From time to time, we’ll share our views of what we’re seeing in the market for software venture capital. Below is the latest.
AI first gets a premium. A lot of companies are claiming they are AI. Really they’re just software. But they’re asking for and getting premium valuations in the 15x to 20x ARR range. Classic SaaS seems much more grounded at 6x to 8x current ARR. We do believe claims of AI may be creating a situation whereby investors may end up stuck with over-valued equity, similar what happened to the capital deployed in 2022.
Unhealthy focus on profitability. Many companies are focusing too much on profitability, whereas there are still funds like us that want to invest in companies generating cash efficient growth. In our view if you can add $0.60+ of high quality net new ARR for every $1 of operating loss, as long as NDR is 100%+, do that! We’ll gladly fund it. That’s a company with a payback period inside 2 years and building a SaaS revenue stream that looks like an annuity. A business like that doesn’t need to be nor should it be profitable. Build that SaaS annuity.
M&A supports strong multiples and cash break-even. Since December 2020, there have been 37 acquisitions of publicly traded software companies we’d call healthy. The businesses on median sold for 8.4x trailing twelve month revenue, had good growth given their size (19%), and slightly positive EBITDA margins (6%). The market is still there for cash break-even or cash efficient burning businesses so long as you’re growing cash efficiently.
Public markets support healthy multiples. Of the publicly traded SaaS companies we follow, the median public SaaS business is trading at 5.9x revenue while the average is 8.6x. Multiples for SaaS companies growing above their peers trade at 8.9x on median and 12.3x on average. The wide spreads between medians and averages indicate premium SaaS companies with wonderful growth are really getting great valuations. Additionally, these are good, healthy multiples more akin to a 2018/2019 environment. Absent another pandemic, we’re not going back to 2020/2021 multiples.
M&A window is open. If you want to sell your company you can and will. The M&A market is active and transactions are at an all time high according to Software Equity Group’s latest data.
Still a complex sales cycles. SaaS companies continue to see the sales cycle elongating, more scrutiny in the sales process, more senior personnel from the customer side in the sales process, and customers being tighter with their budgets. Budgets are not shrinking, but they are being scrutinized by more personnel at the customer. It does seem that buyers have stopped asking “does this have AI” and are instead returning to “tell me about the ROI”.
The hiring market continues to be rich. There are talented engineers, sale reps, product people etc that need jobs. Level-up your talent if you have the capital. We do keep reading about large companies doing layoffs because AI is replacing humans, but we’re skeptical of that and think in some cases it’s a convenient cover. While we see AI very much augmenting and improving productivity, we don’t see it replacing individuals at scale either in the data or anecdotally.
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