The debate between the attractiveness of a horizontal software company v/s a vertical software company is long and never ending. Horizontal software companies – those that target business functions e.g. sales (CRM), HRMS, finance etc. – have large TAMs, the ability to better withstand downcycles, and the potential to create platforms. Vertical software companies – those that are targeting a particular industry e.g. salons, construction, restaurants etc. – have better capital efficiency, disproportionate market share on achieving market leadership, and relatively higher customer stickiness. On the flip side, they are more susceptible to industry level risks, and have a relatively capped upside.

Irrespective of one’s preferences, what cannot be disputed is that a vertical focus has led to the creation of some exceptional businesses, across verticals and time periods. Driven by companies such as AppFolio (real estate), ProCore (construction), Toast (restaurants) and more, the market cap of vertical SaaS companies grew – by one estimate – from 50B to 600B between 2010 and 2020; while the market capitalization of these businesses corrected significantly from 2021, the underlying revenue – a more reliable metric to gauge business strength – of listed vertical SaaS companies doubled between 2020 and 2022.

At Stellaris, we love software businesses of all types, and continue to be long on vertical SaaS. In this post, we will capture our views on what it takes to create market leading vertical SaaS companies focused on SMBs – enterprises also present attractive opportunities for vertical software, but that is a topic for another post – and why AI will be a tailwind for this category for the foreseeable future.

Building for SMBs has differences to building for enterprises. From a product perspective, SMBs generally prefer all-in-one, whereas enterprises look for best-of-breed. Enterprises also have significantly more requirements that are in the nature of administrative / compliance e.g. very sophisticated access controls, security and so on. GTM is also significantly different for the two categories. SMBs have shorter and simpler sales cycles which can often be done remotely; enterprises, on the other hand, have complex sales cycles involving multiple decision makers, and almost always need feet on street.

We have observed a few patterns in the evolution of successful vertical SaaS companies targeting SMBs.

  • They start by solving a specific and meaningful pain point better than any other alternative.
  • With scale, they graduate in one or more of the following directions from a product perspective (a) adding more software features for the same customer, essentially becoming an all-in-one offering (b) adding non-software features for the same customer type. These are most commonly fintech e.g. payments. Other examples include marketplaces to help with procurement. It is not uncommon for companies to continue to ship one major addition to their product line each year, even with significant scale.
  • From a GTM perspective, companies either move upmarket in the same vertical, or expand into adjacent verticals.
  • At scale, market leaders can command ~1-1.5% of a customer’s topline as their share of wallet, and north of 10% as market share.

While looking at such businesses, some of the things we look for are

  • Underserved markets with at least 1B in software revenue in the North American market. Markets can be underserved for a variety of reasons (a) historically underserved at an industry level (b) new industries emerging and categories being created (c) technology shifts drive a need for new software e.g. the switch to mobile for field workers.
  • One clear leader to dislodge. The market has a single dominant vendor, of the legacy variety, with a slam dunk right to win for the upstart against that incumbent.
  • Starting wedge in a core workflow e.g. appointment booking for a local service business. We emphasize core, since that allows for more defensibility. With AI’s capabilities maturing, we expect companies to increasingly have AI-driven wedges at the start. Since AI’s robustness increases with narrow problems, the ability to add value in core, vertical specific workflows is very different to what it used to be earlier. As an example, consider the appointment booking for local service businesses use case, where several high quality AI-first companies have emerged. A decade ago, the state of the art solution would most likely be a static decision-tree implemented via IVR. Today, with advances in NLP and speech to text, software can get very close to mimicking a human receptionist.
  • For companies where the wedge is being driven by AI from the get go, we look for ways in which you can access relevant data from customers – critical for constantly improving your original model(s) – over time.
  • Natural pathway to be in the customer’s flow of money e.g. payroll processing solutions. This allows for seamlessly adding lines of business over time.
  • Sufficient headroom to grow without moving across verticals. Changing verticals usually requires inorganic growth, which is very hard to manage well and inevitably leads to reduced capital efficiency and subdued growth.
  • Last, but definitely not the least, a large part of our investment thesis is the team, and this is what we look for.

In summary, as SMB software adoption increases and AI goes mainstream, a vertical focused approach to building software will continue to create defining global companies. If you are building in this space, or just want to swap notes, please write to me at