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For software entrepreneurs looking to redefine age-old industries like Manufacturing, Legal, or Transportation industries, the opportunities remain enormous. Since 2014 our firm has released a point of view on 10 distinct industry verticals ripe for disruption, and in this year’s edition we continue to see a lot of opportunity. We also came across four interesting surprises:

1. Funding for vertical software startups has seen an uptick through 2016. While the IPO market for software companies in general has stayed cool, we were surprised to see vertical software markets like Healthcare, Manufacturing, and Agriculture continuing to be red hot through 2016. In the Healthcare space, Flatiron Health raised a $175 million Series C round in early 2016 at a $1.2 billion valuation, allowing it to achieve the ranks of unicorn status. Manufacturing software leader Airware raised over $100 million in 2016 in several tranches, valuing the business close to a billion dollars. Agriculture has seen increased growth in agri-tech focused funds, with overall investment doubling through 2016 to reach ~$4.6 billion of invested capital in the space. Follow-on rates continue to go higher, paid-in capital numbers are increasing, and the overall sentiment continues to favor vertical software companies at the application and infrastructure level. Even despite mixed performance in 2016 from the M&A and IPO market, vertical software players continue to reap the benefits of early stage investor demand.

2. Private buyouts of publicly traded vertical software companies dominated this past year from an M&A standpoint. Amazingly, we count six major vertical software buyouts for a combined total of $13.1 billion through the back half of 2016. The bulk of activity this past year has been buyouts by large private equity funds and strategic players looking to roll up best-of-breed vertical software companies at compressed valuations. Construction management software vendor Textura, which had its IPO in 2013, sold to Oracle this year for $663 million. Fleetmatics, a hallmark vertical software IPO in 2012 focused on the transportation space, announced its acquisition by Verizon for $2.4 billion in early November. DealerTrack, Epiq Systems, Vertafore, and PGA Holdings also went public and were bought out through 2016. The market continues to see new M&A players looking to buy growth and strategic advantage, which should create enormous opportunities for vertically minded software founders.

3. Entrepreneurs should pay serious attention to the massive growth within the cannabis vertical software space. Many would be surprised to learn that, as of the beginning of 2016, the US market for legal marijuana had by most measures already well surpassed $3.0 billion. But Election Day this year was a game-changer, as four states joined the existing four (plus DC) in effective recreational legalization, and many other new initiatives brought the total number of states with some sort of legally acceptable use up to 28 (plus DC). As a firm, we see marijuana spending eclipsing $10 billion within five years, with significant upside given recent upswells in popular support for the end of prohibition (now a majority of Americans). Consumer-facing retail technologies, the most visible sub-sector in the space thus far, are only the beginning; the opportunity spans wholesale, logistics, compliance, testing, security (especially physical), and the full ERP gamut. Investor appetite in the space is also turning the corner. Though traditional private equity has been reluctant so far (with notable exceptions like Privateer), only ~70 percent of cannabis businesses were bootstrapped in 2016. Outside of regulatory issues, the cannabis technology market’s biggest current challenge is a dearth of capable founders, something we hope (and project) will change fast as we move into 2017.

4. Unicorns remain rare in vertical software. Of the 108 upstarts that achieved unicorn status in 2015 and 2016, we were surprised to see only seven vertical software companies among them. ZocDoc entered the ranks of unicorn startups in the middle of 2015 with a valuation of $1.8 billion, followed by Flatiron Health with a $1.2 billion valuation in early 2016. Ministry Brands, a software platform for the Religion vertical, was recently valued at $1.5 billion after an investment by Insight Venture Partners. SMS Assist in the Real Estate vertical, Quanergy Systems in the Transportation & Logistics space, Uptake in the Manufacturing space, and BenevolentAI in the Healthcare space all reached the billion-dollar milestone in valuation in 2015 and 2016. While vertical software companies now make up only 6 percent of unicorns, they have still doubled the number in our 2014 report of three unicorns. This should give promise to founders that are interested in building the next unicorns in the vertical software space.

Overall, the vertical software market is continuing to grow as companies have a desire for technology products tailored to their industry-specific needs. Gartner views vertical software as the largest software category at ~$122 billion and one of the fastest growing software market segments. With many successful IPOs and increased market demand coupled with investors targeting the space, entrepreneurs who are positioned for continued differentiation across their industries should see measurable success in upcoming years.

Mike Brown Jr. is General Partner at Bowery Capital.

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