What it takes for a vertical SaaS company to win in the AI age, according to Tidemark’s David Yuan

July 31, 2024

I’ll be real with you: I find the idea of software for incredibly specific niches really compelling. We’re talking software for swimming pools, nail salons, dental offices, restaurants, and construction.

And I think what I like about these vertical SaaS businesses is that they’re tactile, directly related to very specific problems that mom-and-pop businesses often have. It’s a small business view on enterprise software. Of course, there’s a caveat: These niche software businesses can also have a reputation for underperformance or outright failure, kneecapped by limited market sizes, intense competition, and high customer acquisition costs.

But David Yuan, founder and partner at growth equity firm Tidemark, is trying to systematize the playbook for enterprise software companies serving these supposedly too small markets. Tidemark today released its first-ever Vertical & SMB SaaS Benchmark Report. One of the key ideas is this: Vertical SaaS companies need to become dominant “control points” in their markets. (Control point is a term that Tidemark has coined, referring to a customer or business’s most important system.)

“If you own these control points, you can naturally cross-sell multiple products,” said Yuan, who previously spent 15 years at TCV as a general partner before founding Tidemark in 2021. “That improves your life, churn, total addressable market, and then ultimately your customer acquisition cost payback.”

The end game for a vertical SaaS company is to deeply penetrate a specific market, allowing them to then sell not just to core customers, but also their suppliers, consumers, and other stakeholders in that market, Yuan says. And though it’s a rarefied company that’s made it to this promised land, Yuan’s point is that it is possible.

“There are probably five to ten of these companies in vertical SaaS, who’ve gotten to that level of dominance,” said Yuan. “Those businesses are incredible because not only are you really deep in one market, but you actually extend to a lot of stakeholders, so you’re super hard to dislodge.”

Restaurant-focused Toast, life sciences-focused Veeva Systems, and construction-focused CCC all fit into this category, according to Yuan. But all of these winners, of course, were founded before the AI boom took hold, which has facilitated a reckoning within vertical SaaS as the narrative about how AI will affect the space is rapidly evolving.

In the earliest days of the AI boom, after OpenAI’s ChatGPT came out, “everyone was like ‘software’s dead,’” said Yuan, who I spoke with in Tidemark’s Menlo Park offices, in a conference room with a surfboard. (It was a Tidemark-branded shortboard, for anyone wondering.)

“People were saying that vertical software’s dead, because if you have an LLM, you can automatically create workflows, you can create the code, and you can mass customize software to address [swimming] pools, restaurants, and so on,” said Yuan.

That didn’t last long. Six months later “everyone was saying that vertical SaaS is incredible, because it’s not generalized language models, it’s generalized data that matters,” Yuan said. (In Tidemark’s report, of 246 respondents, 31% said they had an AI product already in the market.)

Now, fast-forward to today and yet another narrative has emerged: “We’re back to the idea that software is going to go away and AI itself isn’t going to replace software, but an AI-powered service provider is going to replace software,” said Yuan.

“I think there’s some truth to that, but in my opinion it’ll happen in very narrow circumstances,” Yuan added. “Because if you think about how work is done, very rarely is one task driven by a single set of people or single set of data.” It’s hard to find functions that are purely standalone, he says.

I see Yuan’s point: In my early 20s, I worked in a restaurant where the software needs were both overwhelming and under-met. Tracking orders could be a nightmare, tracking guests and their preferences was even worse. And don’t even get me started on inventory in the wine cellar.

And that’s the nice thing about vertical SaaS—we’ve all been to restaurants and dental offices, and can imagine those business owners need software. It’s not that there’s not a need for vertical SaaS it seems. It’s a matter of those businesses finding the dominance they need to survive.

See you tomorrow,

Allie Garfinkle
Twitter: @agarfinks
Email: alexandra.garfinkle@fortune.com
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Nina Ajemian curated the deals section of today’s newsletter.

VENTURE DEALS

- Flo Health, a London, U.K.-based ovulation and period tracking app, raised $200 million in Series C funding from General Atlantic.

- Gradient AI, a Boston, Mass.-based provider of AI solutions to the insurance industry, raised $56.1 million in Series C funding. Centana Growth Partners led the round and was joined by existing investors MassMutual Ventures, Sandbox Insurtech Ventures, and Forte Ventures.

- unspun, an Oakland, Calif.-based developer of 3D weaving technology, raised $32 million in Series B funding. DCVC led the round and was joined by Lowercarbon Capital, E12, Decathlon, and SOSV.

- Credo AI, a Palo, Alto, Calif.-based developer of AI governance software, raised $21 million in funding from CrimsoNox Capital, Mozilla Ventures, FPV Ventures, Sands Capital, and others..

- Haus, a Mountain View, Calif.-based marketing science platform, raised $20 million in funding. 01 Advisors led the round and was joined by Rahul Mehta, Gokul Rajaram, existing investor Insight Partners, and others.

- Lineaje, a Santa Clara, Calif.-based provider of supply chain security management software, raised $20 million in Series A funding. Prosperity7 Ventures, Neotribe, and Hitachi Ventures led the round and were joined by existing investor Tenable Ventures.

- MedScout, an Austin, Texas-based revenue acceleration platform for medtech and life science businesses, raised $15 million in Series A funding. Fulcrum Equity Partners led the round and was joined by Stage 2 Capital and LiveOak Ventures.

- Hyperbolic, a San Francisco-based provider of open-access AI computing and interference services, raised $7 million in seed funding. Polychain Capital and Lightspeed Faction led the round and were joined by Chapter One, LongHash, Bankless Ventures, Republic Digital, and others.

- FranShares, a Chicago, Ill.-based franchise investing platform, raised $4.1 million in seed funding. Chicago Ventures led the round and was joined by others.

- Mintify, a Uniondale, N.Y.-based NFT trading platform, raised $3.4 million in funding from ARCA, Cumberland, Psalion, Master Ventures, Zeneca, and others.

- Streamkap, a San Francisco, Calif.-based real-time data exchange, raised $3.3 million in seed and pre-seed funding. InReach Ventures led the round and was joined by TEN13, Haatch Ventures, Begin Capital, and angel investors.

- Not Diamond, a San Francisco-based model router maker, raised $2.3 million in funding. defy.vc led the round and was joined by others.

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PRIVATE EQUITY

- Invictus Growth Partners invested $25 million in Axiad, a Santa Clara, Calif.-based provider of identity-first authentication technology.

- Acieta, a portfolio company of Angeles Equity Partners, acquired Capital Industries, a Shelbyville, Ind.-based industrial robotics manufacturer and integrator. Financial terms were not disclosed.

- CORE Industrial Partners acquired a majority stake in Winky Lux, a New York City-based beauty brand. Financial terms were not disclosed.

- Epilog Partners led a majority recapitalization of Care Connectors Medical Group, a Newport Beach, Calif.-based care platform. Echo Health Ventures, HealthQuest Capital, and Blue Venture Fund also participated. Financial terms were not disclosed.

- Unity Partners acquired a majority stake in Katsam Property Services, a St. Louis, Mo.-based facility maintenance services company. Financial terms were not disclosed.

- Sennder, backed by Augusta and Cascade Investment Fund, agreed to acquire the European Surface Transportation operations of C.H. Robinson, a Eden Prairie, Minn.-based global logistics provider. Financial terms were not disclosed.

- SK Capital Partners agreed to acquire the North America Composites and Fuel Containment division of Parker Hannifin Corporation, a Cleveland, Ohio-based motion and control technology company. Financial terms were not disclosed.

- Studio Designer, backed by Serent Capital, acquired Mydoma, an Ottawa, Canada-based project management and design business platform for interior designers. Financial terms were not disclosed.

- Sunland Asphalt, a portfolio company of Huron Capital, acquired Georgia Paving, an Atlanta, Ga.-based asphalt maintenance and paving company. Financial terms were not disclosed.

EXITS

- Arctos Partners agreed to acquire a majority stake in Hayfin Capital Management, a London, England-based alternative asset management firm, from British Columbia Investment Management Corporation. Financial terms were not disclosed.

- SD Worx agreed to acquire F2A, a Milan, Italy-based provider of HR and payroll solutions, from Ardian. Financial terms were not disclosed.

FUNDS + FUNDS OF FUNDS

- Kennet, a London, England-based growth equity firm, raised €266 million ($287.6 million) for its sixth fund focused on B2B SaaS companies.

- Moxxie, a San Francisco-based venture capital fund, raised $95 million for its third fund focused on investing in AI, climate-tech, health care, future of work, and robotics companies.

PEOPLE

- Greycroft, a New York City-based venture capital firm, hired Brian Bustamante-Nicholson as a partner. Formerly, he was with Stripes Group.

- Hunter Point Capital, a New York City-based private equity firm, appointed SD Chu as managing director. Formerly, he was with Carlyle.

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A vertical SaaS playbook