The key types of B2B software companies
We’ve had a surge in startup applications to Galileo Ventures over the past couple of weeks, many of them forging new products in business-to-business software as a service space (B2B SaaS).
From my view, there are 4 main types of business software applications:
1. Core cross-organisational ‘sources of truth’
2. Line of business or role-based ‘systems of record’
3. 'Helpful apps'
4. Specialist tools aka. 'other' category including many dev tools
Each of these have their own unique qualities when it comes to building a big and/or sustainable business that are important to keep in mind.
While there are tons of opportunities in ‘(3) Helpful apps’, and you see these types of products launch everyday on places like ProductHunt and forums, these types of businesses are likely better to be bootstrapped, as they will always have an upper asymptotes and generally don't or can’t get big (or generate "venture scale" returns for investors).
That doesn't make any approach invalid or 'bad' – the best B2B SaaS applications are those that customers pay for, no matter the type. But looking at things from an investor's lens, the size and timing of the potential return from a company is an important aspect we have to consider to make our business model work.
Core cross-organisational sources of truth
Examples: Atlassian Confluence/Wikis, Salesforce, SAP (essentially most larger ERP and CRM), Shopify for eCommerce businesses, email systems/Slack, databases, …
Core software is the software that effectively 'runs the company'. Almost all team members at the customer's company will touch the software in some way (not always directly) and likely interact with it on a regular basis.
Some roles might be a bit more involved than others in interacting (salespeople and Salesforce for example), but this holds true in that it's not a system that is primarily only for their department's use (for example, support people looking through Salesforce for information).
Companies that do well here and become a core source of truth almost always become incredibly valuable, as it is very hard for companies to change/churn from one core system to another. You have to re-train your whole team, rebuild integrations, migrate data, handle custom flows, etc.
The downside is that sales cycles are often very long, it's hard to churn people off competitors (same reason it's sticky once they start using you!), and often core sources of truth need to be very feature rich and 'extensible' for a business to be able to successfully adopt it.
Successful early go-to-market strategy is building a core source of truth for a specific vertical (think Shopify for eCommerce rather than Salesforce for 'practically any business') and then laddering up over time.
Many of Shopify's early customers (even now a lot of them) are brand new eCommerce stores, either from new sellers or from physical retailers moving online. These businesses are more comfortable using a new product because they're starting from mostly nothing.
Later on, you start working your way 'up the ladder' to bigger and bigger businesses as you become more feature-complete and start to build out sales processes. Shopify for example has Shopify Plus, a program specifically for larger merchants to adopt their platform.
The ladder up strategy is a common way that B2B startups go to market, but in core business systems, it's almost always an absolute necessity. Otherwise, you often end up building custom enterprise software for each BigCo sale rather than a platform – which is much harder to scale and generate outsized returns.
Line of business applications or role-based systems of record
Examples: marketing software (e.g. email marketing tools like Mailchimp), GitHub for engineering teams, Zendesk for support teams, Figma in design, CPQ tools for sales teams…
These are applications that are the main place that a department or person in a role gets their job done. These applications are a NEED for that team or role, not a nice to have or a want.
One of the big benefits for these types of systems is that you have a very clear ideal customer profile, and marketing/sales can be quite targeted. That’s great, as it feels for the buyer that you’re building software that is ‘just for them’, which improves conversion rates and speeds up sales cycles.
Feedback is also much easier, as it is easier to identify the consistent parts of problems discussed by customers when they’re all in one particular role or business unit.
Startups in this space often focus on a particular role or line of business within a specific industry, and then expand industry focus over time. Again, this helps with marketing targeting. The more specific and niche your focus is in the early days, the greater the conversion rate and better conversations you will have with prospects.
Given the lower complexity (usually) required to build software of this type, you don’t always see the ladder up strategy in terms of size of customer. Often that is because the switching cost isn’t quite as huge, and the decision making process for the buyer is much more simple.
The big downside of these applications is that because switching costs are lower, people will often change tools as new trends emerge and people move between roles/companies, as often executives will have a ‘preferred stack’ they introduce when they change job.
The best way to fight this is to increase penetration within teams (ie more people using your software) to drive stickiness. The further up market you aim (ie larger companies), the more people you’ll often see using one of these systems (think of support tools for companies with 8 people vs support tools for Uber globally).
As a result, while it’s hard to go straight to enterprise, starting mid-market is usually a much better option than starting in small business and growing, as the needs of a small business in a particular line of business are very different to those in a medium-sized business.
A very hard segment to crack is line of business/role-based systems for small businesses. The good part of all small business focussed software is that there are a lot of small businesses! The bad part is that they are often very price sensitive, go out of business themselves, and can be very difficult to support as they are not a ‘professional’ in the role you are solving for.
Additionally, what is a system of record for a role in one business might be a ‘helpful app’ in another. Particularly when you are working with small businesses as customers, you will often see the business owner being the head of marketing, support, engineering and so on. To that kind of customer, you’re an important tool, but you’re not the tool that is the main place that they get their job done, because it’s so varied.
Examples: website popup creators, map embedding tools, screenshot annotation tools, …
There are a ton of little microservice-like tools or systems that people build, often to scratch their own itch.
Generally they have a quite specific, singular, well scoped purpose, and the customer base is either non-technical so doesn't want to DIY, or it's cheap enough that the build-versus-buy decision is clear.
These companies can still generate a lot of revenue – you can aggregate a lot of small subscriptions, and the good part is that these types of tools often do not require a lot of support overhead once implemented. However they will also usually grow at a much slower rate.
That's why they are well suited to a bootstrapped approach, as you can grow slowly over time and having an upper asymptote is a totally fine outcome for a bootstrapper - as long as it's high enough to cover your expenses!
To be very clear, anyone who tells you these types of businesses are a waste of your time is an idiot, and you should ignore them. A profitable business turning over a few million in revenue supporting a small team (and growing at some small(er) rate or staying flat year-on-year) can be a fantastic founder outcome, it just isn’t (necessarily) a good one for a venture capital fund.
However, you will probably have a hard time raising institutional venture capital (or even angel money), and likely (IMO) you shouldn’t be raising any money anyway.
That doesn’t make them a bad business – everyone has their own limitations, and the limitations that come with venture capital are not to be ignored (exits are important, optics are important, fundraising cadence is important, you have to do board reporting, …).
‘Specialist tools’ aka other stuff not really covered
There are always exceptions to the rule though. For example, is Twilio a core source of truth? Not really. Nor is it 'just' for one particular line of business. A lot of ‘dev tools’ can fit in here.
A lot of those kinds of tools that interact heavily with core sources of truth are also in a weird zone. They might be quite a specific microservice, but they're still very much a necessity for a part of the business to run, and touch many roles without someone being 'directly' responsible for them. Zapier being a core service that is the “glue”/”pipe” between other services is probably a good example of this.
I don’t have a good concept of exactly how to describe some of these groups, but maybe a future update to the post will be needed when I work it out one day.
Understanding what you want in business
Ultimately, it’s important to understand and agree as a founding team what kind of software you’re building, and what kind of journey that you want to take.
No matter what you’re building, founding a company is a long journey, and you need to be passionate about the space you’re in and the problem you’re solving.
From an investor perspective, we want to partner with founders for a long time, but we still have to manage our own investors’ needs and perspectives (we manage the money of others after all!).
That means sometimes we end up not investing in businesses we don’t think will generate the returns we need to make our business a success.
We could always be wrong – and please prove me wrong and then email me and make me feel guilty! Every investor will tell you with regret about the companies that they didn’t invest in for some reason but turn out to be huge, and I will definitely have some (hopefully not many).
As a founder though, it’s not up to us to dictate what the right journey looks like for you. If you’re planning to take a massive swing and build a huge company, we want to be there shoulder-to-shoulder with you. But equally, aspiring to make a profitable business that supports a small team is just as great an outcome for many entrepreneurs – and is not easier or ‘better’, just different.
Either way, we look forward to meeting, helping and hopefully funding many of you along the journey!