While market conditions may not be as favourable as they were pre-pandemic, software deal activity is still expected to increase into 2025. Recently announced interest rate cuts and declining market volatility have brought dealmakers back into the playing field. And the software industry, a steady source of technological innovation, is poised to expand its share of private equity investments with a wave of opportunities rapidly emerging around a growing AI and Generative AI ecosystem.
As software investments continue to gain share of total private equity and venture capital investments—15-20% of capital allocations over the last three years, up from 8-12% of capital invested from 2011–2017—software investors and portfolio company leaders must adapt to changing market expectations for the industry to successfully generate returns.
Over the last two years, the software market's focus has shifted from rewarding high growth at all costs to emphasizing disciplined growth rooted in strong unit economics. From Meritech’s research of next twelve-month revenue multiples going back to 2017 (Link), it becomes clear that more holistic measurements of growth and operating efficiency—like the industry’s ‘Rule of 40’ stating that a software-as-a-service (SaaS) company’s combined annual growth rate and operating margin should be at least 40%—have become better indicators of software valuations.
As a result, we have seen public SaaS companies shift their focus toward efficiency, with forward growth rate expectations decreasing dramatically and free cash flow margins rising across the board. This shift in priorities indicates that investors are placing greater emphasis on balanced growth and profitability rather than just top-line expansion.
For software investors—who have historically underutilized operational interventions relative to their peers investing in other industries—this signals that the time has come to revamp the traditional operating playbook for their software investments.
Unlocking Software value with a new playbook
While private equity firms over the last decade have increasingly adopted a more hands-on operational approach, software investors have historically been less directive. Given the shifting valuation dynamics of the industry, software investors will need to adopt a more aggressive value creation playbook to deliver the same returns to limited partners.
As the world’s largest system integrator and a leading go-to-market and operational partner to software companies, there are four things that we are seeing software investors adopt to best position their investments for successful exits in this evolving landscape:
1. Craft market-winning investment strategies that deliver measurable outcomes
Pressures on IT spending, accelerated innovation, disruption via AI and increasing regulatory scrutiny are rapidly shifting the dynamics of the software industry. Placing bets in the right software areas is critical for technology investors looking to avoid fighting an uphill battle to deliver returns on their investments. We identified three major archetypes for attractive software investments:
A. High demand and fragmented segments: Software segments like cybersecurity, data & analytics, and sales & marketing technology will continue to be major focus areas for IT spend, while providing private equity firms sufficient opportunity for organic and inorganic growth.
These segments will present consolidation opportunities for investors and operators looking to execute bolt-on acquisitions—with minimal threat of regulatory scrutiny—while they design solution suites with cross-sell initiatives across targeted customer segments.
B. AI-Led product enhancements and rurnarounds: Many market incumbents will find themselves in a race to embed new AI capabilities into their products as the rate of AI-led market disruption accelerates. For companies struggling to achieve operational efficiency—particularly public software businesses under quarter-to-quarter market scrutiny—commitment to these medium-to-long term product investments will be challenging.
Private equity firms will be crucial to the success of these companies. By providing essential capital and strategic guidance, private equity firms can enable businesses to reinvest in core products and platforms, prioritize returns on AI initiatives and access specialized talent. This support will be instrumental in developing and executing a revitalized product strategy and AI roadmap, unburdened by the pressures of public market scrutiny.
C. Resilient IT spend categories: While growth has slowed across many IT segments, software investors can continue to develop winning strategies in stable spend categories.
Mission-critical business applications such as ERP and infrastructure solutions like cloud platforms or databases will continue to be necessary spend items for enterprises. Software investors can target these as candidates for improved operational efficiency.
2. Boost growth with leaner go-to-market and R&D
Growth has become increasingly challenging and costly for software companies. On the demand side, extended sales cycles and more demanding buyers have led to rising sales and marketing (S&M) expenses relative to new annual recurring revenue (ARR). On the supply side, growing competition and pressure to innovate AI capabilities have caused research and development (R&D) costs to balloon.