vSaaS Payments Strategies
Square, margin improvement, and rollups
Toast and Shopify infused the vertical SaaS category with a TAM-expanding thesis: Payments can catapult vertical SaaS companies to become multi-billion dollar categories. And for most companies, payments are also the starting point in the pursuit of additional fintech revenues. Getting a customer to switch to your payments product gives you a clear line of sight into other organic growth opportunities. Toast Capital, their lending product, made 26 million in profit in Q1. Payments and fintech is a meaningful revenue driver and has scaling margins with more payments volume.
At the same time, many vSaaS companies might be able to achieve 5-10B in GPV, but have no clear path to scaling to Toast levels around 100B in gross payments volume.
There are two hypotheses I have for the SMB segment:
There should be some kingmakers in the Series D+ and in PE advocating for transactionally-focused vSaaS to do M&A across vertical segments.
And if you’re a fan of a bit more complexity, there’s an opportunity to run the Xplor and Evercommerce playbooks at an ever grander scale to create 50B dollar vertical SaaS giants.
The players whom are already pursuing this are some of the more brilliant rollups out there.
Volume and Take Rate
The reason is pretty simple: payments volume increases bargaining power in payfac negotiations.1
Right now payments facilitation is effectively an economic oligopoly comprising Stripe, Global Payments, Worldpay, Fiserv, and Adyen.2
And all of them are aware of how crucial embedded payments is to their continued success.
Their calculus is relatively simple: if you sign vSaaS platforms that are capable of explosive growth, you effectively redirect payments volume formerly on an independent Clover terminal into your ecosystem.
Patrick Collison is very optimistic about vertical SaaS no doubt in part because of this dynamic.3 Shopify’s explosive growth, after all, was critical to Stripe’s own explosive growth.
In exchange for giving you the infrastructure to embed or facilitate payments, all of these providers are going to have some take rate for their service. That take rate tends to scale down with volume. And most will have some tiering linked to the volume that informs their take rate.
What that means is that there is meaningful room for unit economics improvements on payments - quite literally next-to-free margin improvement by consolidating several 1-5B GPV vSaaS companies under a single payfac.
The more bargaining power (payments volume), you have consolidated, the more effectively you can negotiate these conversations and improve margins.
This is effectively the strategy that Quilt and Fullsteam are both pursuing.
Sure, you might have to be willing to go through a migration to a new processor to really make good on your newfound bargaining power. But most likely, your acquisition base will already be scattered across different payfacs - so to get the margin improvement, you’re already doing a conversion of sorts. Just go where you are most wanted.
And even if you aren’t a believer in fully converting your customer base all over to one payfac, there’s still massive benefits to be had from newfound bargaining power with a multiprocessor strategy.
At the very least, you will get meaningful margin improvement on existing payments volume as well as accrue efficiencies in the GTM motion.4
Wholly Own the Processor
The second strategy: Don’t just get margin improvement, get the whole margin. We have a payments oligopoly, but there are of course plenty of independent PSPs looking to adapt their entire payments strategy towards embedded payments.5 All of them also realize the power of embedded payments for their business model and likewise are making a run at vSaaS.
Plenty of these players have no path to claiming 5-10B GPV vSaaS companies, and yet capable of managing the volume. Their path is simply tough because they lack the name recognition and GTM to win these sorts of businesses.
Acquire one with the necessary tech, adopt the processor across the vSaaS rollup, and within years accrue massive value to the integrated company.
That’s quite literally the strategy two PE-backed rollups have done.
Advent did this with TSG (vSaaS) and Clearent (payments), creating Xplor. A string of PE/growth equity firms including PSG and Susquehannah did the same with Paysimple and various vertical SaaS companies to create Evercommerce.
The nuances within each are a bit too detailed for this piece, but the strategy generalizes to both. Bring over vSaaS payments volume onto a wholly-owned processor and accrue the benefits.
What nobody has attempted to do is to take next-generation category leaders encountering a tough slog to passing 10B in GPV in their vertical and roll them up with other next-generation players.6 This is where I think we are headed.
It’s not an easy undertaking. Navigating an integration between a vSaaS rollup and a payments company is a bit like charting a course through Scylla and Charybdis. Both have their own gravitational pull, different understandings around how to serve the customer, and GTMs.
But I do think we have external evidence for where the priority should be for these new rollups: focus on the vertical SaaS value proposition as the way to achieve high momentum and profitable growth.
Square’s Verticalization
Square has realized that the vertical solutions increase profitability and GTM efficiencies. It’s why they are pursuing rapid verticalization around three anchor verticals: retail, beauty, and restaurants.
Their entire GTM motion has shifted, from their website landing pages to their sales team:
Within sales, the work that we've been doing is continuing to shift to a verticalized software-led sales team. We've now implemented this with our U.S. inbound sales team, which is verticalized and over the next two quarters, we're going to be doing that with our U.S. outbound sales team.7
Square buys into the vertical future upon a common payments core while leading with vertical software. Yet, they will never touch the workflow fidelity that most independent vSaaS companies have achieved for their vertical. That will give any firm a massive leg up in assembling this vision and executing a strategy to surpass Square one day in GPV.
It’s a bit out of scope to detail the confusing difference between ISVs, payfacs, and hybrid models - generally I’m just going to deem all this as embedded payments, but happy to have a conversation with anyone seriously considering executing this strategy and the implications.
My personal take is that this isn’t a bad thing, quite the opposite. In fact, a super nerdy way to read the embedded payments movement is as a reckoning with the inefficiencies stemming from the ISO channel structure that previously brokered SMB payments. We are getting more efficient at distributing payments due to a) consolidation at the payments infrastructure level and b) channel consolidation through vertical SaaS.
https://greylock.com/greymatter/micro-pessimism-macro-optimism/
I don’t think this is the only reason he’s optimistic of course. Patrick Collison as one of the great modern anti-stagnationists I think also sees the massive productivity gains that we might finally be headed towards with high fidelity workflow software.
In short, there are sales efficiencies that could happen at the SMB level by increasing the potential number of businesses a field sales rep can handle within a territory. This allows you to justify field territory investment due to the increased regional sales volume and ergo get real talent out in the field that you can only justify in an industry as huge as restaurants.
If you were to take a look through the sub 10B GPV processors, most have now adapted decent APIs and a payfac strategy. The space is rapidly pricing in embedded payments and readying itself for this next strategy. One example here. This was a historic direct merchant processor, Fidelity Payments, now devoting resources to building out an integrated payments platform. These examples are myriad.
Xplor has gotten the closest - they’ve got some really good vSaaS offerings in their portfolio, especially in the health and wellness space and childcare.
From Q1 earnings.