This article was published in Evercore’s 2020 State Of The Market report. 

Written By Mark Strauch, Partner at Alpine and Co-Founder of ASG, and Jake Brodsky, Principal at Alpine and Co-Founder of ASG.

Software as a service (SaaS) has become the predominant delivery model for application software since the technology first emerged in a mainstream way about 20 years ago. Over the last five years, we believe an attractive new investment opportunity has emerged in the small-cap SaaS market which we refer to as ‘SaaS 2.0’.

‘First-generation’, or ‘SaaS 1.0’, businesses such as Salesforce, Workday, and Netsuite achieved great success targeting massive end markets like customer relationship management, enterprise resource planning, and human capital management. We observed that they built large, feet-on-the-street salesforces that sold to customers across a wide horizontal array of industries and they raised substantial amounts of venture capital because the businesses were loss-making for many years as they built up necessary infrastructure to scale. Years later, these businesses would go public and generate remarkable returns for their investors. In 2016, Netsuite, then a public company, was acquired by Oracle for $9.3 billion. The market capitalisation of Workday [NASDAQ: WDAY] currently sits at $53 billion, while Salesforce [NYSE: CRM] is valued at a staggering $237 billion. These venture-backed, horizontal software success stories are indeed impressive and many other companies aspire to follow a similar model.

Over the last ten years, however, we have seen the emergence of a different, SaaS 2.0 profile. Advances in cloud infrastructure, the digital transformation of customer behavior, and the broad acceptance of SaaS across more and more industries have led to a materially different archetype — one that describes tens of thousands of new, up-and-coming businesses that are distinct from their 1.0 predecessors in four important ways. These new businesses are (i) vertical, (ii) profitable, (iii) not based in Silicon Valley, and (iv) not in need of venture capital. It is these four defining characteristics, in particular, that make SaaS 2.0 such an interesting — and, as it turns out, overlooked — small-cap investment opportunity.


Some historical context helps to underscore the significance of this new market development. Commercially available business application software first emerged, in primitive form, in the 1980s. The technology architecture of the time was dominated by mainframe computers — massive, complex, centrally located machines from vendors like IBM, UNIVAC, Honeywell, and Burroughs that mainly ran record-keeping software. The mainframes were connected to a number of ‘dumb’ terminals used by select employees to perform basic administrative tasks. Thanks to the advent of personal computers and local area network (LAN) technology, the 1990s ushered in a new ‘client–server’ architectural paradigm. Although systems were still powered by sophisticated and expensive central minicomputers called servers provided by hardware vendors like Hewlett Packard and Sun Microsystems, they were now connected to PC ‘clients’ with more local processing power than their dumb terminal predecessors.

Most people know the rest of the story. An English computer scientist named Tim Berners-Lee created the World Wide Web in 1989. Then a Silicon Valley start-up named Netscape launched the first Web browser software in 1994. In the years that followed, the Web rapidly progressed from a novelty encyclopedic resource and outlet for self-publishers to a commercial technology platform that would support an ever-growing variety of business applications at scale.

Many believe it was Google CEO Eric Schmidt who, on August 9th, 2006, first coined the term ‘cloud computing’ at an industry conference. Cloud computing — ironically, a back-to-the-future client–server architecture — was the force behind a broad range of new SaaS applications becoming available via browser over the Web. These applications came to be viewed as better, faster, and cheaper than their more complicated on-premise software ancestors. They were fundamentally more scalable, easier to use, and less costly to deploy and maintain — all while offering customers flexible payment models. The single instance, multi-tenant architecture of SaaS was officially born.


Bolstered by an increasing number of SaaS 1.0 success stories and the growing realisation that ever-greater processing power and connectivity were inevitable, two additional accelerants paved the way to SaaS 2.0 prosperity as we now know it:

• First, Amazon’s AWS made it easier than ever before to start a SaaS software company. With AWS (and also Microsoft Azure and Google Cloud) providing on-demand development infrastructure and Web services, independent software vendors located anywhere could now focus entirely on building the business features and functions that really mattered, leaving the necessary but undifferentiated technical plumbing to ‘the cloud’. In the US, this development led to a dramatic democratisation of SaaS business formation, with start-ups emerging all across the country outside of traditional technology hotbeds. Figure 1 demonstrates the “Amazon Effect” – the growth of AWS and other cloud infrastructure providers.

• Second, the emergence of faster and cheaper online customer acquisition models rapidly shortened time to profitability. For many businesses, online customer acquisition began to replace the more expensive, traditional feet-on-the-street model. The ubiquity of Google search and the new science of search engine marketing and optimisation led to free-trial business models that could quickly and easily expose prospective customers to a bevy of SaaS alternatives to meet their business needs.

As a direct result of these two developments — and emboldened by the growing popularity of the lean start-up ethos — SaaS 2.0 businesses began to sprout up everywhere. We believe the 2.0 cohort began to emerge around 2005 across literally hundreds of different industry niches. We now estimate that there are approximately 20,000 businesses today in the small-cap SaaS market, and many of these businesses have now come of age and achieved a scale that is addressable by professional investors. In the US alone, there are over 700 different market segments and sub-segments to choose from (see Figure 2). As Marc Andreessen famously predicted, software really was ‘eating the world’.

But here’s where it gets interesting. In general, these businesses are incredibly capital-efficient, which stands to reason in light of the structural advantages inherent in SaaS 2.0 business models. As a result of this capital efficiency, a large number of these businesses are bootstrapped rather than VC-funded. We believe that means there are tens of thousands of growing, profitable, attractive SaaS businesses that, by and large, are not on the institutional radar. In our view, many private equity firms have become too large to make smaller-cheque investments in these emerging businesses. Recently, many PE firms have formed ‘down- market’ funds to endeavour to compete, but their large-scale methods are ill-suited to the unique needs of this SaaS 2.0 world; furthermore, the long tail of deal-sourcing and hands-on talent requirements to serve this niche take many years to develop and refine. Figure 3 shows the distribution of software companies by size, with 64% of businesses having ARR under $15m.


First, SaaS 2.0 is vertical. Most of these businesses provide highly tailored software for a specific set of vertical market customers rather than generic horizontal solutions for broad functional needs like customer relationship or supply chain management. SaaS 2.0 is software narrowly suited to dentists, or lawyers, or plumbers, or digital marketing agencies, or hair salons, or mental health agencies, and so on. The SaaS 2.0 solutions generally deliver industry-specific data benchmarks, pre-defined metrics and KPIs, customized workflow, and industry-specific compliance capabilities. Software that embeds these capabilities tends to fit like a glove for a set of customers with invariably similar requirements. As a result, we see customer retention metrics for SaaS 2.0 companies frequently exceed 90% and revenue retention levels can surpass 100%.

Second, SaaS 2.0 is growing and profitable. Many of these businesses enjoy very high lifetime customer value (LTV) because customers rarely churn. Not only that, the customer acquisition costs (CAC) can be relatively low because domain-specific vertical SaaS business are more familiar with the peculiar needs of their customers and where to find qualified prospects who have those needs. By serving a homogeneous set of customers, these businesses can stretch their R&D dollar further. LTV/CAC ratios of SaaS 2.0 businesses can often exceed 5.0, whereas we believe traditional SaaS 1.0 companies have tended to view anything above 3.0 as exceptional. What’s more, SaaS 2.0 businesses have consistent and predictable Rule of 40 potential. Businesses that satisfy the Rule of 40 — a measure of attractiveness that calculates the sum of revenue growth rate and EBITDA margin — are generally among the most highly valued SaaS businesses in the world. See Figure 4 for a distribution of a select group of public companies, highlighting valuation multiple versus Rule of 40 score.

Third, SaaS 2.0 businesses are more likely to be based in Denver or Kansas City than Silicon Valley or San Francisco. The founders of these companies have typically built their careers in their specific vertical domain, not in high-tech. They have grown up learning the unmet needs of their customers in a very direct, experiential way. Because these market niches are highly self-referencing, SaaS 2.0 founders can sometimes become very well known in the customer community as trusted advisors providing best practice advice in the form of technology workflow. Residing in non-traditional technology geographies usually means less competition for talent. On the flip side, however, companies in these geographies generally have a tougher time attracting the elite leadership talent a business needs to reach the next level of growth.

Finally, SaaS 2.0 businesses choose to forego venture capital funding. Instead, these founders are able to self-fund from profits generated by the business or with relatively modest sums of early capital investment. As a result, it is not uncommon for SaaS 2.0 founders to reach a point – we believe often between $3m and $15m ARR — where they seek liquidity, need professional expertise to scale further, and recognize that their own conservatism risks holding the business back. The demands of running a growing business can begin to take a toll. Many times, the founder wants to be liberated from the day-to-day management burden to focus on what they know and love the best — whether it’s writing code, serving as Chief Customer Officer, or developing new strategic partnerships or M&A. As SaaS 2.0 founders reach a point where they are contemplating a sale or recapitalization, they do not always enjoy wide access to alternative capital provider partners. Some of these SaaS businesses are ‘off the grid’ and have limited, if any, investment banker representation. As a result, the successful investor in SaaS 2.0 must be proactive, engaging in extensive market mapping research and direct outreach for deal origination. When seeking the right investor partner, SaaS 2.0 sellers care about factors such as hands-on operatingcapabilities, access to elite leadership talent, and ability to execute add-on acquisitions. It’s important to remember that bootstrapped founder-led companies are closely held businesses for whom cultural fit is a top priority. The right investor partner must both understand how to honour the legacy of what already exists, while being able to introduce the changes necessary to take the business to the next level of growth.


At Alpine Investors, we launched ASG — Alpine Software Group – to meet the SaaS 2.0 needs that exist between venture capital and traditional buyout. Since ramping up initial operations in 2017, ASG has completed 30 acquisitions across nine different vertical SaaS categories. The business has become a pathway to invest in a diversified set of compelling SaaS companies.

ASG has a dedicated corporate development team and a research-heavy process for market mapping and deal origination. Thousands of companies in the ASG database are contacted and updated on a regular basis. ASG positions itself as an alternative to ‘selling out’ to a traditional PE firm or ‘giving up’ to a massive strategic buyer. Over time, ASG has concentrated its capital deployment into vertical segments that show particular promise, allowing these businesses to scale faster. In addition to sourcing, ASG offers leadership talent to its companies by matching operating executives trained in the SaaS metrics playbook with each company. We believe that investing in small-cap SaaS requires substantial human capital – beyond the typical PE advisory model – because these businesses generally have thin teams and underdeveloped leadership talent pools.

Every ASG business runs off of the same financial reporting and administrative back-end systems. Because the operating fundamentals of all vertical SaaS businesses can be consistently applied no matter the end market, every ASG business is measured against standard SaaS performance indicators such as the LTV/CAC ratio, SaaS magic number, R&D efficiency, and the Rule of 40 (see Figure 5). The ASG businesses have grown organically, have typically integrated at least two add-on acquisitions, and have professionalized their business practices to create attractive financial profiles.


SaaS 2.0 is a lasting and long-range opportunity that is still unfolding in today’s investment markets. With a growing number of interesting investment opportunities, more investment firms are likely to follow a similar course. And yet, the unique aspects of this small-cap universe require a long-term commitment and a differentiated, hands-on approach in sourcing and talent, in particular. We believe the vertical SaaS category will continue to expand as new segments emerge and native SaaS entrants compete. In addition, we expect to see more and more migration to the cloud from traditional on-premise providers, providing further opportunities for the experienced SaaS 2.0 investor. Whether in the form of native SaaS or cloud migration, we expect the growing business demand for highly tailored, easy-to-use, mission-critical SaaS 2.0 software will continue for years to come. Further, we believe the ever-growing roster of multi-billion-dollar software buyout funds and publicly traded strategics will continue to provide an abundance of competitive exit alternatives for those businesses to land.

This article is provided for informational and educational purposes only. It does not constitute investment advice and should not be construed as an offer to sell or a solicitation to buy securities. The views and opinions expressed are those of the authors as of the date of this article, and such views may be subject to change after such date. Any forward-looking statements are as of the date of this article, and are subject to uncertainties.

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