This piece is about investing in vertical market software (VMS)—software built for one specific industry, like restaurants or auto repair. Guest Dave Yuan says the moat comes from being the "last system a merchant would turn off"—the one holding the most important data or daily workflow. The real home run is expanding from one part of the value chain to another, e.g., from serving insurers to serving repair shops. Key holdings: Toast (restaurant POS, helped eateries survive COVID via online ordering), CCC (from auto insurance to repair shops, building an online parts marketplace), and FareHarbor (activity booking platform, charged consumers 6-7% fee, sales reps got 50% of first-year revenue as commission, later sold to Booking).
Dave Yuan (Founder of Tidemark Capital) systematically elaborated on the investment framework for vertical market software (VMS) in a podcast. Core thesis: VMS serves small and medium-sized businesses (SMBs) through industry-specific functionalities, with its moat derived from control points (e.g.,
Dave Yuan (Founder of Tidemark Capital, former TCV Partner, board member of Toast and Karbon) systematically articulates an investment framework for Vertical Market Software (VMS). Core thesis: The moat of VMS stems from the "Control Point"—i.e., the system that stores the most critical data, hosts the core workflow, and is the "last system a merchant would shut down"; true excess returns come from the ability to extend from a single control point upstream and downstream along the value chain.
Dave Yuan argues that the essence of VMS is "software built for a specific end industry," with its core concept being the "control point."
The control point consists of three types of "gravity":
> "If you have to shut down all systems to close for business, which system is the last one you turn off? That is your account gravity." — Dave Yuan
Key Distinction: VMS is not the same as SMB. While most VMS solutions serve local merchants (restaurants, hotels, retail), there are also cases serving large enterprises—such as CCC (where Dave Yuan previously served on the board), which sells to the largest auto insurance companies in the United States.
Dave Yuan points out that evaluating VMS opportunities requires prioritizing three variables, which determine the company's structure and investment strategy.
| Assessment Dimension | Core Question | Impact on Strategy |
|---|---|---|
| TAM (Total Addressable Market) | 800,000 to 1 million restaurant locations in the U.S. vs. laundromats? | Large TAM resembles a horizontal market, requiring aggressive expansion; small TAM demands meticulous cultivation |
| Competitive Intensity | Number of suppliers and market structure | Large TAM typically faces fiercer competition, positively correlated with TAM |
| Industry Growth Dynamics | Speed of industry change, frequency of merchant software replacement | In stable industries, only about 5% of merchants reassess software annually, making customer acquisition opportunities scarce |
Key Insight: A VMS public company CEO once described his market—"Only about 5% of merchants reassess their software each year. My job is to see every sales cycle and win 75% of them." This means VMS customer acquisition strategies are "measured," unlike the S-curve expansion of horizontal SaaS.
Dave Yuan identifies "trust" as the most nuanced yet highest-return variable in VMS investing—it determines whether a company can expand from serving one link in the value chain to serving the entire chain.
Mechanism Breakdown:
Why Trust Matters:
> "If you go from auto insurance to auto repair shops, you are now selling software to both sides of the transaction. This industry has existed for a long time, with various interaction stages between the two sides, requiring you as a service provider to build trust over the long term." — Dave Yuan
Reader Note: Dave acknowledges this is the "most frontier" variable, difficult to underwrite, but with enormous returns once successful.
Dave Yuan argues that VMS marketing strategies differ fundamentally from horizontal SaaS—the core lies in leveraging local network effects.
Dave Yuan distinguishes between gross retention and net retention, noting that VMS retention logic spans both enterprise software and consumer businesses.
| Retention Type | Definition | Typical VMS Range |
|---|---|---|
| Gross Retention | Customer count retention rate | SMBs typically below 90% |
| Net Retention | Gross retention + expansion from existing customers | Must exceed 100% to change the economic model |
Three drivers of high retention:
1. Control point gravity: The stronger the data/workflow/account gravity, the less likely customers are to churn.
2. Individual retention: If Joe fails at his lemonade stand and switches to a taco stand, retaining Joe himself counts as retention—this is a “consumer mindset.”
3. Broad and cheap customer acquisition: If gross retention is 60-65% but acquisition costs are extremely low (e.g., linear TV ads), it is still acceptable—consumer businesses often have only 20% retention.
> “If you have 60% retention, that’s catastrophic in the enterprise market—a leaky bucket. But if you have broad and cheap acquisition channels, it’s more like a consumer business. Any consumer business would trade a 20% retention rate for 60%.” — Dave Yuan
Dave Yuan emphasizes that VMS founders must adopt a multi-product mindset early on — this contradicts the traditional advice of "focusing on one thing at a time."
Meaning of Multi-Product:
Pricing Strategy:
Dave Yuan uses two cases to illustrate the "art" rather than the "science" of VMS — the creative combination of pricing, product, and GTM.
Dave Yuan argues that the core of VMS valuation lies not in exit multiples, but in the "Location × ARPU" construction of the P&L.
Key valuation variables:
Market maturity assessment:
| Position | Guest Stance | Key Data |
|---|---|---|
| Toast | Bullish (Board Member) | Helped restaurants survive during the pandemic via online delivery; POS + payment integration, 1+1=5 |
| CCC | Bullish (Former Board Member) | Expanded from auto insurance companies to repair shops, building an online parts marketplace—the "strongest expression" of value chain extension |
| SiteMinder | Positive Case | Integrates with 97% of global hotel PMS, disrupting traditional control points through an "integration and encirclement" strategy |
| FareHarbor | Positive Case | Charges consumers a 6-7% buyer fee; sales reps receive 50% commission on first-year booking revenue; eventually sold to Booking |
| AppFolio | Positive Case | Extends from property management to equity holders and creditors, building a "single source of truth" across the value chain |
| MindBody/ClassPass | Research Case | Integration logic of operating system + marketplace, but complex monetization issues in actual execution |
| ZipRecruiter | Research Case | From job distribution tool → building own candidate pool → heavy investment in consumer brand, proving "no shortcuts" |
| Square | Mentioned | Instant deposit feature (allowing merchants to receive funds immediately instead of waiting 3 days); very low risk but highly profitable |
| Intuit/Xero | Mentioned | Serving "one-person businesses" (FDE of 1); naturally lower gross retention, but compensated through individual retention |
| OneStream | Mentioned | Horizontal business, but the "single source of truth" concept also applies to VMS |
1. Control Point Definition (Dave Yuan): The core of VMS is not "industry software" but "the last system a merchant would shut down"—composed of data gravity, workflow gravity, and account gravity.
2. 5% Rule (Dave Yuan quoting a CEO): "Only about 5% of merchants reassess their software each year"—VMS customer acquisition strategies must be "measured," unlike the S-curve expansion of horizontal SaaS.
3. Trust as a Moonshot Variable (Dave Yuan): Extending from one layer of the service value chain to another requires long-established industry trust—the gap between success and failure can be "orders of magnitude."
4. Individual Retention (Dave Yuan): If Joe fails at a lemonade stand and switches to a taco stand, retaining Joe counts as retention—VMS requires a consumer mindset, not a purely enterprise mindset.
5. FareHarbor's Triple Innovation (Dave Yuan): Pricing (charging buyer-side fees to consumers) + Product (building websites for clients during the sales cycle) + GTM (sales reps earning 50% commission on first-year booking revenue)—the combination created an advantage competitors could not replicate.
6. Multi-Product Thinking Must Be Early (Dave Yuan): VMS entrepreneurs need to "think several steps ahead"—this contradicts the traditional advice of "doing one thing well at a time," but it is an inherent requirement of VMS.
7. ARPU Construction Determines Deal Quality (Dave Yuan): The difference between a 20% vs. 100% payment attachment rate can turn a good deal into a mediocre one—investors must deeply understand the actual penetration rate of each add-on product.
8. Time Horizon Determines Success or Failure (Dave Yuan): The VMS market turns over slowly, and the best investors need an extremely long time horizon—some of the best VMS companies have been operating for 30 years; otherwise, you will be driven by multiples rather than P&L.