Dave Yuan - A Primer on Vertical Market Software - [Invest Like the Best, EP.335]

Transcript from https://podmenti.com/t/5ca8dadfbb6f4dc9

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Hello and welcome, everyone. I'm Patrick O'Shaughnessy, and this is Invest Like the Best.
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My guest today is Dave Yuan.
Dave is the founder of Tidemar Capital, which he started in 2021 after 15 years as a general partner at Technology Crossover Ventures.
Dave has been investing in vertical market software as long as anyone I know, and he currently sits on the board of two VMS businesses, Toast and Carbon.
He is the perfect guest to deliver a primer on VMS, which is exactly what we do in this episode. Please enjoy my conversation with Dave Yuan.
So, Dave, since we last talked, I spent so much time really after reading so much of your thinking and work on the world of vertical market software.
Obviously, there's now a lot of people that have thought about this, investigated VMS businesses.
But I think you've been doing and thinking about this as long as anybody. And I'm really excited to make this a master class.
at this kind of company building, this kind of investing.
We'll stray beyond BMS alone, but you just have this wealth of knowledge that you very kindly
I've written up and shared with the world. Maybe you could begin by telling us
Why this topic
Or this style of business is so interesting to you in the first place.
I think part of this is 10, 15 years ago when we started investing in vertical software is very much a contrary and
perspective. And so there's a little bit of me that wants to provide a different perspective in the world.
As the world start to appreciate these businesses a bit more
I think what really has taken over is
Two things. One is
the business models that you can create in somebody's verticals. And we'll obviously unpack that into a lot of detail.
The first wave was really interesting how you go to multiproduct, but then
what we're starting to see is really businesses that
Span Piana.
single part of the value chain. That's just super interesting to me.
On a more personal level, you just see what these types of software companies can do for their clients. And so I remember during COVID.
And I was on the board of toast, and we were going through some challenges as restaurants were effectively shutting down.
And I went to our local downtown and there's a local
Takeria called Mama Coco, and it's an awesome story. Uh
The owner and the manager is taking recipes from his grandmother's recipe book.
It's a family business. They're out there building.
And can't leave they're really struggling, and a big part of what allowed them survive is
extending it to online delivery.
You see in good times and in bad times, what software can do for these owners. If you watch any commercial for a small business software or vertical software provider, it's always the owner.
On their cell phone on a beach.
I think it's a nod to the fact that running these businesses is pretty damn hard.
And
Allowing these owners to get out of the judgery and create some automation, create some space for their life.
Is this incredibly
Energizing value prop. And so a big part of why I continue to invest in vertical SaaS, why I continue to pull this apart.
Part of it's a analytical exercise, part of it's also I just love what these products do for their customers, and I love the role that small business plays in America.
It's kind of a stupidly simple question, but just define what VMS means to you, maybe along with like a basic taxonomy of the types of VMS, or are they all sort of of one flavor, just a level set on.
How you think about it so that we can then pick it apart.
Let's start from the ground level and you can push me forward or pull me back as much as you like.
Vertical software versus horizontal software. So it's software built for a specific end industry. Now that end industry can actually be
a pretty wide expanse of characteristics. So
I think most people conflate
S and B and vertical software together because most of the time
A and merchant tends to be a local merchant, a restaurant, a hotel, a retailer.
And I think that's generally true, but there also are larger verticals.
So I was on the board of a CCC that sold to auto insurance companies. Those are some of the largest companies.
In the US.
And so there is a wide expanse of S B to enterprise, but generally it's SMB.
I think in general
What we found
in SMB vertical SAS is there's usually one system that's more important than the others.
And maybe there's two. Maybe there's one at the front office where revenue comes in, and maybe there's one
at the back office which reconciles all the financials to pay bills and to file taxes. But generally there's
One system
People call it system record, system engagement. We call it control point'cause we want to capture
This idea of
Data gravity. It stores the most important data of workflow gravity. It's what you do to get things done. It's what you're engaged in with every day. And finally account gravity, which is
the simple, stupid question or idea that if you're have to turn off every system as you were to go
out of business, what was the system you would turn off last? And that's sort of your account craft. That's another indicator control point.
This is the system that powers your business.
And that way, if you own that and occupy that space.
It gives you lots of opportunity to do more for your customer and expand your offering.
That's what we tend to mean.
when we say vertical SaaS. And to your point, there's a wide range of actually end markets that that might cover in a wide range of business models as well.
If we were to imagine something ridiculously simple, like a barber shop or something like that.
How do you
assessing a new opportunity, think about where the control point might be. Like how
variant.
Are these control points? Or is it just two or three flavors and it's kind of always the same thing regardless of the industry?
I think it's somewhere in between, which is actually if you spend time with merchants and the customers.
You get to the answer pretty damn quickly.
It's what's the most important system, what do you spend all your time in?
What's the last thing you would turn off? Those types of questions can pull forward quite easily.
I think where the nuance comes is
Look, most of these businesses are not going through all the hard work to build a business to sell one product.
And so
As you think about the control point, you need to think about what's the next play.
where you take this foundation extended to.
If we think about the variance of the markets themselves that could be addressed by one of these vertical market solutions.
Walk us through like what you think the variables are. We maybe even like stack rank them.
Okay, there's
Make up the number. There's a hundred different markets we could go after. How do we sort one through one hundred in terms of what might be the most attractive place to go build one of these businesses?
There's probably ten or fifteen factors we would look at.
in making an investment. Let me call out three.
The three things that I think about
With a vertical is you start with Tam.
That's probably obvious place, but
If you're building a company sell into an end market like restaurants.
There's various different versions of TAM, but think of it as like eight hundred to a million locations in the US.
Well, that's a very
different market structure than if you're selling into, let's say, laundry maps.
And so
I do think that the size of the market really changes the
company formation process, it also changes how you think about your investment strategy.
Second is competitive intensity.
What does the vendor universe look like?
And those two things tend to be correlated. And the big TAMs.
Looks a little bit more like a horizontal market where there's a lot of
Both software vendors and a lot of cloud vendors.
I think the third piece is what is the growth dynamic within the industry itself. So
The growth dynamic is important for all
types of investing, right? The more change there is, the more growth, the bigger the TAM is over time, the more turnover.
I think it's super important is these industries because many of these merchants
They're not natural software buyers.
And so once they find a product, they stick with it.
And so if it's a very stable industry.
There may be many locations, but the turnover is relatively infrequent. So your at bats are infrequent.
So you don't really have that much of an opportunity to
start taking share. So you may have to take different approaches to
winning that control point and we should pull that apart. But
The C of a public company of uh software.
Company selling into a very large vertical that you might expect to have lots of turnover. He described it in a really clear way one time. He was like,
Look, Dave.
Only about five percent of this vertical
re evalues their software every year.
And so
My job is to see every single sales cycle of that five percent and win seventy five percent of that.
What that is, is a very measured go to market strategy. This is not your
Salesforce did this masterfully over the years, which is building S curves of sales capacity.
This market that the CEO's describing is the opposite of that.
Those three factors really tell you
the type of company you want to build and therefore the investment strategy you want to pursue.
If you had to add one more example from that list of fifteen onto the three that you've laid out.
Where the criteria is that it's like
A very nuanced one or like a very subtle one.
Just to give us a flavor of the examples of what you might look for, what would you pick?
I'll specifically go a little bit further out on the growth and risk curve on the aspirational curve, which is trust.
And so
If you think about the framework of vertical SaaS, you start out with a control point, you sell a number of products in and around that control point. Okay, that's great.
The real home run is to go from one layer of the value chain. So let's say you sell into auto insurance.
You do a great job there. You win the market. You get to market leadership.
Then the question is, can you extend through the value chain? And in this case, you go from the auto insurers to the auto buyer repair shops. The auto buyer repair shops tend to
be service providers to the auto insurers. Something like, I don't know, 70, 80, 90 percent of an auto buyer repair shop's revenue come from
underwritten insured consumers.
Now the reason why trust is so important there is if you want to go from auto insurance to
auto buyer repair shops, you're now selling software to both sides of a transaction.
This industry has been around a long time.
And there are various different phases of interactions between these two constituents.
That requires you as a service provider to create trust over long periods of time. It also requires there to be
Endemic
Rules of engagement.
industry standards that you can also leverage to span that gap. So
Admittedly, this is the out there.
Attribute. This is something that people get to consider.
I'm sure it's hard to underwrite too.
the difference in the outcome if you get this right and it's potential high trust vendor.
It's huge. Could be orders of magnitude difference in the outcome, so it's worth exploring.
I think that's right. I think maybe if you
Tone it down a little bit too, if you think about just within a merchant class.
If you get to leadership, the more there are trust amongst the merchants themselves, there's a lot of cooperation. There's a lot of collective benchmarking that you can create. So it's a really interesting concept.
I've invested in some vertical market
solutions before and one of the things you learn pretty quickly is that on the marketing side.
It's interesting and different because you kind of know who the buyers.
It's much less work.
to build your inventory of potential buyers.
So you kinda know who to go after. So what do the most talented
Marketers, sellers.
do in VMS, given that the legibility of the client base or the prospect base is a lot easier than in like Slack or something that basically anyone in the world could use Slack.
What have you seen the very best at marketing and selling and positioning?
VMS solutions do.
I think that's a really astute point. I think this is less around discovery. It's more around account based marketing.
There's a lot more talented account based marketers than I that can talk through the specific tactics, but let me share some concepts that
Maybe I see at the board level.
I think the first point is
He really can't
Outstrip your leads.
If there's a hundred thousand locations within the US, maybe there's call it ten thousand in Boston.
Ten thousand Seattle, let's those numbers are probably wrong, but
It takes only a couple S C R
Calling that city
in a year to really burn out their leads. So I think the first point is
You gotta be really careful with traditional sales tactics as it relates to these much smaller verticals.
I do think the advantage, and you need to take advantage of this, is the product market fit is quite a bit stronger, right? You're building a product for a specific type of customer.
And so really leverage that as it relates to the value proposition, the product marketing, how you introduce yourselves to customers.
And then I think the other thing that's quite interesting, this isn't true of all
Verticals.
And
You asked about attributes earlier.
This is another attribute that you can consider.
But in some verticals, there's enough density locally that there actually is a flywheel effect.
And so
The best markers I do believe
think about it much like a online marketplace, which is you go city by city.
You go nail the
Tent pole accounts.
There's a halo effect associated with it, and you start to see in your flywheels.
that actually things get easier.
That's the opposite of horizontal SAS. Horizontal SAS is
The deeper you get in penetration, the harder it gets, because you have to step outside your ICP.
You do have a local network effect available to you in vertical SAS and the smartest marketers and the smartest
go to market executives are taking advantage of that.
On the product side specifically, like why do any of these need to exist, especially with the proliferation of horizontal tools?
You've laid out the players here that matter. There's the vendor, there's the merchant, there's the consumer of the actual thing that the merchant's providing, there's suppliers, employees.
Other stakeholders.
Why can't you just cobble together
A normal ERP
A normal CRM
A normal communications tool. What is the reason that
any of these products exist in the first place? What are the industry specific nuances that make them
rational businesses to create.
The larger the customers are, the more the vertical versus horizontal equation changes.
The smaller the customer is, the more likely they want
immediate time to value, which favors vertical.
There's also just an awareness aspect.
If you're running
A restaurant, if you're running a hotel, if you're running even ten hotels.
Yeah, probably don't.
run a broad RFP. You're looking for a tool that just works.
Just solves every problem.
Kill shot. Kill shot.
And the nice part is
If you just think about software automation.
Even just
small increments of customization.
Really do drive a ton of value. So
Every application is a database. It's a workflow and a UI.
And so therefore
You probably could customize every single one of these horizontals and maybe there's a
template that you can overlay horizontal tool.
But it doesn't get at the heart of what delivers values to the merchant.
And that's why you see many of the best vertical SaaS entrepreneurs.
Start out as customers.
For instance.
Estimates and quotes in many markets is incredibly nuanced.
If you're take a horizontal tool and try and create a
Estimate for bespoke for a certain end vertical, you're basically creating entire data taxonomy. Your workflows might be different, your regulatory rules might be different. And so
These small details actually have outsized impact in terms of
The ease of use and the creation of value for these small merchants.
Yeah, your point earlier too about who the buyer is, the owner of the business, just saying, look, I just need some to solve this workflow problem versus a whole bunch of departments each buying their own. Yeah, obviously is a huge difference too. It brings back to the control points. And I love the way that you have
laid out the various ways in which you can I think you called them gravities earlier. You said workflow, you said data, you said account. Those are all units that make a lot of sense.
And I think you've called those control points one point oh and then there's control points two point oh.
What are those three ways of thinking about other ways to integrate into these
businesses in a way that everybody wins.
We talked earlier about industry attributes, and one of the attributes was this general
turnover or movement within an end market.
And in many and markets, there is very little movement. So
If you think about that, you have a small business owner who may have purchased
legacy software in the control point.
And while that software's not modern or
doesn't do everything that they want to do, it works and it's fully amortized. So they're unlikely to switch.
So what are your choices? Your choices are either
fight the fight and try and slog it out and slowly over time displacist.
Legacy software, or you could do something like
The language we use is integrating surround.
Which is
You integrate into the legacy software, but you provide surrounding functionality that's disruptive.
So a great example of this is the property management system in hotels.
I think it was now.
Ten years ago, the dates might be a little bit off, but about ten years ago
We were really excited to make a bet in property management.
Property management is the control point for hotels.
Hotels are incredibly important in the ecosystem of online travel.
And hotels are really struggling with this idea of syndicating or listening to multiple OTAs while keeping their inventory in sync and not overbooking.
And so we looked really hard at the property management system there.
The issue was that at the time there were
T.
Entrenched
Legacy players
That would be really hard to displace.
And so what we chose to do is look one level up.
the channel. The channel manager and we happen to find this company called SiteMinder in Australia.
Essentially would integrate to every single PMS. They integrated
So
PMS is covering roughly ninety seven percent of the hotel
global market. So integrated to all the PMSs and integrated into all the OTs.
And so what they've done
What they had done and what they continue to do is
Surround the PMS.
to the point where the channel manager and site binder
becomes a essentially integration layer into this legacy system and enjoys a lot of the values that you might attribute to having the control points.
this new generation of VMS players are thinking through how do we
disrupt the existing control points.
How do you think about
the role that demand plays in this whole equation. And I think about this as like the Shopify question. Like Shopify has always said,
We're a tool.
You do product and marketing, we do everything else on the back end.
And we're not gonna compete with you. We're not an aggregator of demand like Amazon.
You're responsible for that and we'll do everything else. How do VMS companies tend to think about this where
Either they're the Shopify or they're the Amazon that also brings demand, which is like a totally separate business model.
How do you think about
That
comparison.
This is the cutting edge, Patrick.
Let me talk about a couple different perspectives and then we'll try to integrate them.
The first perspective which I subscribe to is
Particularly for small merchants, it's all about demand.
Even if they're low margin merchants, even if they're not making high margins on that demand, it's in your mindset.
Your job is to
build a product or a service
And bring customers in the door.
Bringing customers in the door, it's such an emotional need. If you're an entrepreneur, like the biggest thing is what if no one shows up, what if no one walks through that door? And so
I think drive demand is incredibly strategic, and if there's an opportunity to do so.
I think VMS should look at that.
Quite hard.
I think the other thing going in a VMS's favor is that
A lot of the aggregators of demand, like the
online marketplaces, even Amazon are viewed as
Predatory.
I've done interviews for various different vertical online marketplaces and
Almost to the person, the merchants really resent the marketplaces because they're taking twenty percent of uh booking and oftentimes even higher than that.
And doing nothing. They feel like it's doing nothing.
And so
There's a really strong value proposition to your end merchant if you're able to provide demand. Now, the big issue, though, is really twofold. Number one, it's DNA.
People build software.
perhaps don't have the same DNA to go
aggregate.
Traffic.
Bid on keywords.
create social media campaigns, whatever it is, whatever tactics required.
The second piece is they lack density. So a marketplace really
has pretty close to a hundred percent.
of supply in a given geo.
It's very rare.
when a VMS will have even closer that market share in a geo. So you need to think about those two obstacles, but there's a number of different ways that you can get pretty darn close to creating demand or even creating demand.
And find your way around.
I think that is the frontier.
Are there attributes of the entrepreneurs that are building these companies that you think are distinctive from like the generic good software?
Entrepreneur.
Is there anything about
building this kind of business that really requires something different.
Then
The next slack or whatever.
I'll put a couple of ideas out there. I'm not sure if I fully believe them.
I believe enough of them to
Put them out here.
I think on the margin
There's been certainly counter examples of this, but I do think most of the best VMS entrepreneurs have
Really strong personal affity or most likely real working experience in the operations of the merchants that they serve.
The
Best VMS entrepreneurs.
They live it and they breathe it.
And obviously that's true of horizontal entrepreneurs as well, but I think there's a higher premium
On that, and as you think about some of these market dynamics.
having credibility in this tree to get the ten pole customers actually may be more valuable.
All things being equal then in the horizontal.
Context.
I think the second piece and this is probably
A bit more controversial is
Vertical SaaS businesses are inherently multiproduct businesses.
They require focus like every other enterprise. They require an ability to win the control point. But
You do need to start thinking about what's step two, step three, step four. And
As an investor, I've had to train myself to
back off the typical instinct of you can only do one thing
Well at a time.
I think the best protocol SaaS entrepreneurs are thinking
Multi product.
pretty darn early. So I think those are maybe the two distinctions.
If we switch just for a moment, because your idea sparked a thought to the investors' perspective, obviously you've done this very effectively, invest in lots of the best DMS businesses across history, personally.
What do those that try to do this kind of investing
And not do as well or fail.
Get wrong.
Do you think?
Back to our prior conversations, these markets are very, very different.
The size of these markets are very different. The maturity of these markets are very different. The company's growth, where they are in the growth phase, is very different.
to pick some barbells. If you're an up and coming, if you're a disruptor in a very large TAM
Well, you should be very
very aggressive at the point of at times being fairly sloppy with your economics.
You should overfund it, you should go win.
That's the phase you're in.
Likewise, if you're in a big TAM and you're the number one player by a small margin, you should make it a large margin.
Double down raise a lot of expansion capital.
Go big, very similar to horizontal strategy.
On the flip side, if you're in a more modest category.
And you've gotten to category leadership and
Barring some sloppiness from the capital markets, you kinda have this thing
Pretty well understood.
Well, you probably shouldn't raise a big primary round.
If there are other reasons to raise capital, you should maybe
Diversify through secondary liquidity.
Maybe it's M and A.
But the use of capital and therefore the provider
provider's mindset has to be very different. And so
One of the things that we've really both I've enjoyed and I think
we as a firm has benefited from is
When I started investing, I did my first three years at a bio firm.
In two thousand.
Right in time to catch a bunch of falling knives.
And then I went to a growth firm.
And learn the more secular high growth perspective. And I think these integration of the two really helps us.
Look at these various different
markets in these various different companies at really
quite different stages of growth and maturity. So
I think
To do this right, to invest in this and market right, there are certain commonalities in terms of company formation and
thematic pieces, but your mindset has to be really different depending on the end market and the
Cup to your backing.
One of the things that you hear over and over when you talk to VMS businesses and also at VMS investors is the critical importance of gross retention of really, really high
sticky, sticky customers. You already said it, like almost nobody even looks at new software every year.
Talk about what drives
Good or great, I guess, versus good gross retention.
in these businesses. What is it that makes the stickyest versions of these things? When I was doing my
original listening tour on this, which included a conversation with you.
That's one of the things you just hear over and over again. Like you want like ninety eight, ninety nine percent
logo retention, which is unbelievably high.
in order for these things to really become great businesses.
And the difference between ninety nine and ninety four is like enormous.
What drives that wedge or that difference in your experience?
I would make a distinction between net retention and gross retention. Net retention factors in the expansion that you get from existing customers.
Because if you are selling to
Small businesses.
It is unlikely that you'll get into the mid nineties.
There's natural attrition.
And maybe the metric people are citing are ahead of that. So that would make sense. But
I think in all businesses.
And all recurring businesses.
There is this trade off between
TAM and cost of distribution with net retention.
In more limited TAM scenarios, you really do want net retention.
higher than a hundred percent. So
Your gross retention.
plus any expansion that you get from the existing customers.
It just totally changed the economics of the business. Now the question is how you get there.
So I do think
The nice part about this control point framework is it correlates very highly to gross retention.
The more gravity you have, the less likely the customer's gonna turn.
And then if you think through this methodical framework of how you cross attach.
A second, third, fourth product you can go from
Gross retentions.
And typically
depending on the segment you're selling into, they are lower than 90%, but you start increasing the expansion, that gets you well over a hundred percent. So you have these nice
cohorts that are growing in and of themselves, which is the
Goal of every
recurring software investor.
That is how we think about it.
I do think there is this
Really interesting.
Periphery area.
You sort of break vertical SAS down to
It's basic levels.
You are selling to S Bs
And that is like an intersection between consumer and enterprise, right? Just almost like by definition.
And so
You look at these companies and the end customers can be in that spectrum. So they could be more close to the enterprise side where you get to your point mid nineties and gross retention. They could be more on the S and B side.
that gets lower the gross retention, but you make up for net retention. They could be lower. They could be solo practitioners. Shopify.
Many of their customers are actually solo
Endeavors. And if you look at into it, if you look at zero, a big chunk of that market is
F D of one.
by definition gonna have relatively low
retention rates there. And so
What do you do there?
And I think the really interesting part of that segment is a couple things. One is the best companies.
And we have some fellow from some of these companies. What they do is they think about
Retention not on a
enterprise basis, but on individual basis.
So if Joe starts a lemonade stand, it doesn't work out and he starts a taco stand. Well, as long as you keep Joe, that's pretty good retention. So that's one thing.
The second thing, and this is what gets into the consumer side, and this is why you asked me why I invest here and
I love the unconscious. I also love the confluence of function skill set.
This gets more the consumer side, which is
Hey, if you have let's say sixty percent retention, sixty five percent retention.
In an enterprise market, that's really tough.
There's a massive leaky bucket. But if you're in a big tamp.
And you have really
broad and cheap distribution. Let's say you're pretty good at
linear T V, which is many of what these
S and V products have done.
Well that's okay.
Because
You're more like a consumer business.
And any consumer business would die for sixty percent retention.
They're more like 20%. So it's really this spectrum.
I do think to be a great vertical SaaS investor, you have to think from
Uh.
Perhaps expansion stage to buy out to public.
And you also have to have a little bit of enterprise software DNA.
A little consumer DNA, a little fin tech DNA, and then obviously a lot of time.
And this
Core County.
If you think about the products and the multi-product mindset of the entrepreneur, which, like you said, runs a little bit counter to the normal advice.
I guess in all entrepreneurship, which is that you're supposed to do one thing and do it extremely well.
What does multiproduct mean?
When I think of VMS, I think about a single like operating system.
If I'm a barber, it's where I book and bill and do all the stuff that I I need to do to run my business. So what does multiproduct?
really mean.
Is it a new
button that I double click on my desktop to open a second piece of software? Is it new features inside the existing operating system that I
Have to pay extra for? Like what is multiproduct
Defined to you mean.
Let me try to pull apart.
Each of the pieces
You can push me where you want.
Sick toast.
Most of these restaurants have
Point of sale system and they have a payments provider.
Man, it'd be a heck of a lot easier if there was just all in one.
You take payment into your point of sale, there's no reconciliation.
It's easy.
And so
The way Chris, the CO of Twist, describes it, and I think he's great created language that we've started to borrow and maybe even steal.
Is this idea of better together?
One plus one.
Equals five.
They just work better together, reconciliation is better. And in this particular example, we've written an essay around the benefits of integrated payments and because then you
You just get a lot of information on the financial health of your merchant as well as your consumer.
That's the talk.
And I do think because you
typically are selling to an SMB where they don't want a ton of vendors. They just want stuff to work.
You are able to
move to what you're describing, which is an operating for this merchant.
And the more you can add, the better.
And again, it tends the group in front office and back office, but generally the more you add, the better.
Now
I think what you're also pulling on is this idea of monetization.
So if one plus one equals five and that
early example.
What do you charge them?
Do you charge them?
Yeah.
Do you charge them?
One and a half, you're charge them two. Cause presumably the nice part about multiproduct for the vendor for the SaaS company is
There's very little in incremental sales costs. That's not fully true, but it's generally true.
And so
Therein also is a really interesting
Cam question.
If you're in a big team.
You're probably
Charge.
to the lower end because you're adding value and you're just creating this great compounding flywheel. And if the customers are bigger, maybe, then you know you're gonna cross all sorts of other products over time.
If it's a smaller TAM, then
Maybe uh charge it closer to four.
Customers making a dollar'cause one plus one equals five. So they're getting five dollars of value and paying four.
But you're also
Forexing your ARPU, obviously. It's a really nuanced question, but
That's what makes us fun.
What are the other big chunky
You talked about
Payments.
Getting in the payment flow.
Payroll.
What are the other big things you see over and over again as like
Ways to serve in this multi product mindset.
The merchant.
That
kind of always work if you're in that trust.
I do think in the front offices payments and
certain circumstances where it's not a single transaction. It might be engagement over time for a service provider or various different things like the whole billing.
idea. So taking in money is always good. It's the lifeblood of these merchants.
It's always great. And then once you get the flow in, you now have insight of the financial health of
emergence. So you could think about
very low risk lending.
some casual lending. A part of Square's PL, for example, is instant deposit, which is
Getting money.
rather than waiting three days for the money to show up in your account getting it instantly and that's just time.
Yeah.
very little risk associated with that. And so and Square makes quite a bit of money on that. And I think many vertical SaaS companies can do the same. I do think there's a step function in terms of
Effort as well as opportunity, where you do think about what are the constituents around you. There's your customers, there's your employees, there's your suppliers.
If you go to the employee side.
That usually can be
a little bit more linear because these employees work for you and they engage with your systems anyways, then you start thinking about things like employee scheduling and payroll and this idea that
If you think about your control point.
And data gravity.
It's the data about your most important assets. Well, one of your most important assets are your customers and your employees and your suppliers. And so you
Those are natural extensions.
If you go towards the supplier side, then you think about
things like procurement, you think about actually payment flows to them.
You think about over time as you get
back to this trust concept and getting density within a single level merchants, you may think about group buying.
It may be a GPO, maybe other formats of that.
The consumer side, as we talked about earlier, that's the holy grail. That's where there's a lot of money and that's where there's a lot of
joy and energy for your merchants.
there's ways to sort of incrementally move towards the consumer you start out with
Things like CRM, you think things like loyalty.
You think about how to increase the conversion rate, things like consumer lending.
Those types of things.
You can move into
Creating demand.
Either directly
And in very rare circumstances you'll actually start to see
some vertical SaaS companies being able to create something that equates like a consumer marketplace.
I've talked to some investors that think the right approach here
He's pretty mechanical.
There's more science than art.
in this style of software building and investing than would typically be the case because
There's just a lot of overlap between the you've laid out some of the key functions that like all these merchants tend to have. And of course, you got to make it bespoke to the industry, but that there's a lot of science to it. So I'm curious about the art.
When you think about
The most creative
case studies or entrepreneurs that you've engaged with.
What comes to mind? What is the creativity, the imagination, the art?
that you see in what seems to be a consensus more kind of mechanical scientific approach.
There's a guy in our network, a Todmark fellow.
Lawrence Hester, he started this company Fair Harbor. It's a bootstrap business that I think everybody chased and I chased.
Hard.
For three or four years.
So what it was was think about it as a booking platform.
A website.
For tour and activity.
Provider. So helicopter operator.
Luau provider.
Pretty straightforward.
As you think about building a business, all the tough things that we talked about earlier come to mind.
How do you track these people down? How do you get them to buy software? How do you how do you get them to use your software?
And so
The creative thing that Lawrence did is some combination of pricing strategy, product strategy, and go to market.
So
The first thing he did.
He realized is that
A torn activity consumer.
We go on a trip to Hawaii and look for a Lua.
is a transactional customer.
They're probably not gonna go to Hawaii again for quite some time or look for Luau.
So what does that mean?
You can charge them a buy side feed.
So
He would charge, I think
Some percentage, I want to say six to seven percent of the fee. And it's just tucked in at the end.
That's a lot of money.
compared on these high ticket sizes if you're
Taking a helicopter tour, for example.
So as a result
He was making money on the buy side fee, he would charge
The chore operator
payments, but they were paying for
Payment services anyways.
And he would also
Price match and really
take the price quite low.
So that's one piece. He totally changed the business model just through pricing.
The second thing is from a product standpoint
Is
He would go these
operators and say
Hey, you really should think about
Retune your website.
Using software to take bookings.
So on so forth.
Okay. Well, I gotta go around my business. We'll talk later. It's like actually we've done it for you.
By changing the economics, he was making
Tens of thousands and sometimes hundreds of thousands of dollars on these
tour activities where everybody else is trying to sell software at thirty bucks a month.
And so what he could do is he could build a team to go build the product.
Or the customer.
as part of the sales cycle.
And then the final piece is he tied it into a go to market model where
He paid his young
Salespeople these
Folks right out of college.
And realizing the annuity value of these businesses and the increased monetization.
Yeah.
write a compensation plan that provide very low base, but
half the first year's booking.
And so you had these
Sales reps.
There's a great story of a a sales rep that slept in a van.
And drove, I think it was around Hawaii.
And wouldn't come back until he booked every single tour operator in that geo. That combination of
Three factors.
Built a
significant business that you end up selling a booking.
That
Is very far from mechanical.
And
was the winning strategy. And there's other providers in the space that have tried to match it, but there really hasn't been
something as successful. So that that might be a good example.
That is an amazing example, like replete with lessons.
Because that one is so good, I have to ask what's the next one that comes like what's the next great case study that comes to mind? And I'm just gonna leave it there. Like that one was so interesting.
There's his business in LA.
And I'm gonna get this a little wrong because I talked to him maybe four or five years ago, but I got to know him over the years.
I won't name them because they haven't sold and at some point in time we'll go chase them.
But what they did is they went after probably the most manual market that you can imagine, which is the commercial casting market. It's literally finding people that show up
an act for a commercial.
And so where do you think the power is in that?
It's in the casting.
So
What they did was they provide a tool for these casting directors. I didn't know this existed because I'm
Not in that industry, but they provide a tool for this casting director to go through.
hundreds thousands of resumes and various different auditions in a very clean way.
And create
a portfolio very easily.
This used to take hours and hours of time.
It just did all in the software.
They were able to basically offer that.
For very little, or I think it was actually free.
And so they got all the casting directors.
And so on the back end, they just built this LinkedIn where all the actors for a very
Small amount of money.
would upload their content and their prayers. And so
What a great business.
You're taking
a lot of the sweat labor out of the ecosystem.
You're able to monetize the fat end of the market, which is all these actors looking for commercial.
Cares.
By providing
This pretty simple tool at the top of the stack. And so
It's sort of a very micro version of what Ariba's done over the years and
Other folks. So
It's a cool little business.
It's the strategy you take away from there that you should always investigate
What is the scarce thing? Like what's the scarce supply?
in the ecosystem and then really focus on serving that scarce supply in a unique way. Is that like a pretty repeatable
Strategy.
I think that's right. I think when you start thinking about extending through the value chain is our language, but you go sell from one customer to the customers, customers or the other constituents.
The easiest, most linear way is by following the money. You start out with the buyer, then you try and sell it to the supplier. Now, to your point, fragmentation matters a lot. And so if there's only two suppliers and many buyers, well, you start with the suppliers first.
It is very similar to an online marketplace mentality, which is what's the hard side?
What's the scarcity?
So I've two
maturity questions.
both relevant for investors in this space.
The first is like
How saturated and penetrated
just the raw opportunities are for entrepreneurs to go after.
And then the second is how mature and priced in is the idea VMS for
investors.
Another way of asking that one, I'll I'll ask that one second is was the right time to do this when Constellation started doing this? And now it's
Everyone knows about it and it's fine.
And like the attractiveness of EMS is inversely related to how much people know about constellation or something like that. Let's start with the entrepreneurial side.
How
Saturated
Red versus blue ocean, do you think?
In general.
Building a VMS business is
Today.
Relative to the past.
I think it's certainly more saturated in the past, but man, there's so much greenfield in my opinion.
Greenfield that was
Either underserved or not served at all by software or underserved through desktop productivity software that was sold in the nineties.
So I think there's still
quite a bit of opportunity. Now the big end markets
Restaurants, things like that. Yeah. Restaurants construction, the trades
They have had software companies coming at them.
But nonetheless, even in the
Big verticals, there's a lot of sub problems that
Need to be solved.
And so I think there's still a lot of runway.
One quick plug is what we did was we ran all the nix codes.
And we looked at
Every single vertical by location and fragmentation.
To help entrepreneurs pick their spot.
So if people reach out to us, we'll send up. So I think there's a lot of runway, but back to our
How we open the conversation.
Just like an entrepreneur or just like an investor is investing their capital, an entrepreneur also needs to be pretty thoughtful how they invest their time and invest it accordingly to the market attributes. So
If people are looking for a get rich fast.
Approach there's certain
Verticals that make sense if they
wanna build a business methodically over time, there's certainly
other verticals where that's required. So I think you just need to be smart about
what market you go after.
fairly obvious comment, but I think people still get that wrong.
As an investor, I think it's largely the same, which is
I think
Painting.
this set of companies where there is commonality, but
Very different and
Market attributes.
The same.
is really dangerous.
And I do think
Investors tend to
Go for the TLDR and go for the
The sort of quick instinct, and and I think you're starting to see some particularly expansion stage investors sort of paint everything the same.
I don't think returns will be great with that approach.
I do think you have to be a bit more nuanced and be off to go from expansion stage to private equity to public to various different
modalities match the modalities of the end markets that you're investing in.
I think there's some truth to that.
I think you're starting to see people maybe over indexed this market.
That being said, though when
I think
there's a natural ebb and flow of these things and people will pull out as the returns
may not be as great as they anticipated, or they get distracted by some other thing.
I do think
While
maybe the painting this and market all with the same brush may lead on the margin to
Some companies.
Getting overvalued.
Some companies will very much still be undervalued.
with what we're seeing as it relates to the multiproduct orientation and also the ability to
extend up and down the value chain.
And
I think it's just a really productive area to invest in. It's
S M Bs which
Again, the line very closely with vertical SAS employed close to half of the US.
These are big problems that need to be solved.
They have a lot of work to do and
And a lot of that will come through automation. So
I think it's just a great place to invest.
Have you alighted upon
methods of valuation or variables that go into how you think about the multiple that should be placed on a business like this that's different than the normal software metrics that everyone cites for valuing every software company growth rate and ARR and rule of 40 and all these kinds of things. Are there VMS specific valuation considerations that you think are smart or important?
Yes, it's less around what the exit multiples are because I think you can align that to traditional frameworks.
It's more about the piano.
So every P and L is your typical recurring
P with an air or bridge, but for VMS, I think the important look is locations by our poop.
The nuance there were I think
You can take it like any investment framework. You can do a ten minute review. You can do a
ten month review. And I think the nuances that you pick up with a ten month is
On the location build.
segments really, really matter.
'Cause if you think about from a first principle standpoint, back to your earlier question.
A horizontal business looks at
the universe as
Everything in a vertical business is taking a slice. Well, even within vertical, you need to think about sub slices because
First of all, there'll be competitive entry in sub slices, and then also
Your value proposition is
tied to how tight your product market fit is. So I C P is really important.
The Route piece really is
Experience driven
Activity.
It's kind of what you put in the bucket and what you don't.
is ultimately what drives to what you do.
Right now the conventional wisdom is if you own the merch, well, you should get
all the payments and then you should get all the payroll and all the other things.
Well, the reality is there are a lot of nuances as it relates to attached to payments. You have great vertical software companies.
haven't been in business for 10, 12 years, and their tax rate is something like twenty percent to payments.
And there's some operational nuances, there's some end market nuances as to whether
you can get detached a hundred percent. And that there in that difference.
Can turn a
what seems like a great deal into a pretty mediocre deal and vice versa. So I think that our poop build is very nuanced. And so
That's how I think about
investing the space a little less on the exit multiple side, which
Of course, is super important too.
Is there anything that we haven't talked about?
surrounding this discipline of investing in company building that you think is really important.
I do think time horizon matters a lot.
Because most of these markets just by the nature do tend to turn over a little bit slower than a horizontal market, just by
The personas and then also the
organizational structures. And so I do think the best investors in this space need to have a very long time horizon.
'Cause otherwise you'll be more driven by multiple than P N L.
Some of these penals do take a while to build out.
Some of the best VMS businesses have been going at it for thirty years.
So
I think time rising really matters.
What investors or companies should people interested in this category study?
Most carefully, you're not allowed to say constellation software. I'll point out the ones that are less obvious.
I'm no longer on the board. I'm no no longer formally affiliate with the company, but
People should take a look at CCC.
So C C C is the business I described earlier that sells into the
The auto insurers, they moved down to auto bar repair and they're now building an online parts marketplace.
That is to me super interesting.
I think that's the strongest expression of extended to the value chain.
I think
Maybe two others that are a little less covered.
This isn't a comment on their valuations by any means.
Or an investor recommendation.
What our folio is doing is super interesting.
They started obviously at the property management side and they've done a bunch of things on the to engage with tenants, but they're starting to move up the stack into equity holders and
Creditors.
If you think about this idea of like single source of truth.
across layers of the value chain.
That's a really powerful
Concept.
There's trust issues as we described earlier.
But ultimately the unit of measure
On all these things is really the property financial performance.
And so there are various different slices that want to see different views of that.
We invested in a horizontal business called One Stream, which is
Very similar in that regard.
This this concept of single source of truth, I think is applicable across both vertical and horizontal.
I think the other one that are really interesting
Case studies.
And the reason why they're interesting is just the different approaches to the consumer.
extension, which I think captures a lot of imagination and
is quite challenging, but also huge upside.
Spend time with mind body.
And their acquisition of believe it's Class Pass.
I think that's super interesting how that came together.
I spent some time with the team and there's some really interesting nuances that affect
Modernization and
affect the success of that type of approach. Because I think
from an industrial logic standpoint, of course.
You take an operating system software company who that has decent
market share, you add a marketplace and it all works.
And so just unpacking that experience, I think, is super interesting. I think the final one, which is probably
less known as a vertical software player, but I think has a lot of parallels and you could argue is as well as
Zip recruiter?
Yeah, I wrote an essay on this, but
I think just the high level is you go from
A job distribution tool, so
I have a job spec that I want to push to multiple job boards.
Right than
Posting them all of them I'll push just a chip recruiter.
to essentially creating their own
Pull the candidates.
Through very clever tactics. And then they ultimately went in all in and spent a lot of money to build a consumer brand.
And just seeing those phases of development are super interesting.
Ultimately, I think what it suggests is if you really want to build a consumer brand, there's no shortcut around it. You just gotta
Write the big check.
Build the DNA and get after it.
I think there are probably ways to make it easier, but
It's just a really instructive
Case study. So those are the three that come to mind.
Dave, I think if anyone out there wants to understand and study this space that you've created your own system of record, if you will, sort of content of record for understanding the different aspects of how these businesses work, how they grow, the nuance that drive success. I've so enjoyed talking to you and also reading all the things that you very generously
put out there and I love the spirit of sharing this.
very openly and freely. I just think it's so positive, some. I love it.
I ask everyone that I talk to the same traditional closing question. What is the kindest thing that anyone's ever done for you?
Yeah, so I'm a long term listener. You were gonna gonna ask this question. And I think most people might think, all right, what's the most authentic and what's the most novel answer? And hopefully you combine the two. And
The authentic answer is maybe not that novel and it's one I'll go with here is
It really is
My family and the team around me.
And I know that's not a specific answer, but
If you wanna be a great investor and
I aspire to be that. If you want to go start a firm, if you want to go do anything.
You break a lot of glass, and you push really hard. And
I really am grateful to
My family
Like it's more than just going and achieving.
And then
The first two years at Tide Mark were pretty intense. We raised in two thousand twenty one.
We were fortunate to say no a lot in 2021, but it's really hard. We're trying to make a name for ourselves, and that discipline was painful.
And now as we build the business and probably one of the most
Turbulent times.
I'm really grateful to the team to stick with it and keep driving and keep
Put one foot in front of the other and building this team. So Simple but beautiful. Simple, maybe not novel, the truth. The simple things are always the best. It's a lovely place to end. Dave. Thank you so much for your time. Yeah, likewise. Fun conversation, Patrick.
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