Vertical SaaS Isn’t Discretionary

The fate of a tech company during a recession will largely be determined by how essential their product is to their customers. During a market downturn, businesses and consumers alike quickly cut their discretionary spending. We can already see this in the market action of consumer tech companies, which have been some of the hardest hit during the first two quarters this year. Businesses have been scaling back, too. Corporate events, marketing, and even hiring are being treated as “privileges” as companies try to salvage their balance sheets by sacrificing the nice-to-haves to protect the essentials.

In these kinds of macro environments, B2B tech companies — and vertical SaaS companies in particular — have a decisive advantage over many of their consumer-facing peers. The reason is that vertical SaaS platforms are typically a non-discretionary expenditure. This is true of both point solutions and systems of record because these platforms provide the core functionality for a customer’s entire business. In other words, the users of a sufficiently robust vertical SaaS platform can’t afford to stop paying for it.

The stickiness of this kind of software was recognized by Robert Smith, the CEO and founder of Vista Equity Partners, in the early days of SaaS. Smith famously made the case that he’d prefer software contracts to first-lien debt because a “a company will not pay the interest payment on their first lien until after they pay their software maintenance or subscription fee.” Why? Because that customer “can’t run his business without our software.” It’s a simple insight that made Smith a billionaire and turned Vista into a software juggernaut.

Seen this way, a well-built vertical SaaS product is a business expense that is about as optional as taxes, rent, and utilities. It is non-discretionary in the extreme, which is the best possible position to be in as a founder regardless of macro conditions. In most cases, a customer will only stop making payments for their vertical SaaS product if they’re about to shutter their business entirely. Their software is the last expense to go before the lights go off.

Of course, the fact that vertical SaaS products are essential to their customers is only part of their advantage in a recessionary environment. To the extent that their software helps their customers — especially SMBs — operate their businesses more efficiently and improve their margins, they will continue to see relatively strong revenue growth. Moreover, vertical SaaS businesses themselves tend to have very strong unit economics and FCF margins, a critical quality for a tech company at a time when cash is king.

Despite the lackluster macro backdrop, at Fractal we’ve never been more bullish on the future of vertical SaaS. We believe that now is the perfect time to launch these critical software businesses that will transform America’s industries and the companies that launch during hard times will only come out stronger on the other side.