total cost of ownership (TCO) is important, that’s not the top item. First and foremost, mid-market solutions are about simplicity and friendliness to businesses that have limited technical teams. When building a product, it’s far more difficult to simplify it than to make it complex. Product simplicity is therefore the cornerstone of building a moat based on size.
The magic word is ease: ease-of-deployment and ease-of-use. The mid-market looks for products that are fast to deploy and require little internal resources to maintain. Mid-sized businesses are willing to pay more than you might think, and startups should price their solutions accordingly. However, they won’t accept additional headcount, consuming too much of their staff’s time or long deployment cycles.
Deployment, in particular, has been the ruin of many IT projects at mid-sized businesses that couldn’t muster the headcount and time to successfully see it through. Dot Compliance, the quality management and compliance platform for mid-sized life sciences companies, has gained market share by offering an off-the-shelf solution in a category that has long required lengthy specification and implementation projects.
Mid-market companies have long heralded the consumerization of IT. Superb UI/UX, intuitive workflows and avoiding overspec-ing aren’t just the virtues of a mid-market product, but the product itself. Overspec-ing, specifically, could give the product too much of an enterprise flavor, making it too complex and increasing its cost.
Some upper mid-market businesses may require additional capabilities as a condition of signing the contract. They may be great design partners for taking the product to the next level or for developing advanced modules for upsell. However, if it distracts them from their core strategy and roadmap, startups should decline the opportunity. In any case, the core product should remain the same and enhancements shouldn’t amount to a separate product platform. I once saw a company that had split its product into two platforms, and the loss of focus brought it to the brink of collapse.
The road to $100 million ARR and beyond
At early stages, the road to $100 million in annual recurring revenues (ARR) as a mid-market player seems simple: just land more mid-sized businesses and you’re there. Soon enough, startups realize it’s almost impossible to reach that goal without pushing toward larger customers and increasing the ACV.
Once a startup has reached mid-single digit million ARR, it’s time to tap the upper mid-market to land 6-figure ACVs repeatably. At this point, the product is mature enough to meet the needs of the upper mid-market. In fact, the customer base will likely already count a few such customers that landed at a smaller scale and expanded over time.
When approaching double-digit million ARR, startups may want to split their sales organization into core and upper mid-market teams to account for different sales cycles, customer requirements and seniority of decision makers. Similar to the product, the core inside sales motion should remain the same, and startups shouldn’t be tempted into high-touch sales despite the allure of higher ACVs.
At some point, the smaller customers whom startups began their journey with seem too small. They make up a large share of the logos and a small share of the revenues, and their unit economics are unattractive. The decision to set a minimum bar and stop serving this crowd sometimes proves challenging. Some mid-market companies want to continue locking in customers while they’re still small and be able to grow with them, while others worry about competition appearing from below. However, a line must be drawn. One way to make the decision easier is to set the bar lower for venture/PE-backed customers who are likely to grow and higher for privately-owned ones who are slower to grow.
Mid-market companies also drive higher ACVs by adding more products and building a suite around their core product. In mid-market settings, best-of-suite isn’t a dirty word and isn’t necessarily at odds with best-of-breed. Mid-sized businesses are unlikely to require the full feature set of an enterprise solution, and they can greatly benefit from an integrated suite where all components communicate seamlessly. Startups shouldn’t limit themselves to in-house development and should also explore M&A opportunities. Guesty, the property management system (PMS) for alternative accommodations, has managed to command premium prices by building a unified platform to consolidate the solutions property managers need. It later acquired several companies to round out its offering.
Mid-market companies that are able to price their solution based on the overall headcount of their customers naturally expand faster than their peers. While such pricing is not feasible for most companies, the product strategy should aim to expand the user base within the organization. Hibob, the HR platform for mid-sized businesses, is priced on a per employee basis. The primary customer is the HR department, and HR-related modules are also offered for the finance department.
Mid-market SaaS metrics: rivaling the enterprise
SaaS companies are willing to go to lengths to win enterprise customers not only for their sizeable contracts but also for the financial stability, stickiness and inclination to expand with their vendors. The beauty of the mid-market is that while the cost of acquiring mid-sized customers is not as steep, they prove to be no less stable, sticky and disposed to expansion than enterprises. The table below shows SaaS benchmark metrics for mid-market companies.
In the current macroeconomic environment, churn and NRR are top of mind and are worth discussing in mid-market context.
Churn. With a multiyear median annual churn rate of 12% (including downsell) and a few companies that recorded best-in-class rates of 4 — 6%, the mid-market demonstrates great stability and stickiness comparable to that of enterprises. Mid-sized businesses might still involuntarily churn if they’re acquired or go bankrupt. In the former case, the acquiring company usually onboards the acquired company onto its existing IT infrastructure. At the early growth stages of mid-market companies, when the rule of small numbers still applies, it’s helpful to distinguish between “voluntary” and “involuntary” churn to estimate what the overall churn rate might be at scale.
NRR. Mid-sized businesses experience the fastest growth in headcount in the economy. According to the National Center for the Middle Market, headcount at mid-sized businesses in the US grew by 11% in 2022, compared to 5% for enterprises and 2% for SMBs. This represents a great opportunity for mid-market companies to expand organically with their customer base. The multiyear median annual NRR rate is 108%, with a few companies posting best-in-class rates of 130–140%. Today’s challenging environment underscores how resilient the mid-market is: while the median NRR rate for 2022 has dropped to 100%, churn has budged only slightly. Mid-sized businesses are adjusting their spending but staying true to their IT solutions. This gives hope that expansion will recover once we get past the current cycle.
The future of mid-market SaaS
Building enterprise software companies will change as we move away from a prolonged period of zero interest rates. Mid-market SaaS solutions have a vital role to play in the future of enterprise software. In many markets, the mid-market segment remains underserved and offers a high growth opportunity where enterprise growth may have slowed.
Founders of mid-market SaaS companies and VCs with such portfolio companies — if you’re seeking capital or have questions about this piece, please feel free to contact me at yoni@igpcapital.com.
