The global SaaS market is measured to be $250 billion annually and still growing rapidly, as much as 20% per year according to some analyst estimates. Within the SaaS market, there is an increased focus on vertical SaaS – industry-specific or niche-focused functionality that follows the SaaS playbook. Remarkably, there are now nine public Vertical SaaS companies reporting more than $1 billion in revenue. These companies have captured tremendous opportunities by digitizing long-overdue analog industries or sleepy business processes. 

For entrepreneurs and investors, vertical SaaS companies have been a goldmine of market opportunity. The combination of SaaS-like high gross margins (80-90%), recurring revenue (often net dollar retention rates exceeding 100%), and more efficient sales and marketing costs (pursuing focused, target markets) has consistently generated outstanding success. Some vertical SaaS companies capture over 40% of market share as compared to leaders in horizontal SaaS markets that struggle to hit 20%, leading to better pricing power and more attractive unit economics. 

Vertical SaaS:  Size Matters

Over the years, the knock against vertical SaaS is that market sizes have been too small to justify venture capital investment. However, two concurrent trends have recently dispelled this issue. First, market sizes have proven larger than originally projected, driven by dramatically accelerated technology adoption rates (see Crossing the Chasm Is Due for a Refresh). Given how impactful technology has been in creating competitive advantage in hotly contested markets, no company can afford to be a laggard. Second, vertical SaaS companies have successfully expanded their Total Available Market (TAM) by upselling additional products to their existing customer base.

The playbook for vertical SaaS is thus now well-understood: as a first act, establish a foothold in a niche with a tightly focused product distributed through classic early-stage go-to-market (GTM) techniques:  find a few “lighthouse customers”, shape the product to meet their requirements, smother them with resources to help make them successful, and then use them as positive customer references in the market to attract others like them. Once a startup has integrated itself within an enterprise and its workflows and proven their indispensability, these companies can then proceed to extend their product portfolio to the same customers, typically offering follow-on products as well as some sort of fintech product. Eventually, vertical SaaS companies transcend point products and become true platforms and systems of record.

Vertical SaaS + Fintech Case Study: Toast

This strategy is commonly known as “SaaS + fintech” and a particular pioneer for this playbook was Boston-based Toast (NYSE: TOST), which has ridden this playbook to an $13 billion market cap. The company’s initial offering established a foothold through its point-of-sale order management software for restaurants – an approach many dismissed as too small a niche (including this foolish VC! 😜). As the company rapidly succeeded with this wedge product, the potential for more than just a single offering became clear.

As articulated by Bessemer partner Kent Bennett, who wrote in his Series A investment memo, “There are countless ways they can expand the product offering over time.” That forecast has proven prescient. The company has added to its “Lego stack” or “layer cake” of offerings with numerous fintech products such as payment processing and lending or credit (see figure below) – fueling a flywheel where both elements of their business model are proving to be accretive. In their Q1 2023 earnings release, Toast reported that of their $174M in gross profit, $71M came from their SaaS offerings while $150M came from their financial technology solutions (the company took a loss in hardware and professional services, making up the difference).

Flipping the Model:  Fintech + Vertical SaaS

However, the classic Vertical SaaS + fintech playbook can be expensive to execute. Building an enterprise-ready SaaS product and creating an effective GTM motion – even in the age of product-led growth (PLG) – takes time and capital. This approach faces increasing challenges as markets and channels become cluttered, resulting in a more complex and expensive GTM – all at a time when the cost of capital has risen dramatically.

Further, the Vertical SaaS + fintech playbook was developed before the Age of AI. When the value of SaaS platforms was solely focused on workflow and business process optimization, the data collected was only marginally valuable. Today, the Age of AI means that AI is redefining vertical software. As my Flybridge colleague Daniel Porras Reyes writes, Vertical SaaS is becoming AI native, creating a powerful data moat as industry-specific systems and databases provide a powerful training set for machine learning models. The faster a company can acquire and leverage this proprietary data set, the better the models – and ultimate scale of the customer value proposition – will be.

Flybridge has thus developed an investment thesis that is an innovative approach to vertical SaaS. We seek companies that are flipping the standard playbook and starting with fintech as the first product offering and then develop the second or third act as a vertical SaaS platform. In other words, Fintech + Vertical SaaS instead of Vertical SaaS + Fintech. 

Determining the sequence of products or services offered to your customers should be primarily guided by their specific needs, with a particular focus on addressing their greatest pain or “must-have” requirements. For instance, consider businesses that have a high demand for working capital. The optimal strategy to attract these customers might be to initially address their working capital challenges with a direct offering (“must-have”) rather than proposing front or back-office software solutions to improve their business processes (“nice to have”). By taking this approach, customers don’t have to justify new software expenditures, budget allocation, or prioritize valuable IT resources – all of which slow down buying processes and increase customer acquisition costs (CAC). 

We believe companies can significantly diminish adoption barriers with a financial product as a “first act” and then later offer a SaaS product that gets embedded into their environment. By turning the classic vertical SaaS playbook on its head, startups can drive adoption up and CAC down, essentially using their fintech offering as a way to subsidize the CAC for their downstream SaaS products instead of the other way around. Further, a fintech-first approach eases the conversation with cost-conscious CFOs, who tend to be a major obstacle in enterprise sales.

Case Study:  ZestAI

ZestAI is a technology company that uses AI software to automate and make credit underwriting more accurate. Flybridge was a seed investor in the LA-based startup and bought into a “flipped playbook” as part of the company’s vision: begin by lending capital to consumers off our balance sheet, collect data to train and fine-tune the credit models, and then spin out our own platform as a vertical SaaS offering that provides sophisticated, AI-driven underwriting for financial services firms.

The execution of this strategy has proven to take longer than we thought as we were early on the machine learning (ML) tools side (the company was founded in 2009!) and it took us time to pivot the organization and platform from B2C (directly lending to consumers) to B2B (selling an ML-based underwriting platform to financial services customers) as we ramped up an enterprise GTM organization from scratch. Operating in a heavily regulated environment didn’t help. Nonetheless, the company has seen tremendous success, doubled its customer base in 2022 after tripling it in 2021, and recently closed a $50 million growth financing (a rarity in late 2022).

Case Study:  Finkargo

Another example of our flipped model thesis at work is our portfolio company Finkargo. The Colombia and Mexico-based startup has built a trade financing platform for international purchases serving small and medium-sized importers from Latin America. The company’s vision is to take advantage of the vacuum left by large banks in the region, using sophisticated underwriting technology based on import/export data to provide credit for SMBs, and then offer SaaS workflow software to connect importing SMBs with supply chain services and international suppliers, providing superior business intelligence and financial management.

For Finkargo, the sequencing of fintech + vertical SaaS was an attractive option given the industry and the market they are operating in. In LatAm, the credit crunch for SMBs is a massive opportunity as commercial banks are oligopolies with fat margins and little incentive to innovate or take risks. LatAm imports over $1 trillion annually, of which 40% is imported by SMBs (i.e., $400 billion). The company estimates that only 17% of these SMBs can access working capital. The credit crunch is even more acute with the growth in international transactions. Many companies in this category and region are family-owned, still operating with “pen and paper” or rudimentary spreadsheets, and are generally apprehensive about adopting technology solutions. 

Imagine being an importer with a history of selling a product that has demand but cannot scale due to a lack of financing or cash flow mismatches. No front or back-office software value proposition is going to solve this pressing issue and jump to the top of your priority list. By offering importers new financing solutions, Finkargo has cracked the code on rapid adoption, resulting in a CAC payback of less than six months (unheard of in the world of SaaS), and building the foundation for a more comprehensive SaaS play.

Challenges to Fintech + Vertical SaaS 

There are, of course, challenges to this Fintech + Vertical SaaS strategy that entrepreneurs need to overcome. In our experience, there are five major ones, detailed below.

1. Fintech is capital-intensive and requires capital sophistication. Although perhaps less expensive from an equity capital standpoint (if GTM can indeed be made more efficient), a fintech’s financing needs are quite different from the traditional path of Vertical SaaS + Fintech as providing working capital (lending), transfers (remittance), payment functionality, or insurance – four common fintech offerings – inherently requires capital. Thus, successful entrepreneurs who pursue this strategy need to be skilled at raising money from alternative capital sources at a low cost. Finkargo’s founder, Santiago Molina, is a sophisticated fintech founder who knew how to access low-cost capital and rapidly worked his way further down the cost curve as the data proved out the loan quality.
2. Building a fintech vs. SaaS culture and team. The operational and strategic differences in building a fintech vs. a SaaS startup are significant. Starting with a fintech-focused team requires a staff who understands and can operate in highly secure and complex regulatory environments. Sometimes it can feel as if fintech founders and SaaS founders and joiners (i.e., the early employees who join a startup) speak a different language. Fintech execs often come from traditional financial services industries (where suits, stare at balance sheets, and pay attention to the market and interest rate swings) while SaaS execs are trained in Lean Startup principles (and wear shorts, stare at no-code platforms to assist them with prototyping, and pay attention to the latest release of ChatGPT). The successful entrepreneur will find a way to merge these two cultures and skills into a single team with a shared mission. The two founders of ZestAI were ex-Google and CapitalOne. Merging these two cultures was not easy.
3. Prioritizing investments in software development. Fintech companies typically are more focused on the cost of capital as well as business process and financial systems integration rather than building great software products. Software investments in client-facing interfaces and building superior UI/UX capabilities will often get deprioritized. For a “flipped playbook” startup to achieve success, a long-term view on software development investments must be balanced with a shorter-term prioritization of fintech functionality, such as the flow of funds.
4. Fintech retention is harder, so don’t dawdle. When a startup chooses the Fintech + Vertical SaaS path, it is imperative to focus on a niche target industry, precisely define the Ideal Customer Profile (ICP), and deeply understand their pain points and requirements. As A16z put it: “While financial services can add a lot of value for customers, ultimately, a vertical SaaS company acquires and retains its customers because of its differentiated software, not the financial services it offers.” Thus, although an initial focus on a fintech offering is a shrewd go-to-market technique, it must be rapidly followed up with SaaS, even if the initial capabilities are rudimentary and unpolished. Finkargo’s initial SaaS functionality was basic and focused. Over time, it has become more robust and better designed as the company understands the supply chain workflows and use cases better by working directly with companies.
5. Raising money initially as a fintech. Another hurdle for a founder could be articulating their vision and securing funding when using fintech as the initial strategic focus. Investors value fintech revenue less highly than SaaS revenue for all the obvious reasons (non-recurring, lower gross margins, fewer economies of scale). Thus, public fintech comparables typically are valued at lower revenue multiples (2-4x) compared to SaaS revenue multiples (8-10x). As a result, founders need to be excellent fundraisers – painting a compelling and achievable SaaS vision. The goal is to persuade investors that, despite fintech being the primary short-term revenue source, the long-term business model envisages a significant portion of the revenue and margins eventually coming from SaaS.

For entrepreneurs who can master these challenges, we are enthusiastic about the opportunities that the flipped strategy Fintech + Vertical SaaS can bring. 

Let us know if you are a founder taking this approach. We would love to hear more about what you are building! 

Many thanks to Cristina Castellan Mello for her excellent contributions to this post.