Our SMB Software Market Thesis
Since 2009, I have immersed myself in the SMB SaaS world, either as CFO for companies like Shopify and FreshBooks or as a VC investing in companies like SweetIQ, Unbounce, Thinknear and others. Over that time, I have developed a real passion for the SMB software space.
We have made SMB software a core focus for us at SurePath Capital Partners. In fact, we have set a simple, yet lofty goal for our firm: To be the leading boutique investment bank in the SMB software space globally.
In this post, I’d like to summarize our thinking on SMB and why we are so bullish about this market.
Our thesis for SMB software
The SMB market is already large and global, however, it is about to grow significantly due to changing demographics and a change in the nature of work.
Most categories of software for SMB have been around for a long time and will continue for a long time. Unlike consumer and enterprise tech markets, it is virtually impossible to dominate or monopolize the SMB market due its size and global nature.
Most small businesses fail. While they fail for many reasons, the biggest issue SMBs face is finding customers and growing. Technology is playing an ever-increasing role in not only providing features and functionality, but actually delivering new revenue to SMBs.
Small business owners have no time. Despite the advances in technology, this won’t change soon. This has implications for product design.
From a funding perspective, SMB is a challenging market for early stage VC but a great market for growth stage/ private equity capital.
There is no one dominant consolidator SMB. An opportunity exists to create one or more comprehensive systems of record for the SMB space.
Let’s unpack these points:
A large market
According to Intuit, there are 30 million SMBs in the US alone, 60 million in the English-speaking countries and somewhere between 460 and 600 million globally. By any measure these are large markets, offering consumer-like scale but with direct monetization.
Growth drivers
i.) A change in the nature of work: It is increasingly rare for people to graduate from college and join a large, “safe” company to work their way through the ranks. Today’s graduate wants meaning, flexibility and autonomy. This is leading many people to choose to work for themselves either full time or part time. The “side hustle” is alive and well.There were 15 million self-employed people in the US alone in 2015. This number will keep growing.
ii.) Changing demographics: According to Neal Polacheck, former CEO of the Kelsey Group, every day in the US 10,000 people turn sixty five. If you fast forward this trend, by 2025, 3/4 of US small businesses will be run by millennials. This has massive implications for the adoption of technology by SMBs.
Older business owners are perfectly happy running their business on pen and paper or MS Word and Excel. But these younger entrepreneurs are not. Whatever technology need they have, be it front office or back office, they will look on their smart phones first, and if they don’t find something there they will search on their desktop browser, find something and try it.
We believe this change in demographics will drive massive expansion across almost every technology category over time.
Evergreen Markets
According to the Kaufmann Foundation, over 500K new small businesses are started every month. Many of these new businesses will have similar needs, be it a domain, website, email platform, accounting software, CRM, etc, etc. As a result, these product categories see continuous incremental growth.
No Monopolies
Consumer and enterprise markets are often ‘winner takes all’ or ‘winner takes most’ affairs. There is a massive difference between the top and the 10th player in any market segment. In contrast, the SMB market is too large and fragmented for any one vendor to build a dominant share.
Let’s look at accounting software as just one example: Intuit has been around for three decades. Approximately 7 million businesses keep their books on Intuit software. With 30 million businesses in the US alone, Intuit is the clear leader in the US, but there are more businesses that don’t use Intuit than those that do.
You see this in every product category. As a result, there is always room for a new entrant with a fresh take on an old solution. Similarly, there is always room for established players to buy younger companies to expand product or market share.
Reducing failure (and churn) by actually helping SMBs grow
No matter how great your software is, if the small business you serve shuts down, then you have lost a customer. This, of course, happens all the time and is the single biggest source of churn in the SMB SaaS world.
SaaS products that just save a business owner time tend to not do well. They’re like vitamins. I can live without them. SaaS products that actually help me grow my business are pain killers. I can’t live without them.
Whether it’s pure play SaaS companies like Shopify offering an ecosystem of tools, partners and channels for new revenue or marketplaces such as Homeadvisor, Opencare, etc that directly drive revenue for their customers, small business owners have a reasonable (and growing) expectation that technology can truly help their business grow and succeed.
Designing user experiences for the entrepreneur with no time
Despite the advances in technology, business owners have no time. Any spare time they create, they want to spend advancing their craft, serving customers and designing product, not mastering new technology.
Software that requires high engagement from a business owner will fail. The software may solve genuine issues for that owner, but she will never invest the time in the software to realize that.
We see two extremes of user experience design that will succeed given this time-constrained reality:
- Automation: With machine learning and artificial intelligence getting more and more powerful, one solution is to build single purpose apps that just work. As a business owner I don’t need to engage. Your black box does what I need. Period. Today, automation and machine learning are still in an early state, with error rates that we would never tolerate in humans. But it’s clear that we are headed towards an increasingly automated future.
- Do it for me (software and services): If your software is too complex to be automated, then complement your software with services that you either provide directly or that partners provide. Shopify and Squarespace are just two examples of companies with robust ecosystems around them so that customers can get the support they need to succeed with their software.
One really interesting middle step between automation and do it for me is chat. We believe that this will become an important interface for SMBs and their customers.
Growth Capital is a perfect fit for SMB
Early stage VCs have mixed feelings with SMB. On the one hand, they love that these smaller customers are easier to acquire. However, they struggle with churn rates and growth rates.
It’s rare to find SMB focused companies growing 2x or 3x per year. This actually ties back to the evergreen, long term nature of most SMB software categories. Disruptive, viral products experience rapid growth. While it is possible to create viral products in SMB (Surveymonkey, Mailchimp, etc.), it is rare to see something that is truly disruptive.
This lack of disruptability leading to durable, long-term market opportunities is a perfect hunting ground for PE investors who are not looking for hyper growth, but want relatively certain ‘good’ growth. A PE investor can come invest in this space with the ability to grow a typical company 20–40% per year, more or less in perpetuity.
On top of that, the fragmented nature of most SMB markets means that in addition to sustained organic growth there is usually the potential to use acquisitions to drive more growth.
A long tail of buyers with no dominant consolidator (yet…)
Finally, on exits: to date, there has not been one dominant buyer of SMB companies like you see in enterprise with companies like IBM, Salesforce and Oracle. You see this sometimes in vertical roll ups (such as Endurance International rolling up 80 domain name companies), but there is no dominant cross category buyer.
Given the fit with PE, we think that financial buyers will be very active in this space. We have already seen firms like Providence Equity get busy.
On the strategic buyer front, we think there is an opportunity for someone to build/ buy the authoritative ‘system of record’ for SMBs where their universe of customer relationships is captured, nurtured and managed in one place. Younger entrepreneurs will likely want an end-to-end technology solution like this. The company that steps up to deliver that solution might become a very active buyer over time.
I’d like to thank Mike McDerment from FreshBooks for providing some of the foundational thinking for this during my time there.
