Software Revenue Growth Slows: Is the Trend Reversing?

Record Startup Funding and the Value of Software Revenue

Globally, startups are currently securing unprecedented levels of funding, a trend driven by a confluence of factors. As previously discussed, historically low interest rates have empowered venture capitalists to raise larger funds than ever before.

These reduced rates have also benefited startups by influencing investor behavior. With diminished returns from certain asset classes, investors have increasingly sought growth opportunities, particularly within the technology sector.

In recent years, public software companies have attracted significant investment, leading to record-high valuations based on their revenue. This, in turn, positively impacted the valuations of private tech companies, as comparable revenue multiples steadily increased.

However, this period of sustained growth may be nearing its end.

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I have deliberately refrained from extensively covering software revenue valuations for several months, having dedicated considerable time to the topic in prior quarters. The observation that simply updating numerical values could yield a similar analysis prompted a necessary pause.

Nevertheless, the recent performance of software revenue valuations has been remarkable, and the data warrants attention.

The Astounding Rise in Software Revenue Multiples

The rate at which software revenues were revalued upwards in recent years is truly exceptional. According to the Bessemer Cloud Index, the median revenue multiple for public SaaS companies stood around 5x in 2016.

By the beginning of 2018, this multiple had expanded to approximately 7x, representing a 40% increase in valuation.

This increase proved to be merely a prelude to even greater gains.

By the close of 2019, the median figure had risen to around 9x. Currently, it stands at just under 18x. This surge in valuation is a primary reason why software companies have been able to secure funding more readily, at earlier stages, and in larger amounts.

In mid-2016, each dollar of recurring revenue generated by a software company corresponded to a market capitalization of $5. By the end of 2019, that same dollar of revenue was valued at $9. Today, for the median public software company, its value is approximately $18.

While nuances exist within the data, the overarching trend is clear: the median value of SaaS revenues more than tripled between 2016 and 2021 – an extraordinary level of growth.

A Plateau in Growth

Recently, however, this upward trajectory has begun to stabilize. The following chart illustrates the history of SaaS multiples:

As the chart demonstrates, the pandemic provided a significant boost to the value of software shares, and consequently, to tech startups in general. Software remains the dominant product category for startups, with SaaS being the most prevalent business model.

It’s important to note that the disparity between multiples for low-growth and high-growth companies has widened, although a more detailed mathematical analysis has not been conducted.

Here’s a further perspective on the current situation:

Acknowledging the technical nature of this analysis, we observe that the value of low, mid, and high-multiple SaaS companies has each established a relatively stable trading range following a period of growth since early 2016.

Implications for Startups

What does this mean for startups? It does not signal the end of favorable valuations or continued investor interest. Instead, it suggests that the period of rapid improvement may have passed, and the current positive conditions are likely to persist.

This is a bullish indicator, as valuations remain at record highs relative to underlying revenue. However, the momentum may have peaked.

As noted yesterday, a substantial market correction would be required to fundamentally alter the landscape for startups. Structural factors have made technology revenue more attractive than historically observed. The resilience of multiple gains further supports this argument.

Even significant declines in revenue multiples would still leave the value of software companies at elevated levels.

Currently, investors are paying a premium for recurring revenue, with prices that are exceptionally high. Many companies within the analyzed dataset are unprofitable, yet median revenue multiples for public software companies exceed the historical median price/earnings ratio for the S&P 500.

This valuation level is arguably excessive.

Looking ahead, predicting future trends remains challenging. However, the relative stability observed over the past several months suggests that the upward movement of SaaS multiples has likely concluded for the time being. These conditions continue to represent a favorable environment for startups.