The State of Vertical SaaS (2021) — Fractal Software

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Top Highlights

• SaaS startups are increasingly achieving multi-billion dollar valuations by building software tailored to the needs of specific industries, rather than specific business functions. The recent IPOs of vertical SaaS companies like Blend, Procore, and Toast are proof of the massive upside for companies building industry-specific software.

• The reason vertical SaaS markets seem small is because they are typically measured by the size of the existing base of installed software. But this ignores the many opportunities for vertical SaaS companies to expand their addressable markets. They can increase ACVs by raising prices, upselling with new features, integrating or partnering with fintech providers, or embedding commerce solutions. By targeting a specific vertical, they can also capture substantial market share that serves as a launchpad for expanding internationally or into new verticals.

• The rapid growth of vertical SaaS in public and private markets reflects a secular trend toward the digitization of all industries.

• Even though these businesses may recognize the value of using vertical-specific software for their workflows, there are no high quality software products built for their industry. This points to an inescapable conclusion: vertical SaaS is poised to be the next big thing in cloud software.

• The number of vertical SaaS companies in the index has grown by 28% since the beginning of 2020 alone.

• Procore is an important bellwether for vertical SaaS because it is a company that defies conventional wisdom about what makes a software business successful. Construction is a $1 trillion industry, but its software spend represents less than a hundredth of the industry revenue. It is also one of the most analog sectors imaginable. According to McKinsey’s industry digitization index, construction is the second least digitized industry across all major sectors. To sell a SaaS product into the construction industry wasn’t simply a matter of getting contractors to change their software provider; it meant fundamentally changing the way the industry conducted its business.

• Procore is growing at a fast clip (38% over the past year) and has maintained high gross margins (82%).

• Procore’s more SaaS-specific metrics look great, too. According to the S-1, the company has just over 10,100 customers with an average contract value of $43,000. It’s product is also very sticky. Procore reports a gross retention rate between 94 and 95% over the past three years. Its net retention rate also speaks to the lucrative upsell opportunities available to the company: Over the past three years, Procore has an average net retention of 115%. Despite the company’s relatively steep 29-month gross margin adjusted CAC payback period,

• During the early days of the pandemic, Toast was forced to cut half of its workforce due to restaurant sales falling by more than 80% in many cities. It’s platform was primarily built to combine restaurant point-of-sale systems with back office workflows like inventory management. But  in response to shifting dining dynamics driven by global pandemic, Toast rapidly adjusted its software platform to meet the evolving needs of restaurants. It prioritized features that made online and contactless ordering simpler. Toast  had prioritized fintech integrations early on, which enabled the company to rapidly increase revenue by taking a cut of online orders after reconfiguring its product to meet the needs of restaurants battered by Covid. The results are striking: In the second quarter of this year, Toast nearly tripled its revenue over the same period last year to $424.7 million.

• By digitizing previously analog workflows, expanding into adjacent verticals, and integrating fintech applications onto an industry-specific workflow platform, vertical SaaS companies can expand their addressable markets by orders of magnitude compared to estimates based on current industry software spend.

• Investors are taking note. On the heels of its Aspire acquisition, ServiceTitan announced a $200 million Series G round at a $9.5 billion valuation. The funding came just three months after the company raised $500 million at an $8.3 billion valuation in a round led by Sequoia’s Global Equities Fund and Tiger Global Management. KeepTrucking, a software provider for trucking companies, joined ServiceTitan in the ranks of unicorn vertical SaaS companies this year with a $190 million Series E round that valued the company at $2 billion. A substantial amount of VC dollars flowed into early- and mid-stage vertical SaaS companies this year, too. Qualia, a real estate software provider founded by Fractal co-founder Nate Baker, raised a $65 million Series D that officially tipped the company into unicorn territory. Squire, a software platform for barbershops, raised a $59 million Series C just months after closing a $34 million Series B. On the earlier side of the fundraising spectrum, Cents, a laundromat SaaS provider, hauled in an eyebrow-raising $9.3 million during its seed round.