More Vertical Fintech, Please

Before generative AI became all the rage, vertical software, and embedded/vertical fintech were all the rage (perhaps it still is for many others as it is for me). At Equal, we love investing in vertical software businesses. When properly executed, vertical software leverages the nuances of a given market to improve efficiencies around critical workflows and to aggregate and surface key business insights. The best-in-class examples create a system of record for businesses within the category.

We also love investing in fintech focused businesses; with that said, there isn’t anything inherently defensible about financial services for the sake of financial services. Most pure-play financial services offerings are commoditized offerings. It is extremely difficult to create stickiness with your end customer when the customer can always find a better rate, lower payment costs, or better rewards programs somewhere else.

However, marrying vertical software and financial services can be extremely powerful because of the significant increase in market size that occurs from combining these two product offerings and business models. Workflow software can be quite sticky, but there is always only so much that a business will be willing to pay for software. Conversely, financial services (payments, take rates, insurance, lending, etc.) can be lucrative ways to monetize but tends to have challenges regarding retention.

The playbook here isn’t some earth-shattering secret; it’s actually pretty simple and relatively widely known at this point. Providing a customer with workflow improvement while also bundling one or more financial services products enables you to supplement SaaS revenue with fintech or even partially or entirely subsidize SaaS revenue with financial services revenue. And now you have a software business that can tap into the total spend/GMV of an entire market while reducing sales friction and increasing stickiness.

The ability to combine vertical software with fintech dramatically increases the number of verticalized software opportunities that can produce large exits, but it doesn't mean that this playbook will turn every market into a lucrative opportunity. While we are still trying to figure out the traits of a market that make it ripe for a vertical fintech opportunity, a SaaS + fintech revenue model could capture anywhere from 1% - 3% of a market’s spend. This implies that, at a bare minimum, there needs to be at least $25B - $30B of market spend in a category for a large-scale vertical business to be built.

In addition to determining the relative spend of a market, fragmentation of end customers is another trait that we find to be an essential characteristic of a market ripe for a vertical SaaS + fintech opportunity. With that said, there is also such a thing as too much fragmentation, particularly if there is not a cost-efficient way to get in front of those heavily fragmented end customers.

Lastly, there are many markets that still operate on manual processes and archaic software (if any software is used at all). We view markets with low levels of software penetration/digitization as great fits for this playbook. A few years ago, McKinsey put out its Digitization Index, which ranks markets in order of digitization, and serves as a good guide for market selection.

An example of a market that we think fits this model well is the construction market. The construction market is a massive industry with many stakeholders such as general contractors, subcontractors, material suppliers, developers, etc., all of which have tremendous amounts of spend (hundreds of billions) that flow through them. In addition, general contractors, subcontractors, and material suppliers are all fragmented categories. However, GCs and subs might actually be too fragmented of a segment to focus on. The average GC or sub are very small businesses, which means that one can’t afford to spend any meaningful amount of money to acquire GCs or subs given the low level of monetization that you can capture from them. You can find our broader thoughts on the construction market here. 

Like GCs and subs, material suppliers are also a fragmented group, but not as fragmented, and more importantly, the average material suppliers are much larger businesses and transact with hundreds if not thousands of GCs and subs. This is why we chose the material supplier segment as our first investment within construction via our investment in Suppli, a payments platform for material suppliers.

Another vertical that we found attractive from a verticalized fintech play was the entertainment industry. There is well over $100B spent annually by production companies across payroll, insurance, and B2B payments within the entertainment industry across film, tv, commercial, and live events. Like the material suppliers within construction, there is fragmentation amongst production companies, many of which are sizable businesses with lots of spend to capture. Lastly, the entertainment industry is unique in that the workers in the space are all contractors and are primarily unionized. This makes it ripe for a vertical fintech business focused on payroll, which is why we led the seed round in Wrapbook, a vertical payroll provider for the entertainment industry. We will share more of our thoughts on vertical payroll opportunities in a future post.

In addition to our investments in Wrapbook and Suppli, we have made vertical fintech and embedded fintech investments across a variety of categories, including MVMNT and SmartHop within logistics/supply chain, and Odyssey within energy/climate. We continue to look for more opportunities.

We are certainly not unique in our excitement for vertical SaaS + fintech, but hopefully, this post provides context into how we think the playbook can work across markets. If you are working on a vertical fintech opportunity or want to jam on the space, feel free to reach out!

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