The Vertical SaaS Profit Premium

Introducing the Euclid Vertical SaaS Index

There are some great general software comp sets out there, from Bessemer’s Cloud Index to Meritech’s SaaS Index. None, however, offer a comprehensive breakdown of vertical software businesses, with a focus on differences from horizontal peers. So we pulled together our own. The Euclid Index we’re sharing today includes 36 leading industry-specific public software companies, alongside 60 horizontal SaaS players for comparison. We’ll aim to update it from time to time and unpack a data-driven vertical SaaS insight top-of-mind to our investment team. 

Today, we will discuss a finding from the Index that gets to the heart of the vSaaS business model: the vertical profit premium.

The Vertical Profit Premium

Public Vertical SaaS companies trade at nearly double the EV / Gross Profit multiples of their horizontal peers—11x vs. 5x, on the median. Amongst profitable companies, vertical EBITDA multiples also demonstrate a 10x advantage—44x vs. 34x.

Why does the market pay more for a dollar of vertical SaaS profit?

We won’t find the answer in the top line. A dollar of revenue is valued at about the same premium across horizontal and vertical comps. Whether trailing or forward, average revenue multiples fall within a 6-8x band, with vSaaS generally at a slight, one-turn advantage.

Nor do differences in relative scale or growth have much bearing. Horizontals do have a few outliers that bring their average Enterprise Value (EV) up–mostly companies around since before SaaS was a term, like Salesforce and Adobe. But median EVs are about on par, in the $4-5B range. Vertical growth rates are actually notably lower on average but the gap is marginal when you pull out 1-2 particular laggards (e.g. Blend and Expensify, both shrinking double-digits). The top quartile of businesses in both sets are scaling revenue at nearly the same rate—just over 30% year-over-year.

Factor 1: Market Dominance

Vertical software gross margins tend to be lower than horizontal peers–roughly 65% vs. 75% on average. Not surprising given vertical software platforms tend to have a wider variety of revenue streams. Toast, for example, derives more or less equal amounts of revenue from subscription and transactional products. So why would something gener​​ally perceived as a negative be a good rationale for a profit premium?

While such non-subscription streams do have universally lower gross margins, they also speak to a hallmark of vertical success–the ability to expand product suites and capture more dollars from a captive ecosystem. As Bezos said, “your margin is my opportunity.” In terms of pricing in future performance, moreover, a 90%-GM SaaS offering has very little room to expand. Analysts may be expecting vertical SaaS companies to grow margins over time, especially as they chase a generally higher market penetration rate ceiling than horizontal peers.

Factor 2: Product Stickiness

While vertical platforms do tend to benefit from retention advantages, the public company data is too weak to explain the profit premium. Average Net Dollar Retention (NDR) is basically the same across our horizontal and vertical comps, at just under 110%.

That said, as available data was sparse, selection bias likely taints the picture here—as companies don’t have to report NDR, they are more likely to do so when it’s good. vSaaS NDR advantages are indeed quite strong sub-$50m ARR (131% vs. 121% in top quartile) but tail off >$100m ARR.¹ Given more thorough public NDR data, we suspect vertical stickiness might speak to the lasting performance of vertical stalwarts like Autodesk or AppFolio.

Factor 3: Go-to-Market Efficiency

As we’ve touched on in previous writings, vSaaS businesses tend to be more efficient in regards to sales and marketing (G2M). While we didn’t pull granular spend data in this run of our Index, many reports attest to the effect: public vertical software companies spend half as much on G2M per dollar of revenue than horizontal ones² and <$100m ARR vSaaS boasts top quartile Net Magic Numbers 30-50% higher³.

Interestingly, our ARR / Employee figures demonstrate a disadvantage for vertical SaaS–though this likely speaks to higher headcounts supporting ancillary services and R&D vs. G2M. As vertical SaaS businesses scale, the proportion of FTEs focused on G2M drops below 40% on average. As Tom Tunguz wrote almost a decade ago:

Vertical software companies do benefit from a better sales efficiency. But it’s unclear what that efficiency translates into, aside from lower sales and marketing costs.

It seems clearer today that this G2M edge—or at least some combination of the factors listed above—translate into a distinct premium in the public markets.

The Euclid Vertical SaaS Index

Market data as of May 9, 2024.⁴

Subscribe to Euclid Ventures for regular updates of the Vertical SaaS Index! If there are questions you’d like us to explore in future posts, share in the comments below.

Sources

• Anders, Guo (2023). 2023 Growth & Efficiency: The Vertical SaaS Companion Guide. ICONIQ.

• Bessemer Ventures Partners, Nasdaq (2023). Emerging Cloud Index.

• Main Capital Partners (2024). Vertical vs. Horizontal SaaS.

• Meritech (2024). Meritech SaaS Index.

• Public Comps (2024). Public Comps GSheets Plugin.

• Tunguz (2015). Do Vertical SaaS Companies Benefit from Higher Sales Efficiency? Tom Tunguz Blog.

1. From ICONIQ report above.

2. From Main Capital Partners report above.

3. From ICONIQ report above.

4. From PublicComps.com, Finviz, and Yahoo Finance.