On the heels of news that the U.S. venture capital market’s third quarter was far from catastrophic, it’s becoming clear that while startup investment has slowed, it’s still a great time to build a software company.
Thanks to a new sheaf of data from SVB, we can see quite clearly that the macro picture for IT is robust and venture capitalists have an ocean of capital to put to work. The combination appears to be supporting investment into software startups — software as a service, or SaaS, in the modern context — that will make 2022 the second-best year on record in the United States.
Some declines are evident; you won’t get 2021’s venture capital results again for some time. But that’s not stopping valuations and deal sizes from ticking higher at most well-trod startup stages. Down rounds are also in decline as venture investors react, perhaps somewhat surprisingly, to a rising interest rate environment and a general selloff in the value of tech stocks.
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Not all the data is sunny. SaaS startups may see some of their valuation gains between rounds moderate somewhat if they are busy raising today, and, yes, we will see fewer U.S. SaaS deals this year. But if you thought that 2020 was an OK year for overall startup investment, you are going to love 2022.
As a final note before we slather ourselves in data: IPOs remain a thorn in the side of the software market. However, even when we consider this particular issue, SVB has some decent news for SaaS founders. The M&A market is alive and well, and that’s putting duckets into pockets.
A rising tide
Back in April, this column noted that SaaS companies were holding up better than other startup sectors as private-market investors went from bullish to — at least publicly — more conservative. At the time, we noted a number of matters that made it somewhat unsurprising that software companies were holding onto investor favor:
At this juncture, it would be tempting to make a joke along the lines of “well, SaaS is boring and formulaic, just like VCs,” but that would be childish of us, so we’ll refrain.
Instead, let’s consider what SaaS really does have going for it: anticipated growth rates, predictable upsells and net churn, and a proven ability to handle market downturns. So, in short, SaaS is unsurprising. Mix in the fact that SaaS creates high-margin revenues, and it’s a recipe for continued venture capital interest when riskier — and more exciting — bets are less enticing.
Sometimes being well understood, metricized and predictable are points in your favor. Say, during a market downturn.
But that’s only part of the reason why SaaS is holding up as the venture and startup game evolved from last year’s party to this year’s hangover. The latest from SVB, its H2 State of SaaS report, has a good explanation as to why that’s the case.
I won’t leave you in suspense: It’s IT spending. SVB notes that from 2021 to 2024, software spending among U.S. corporates is expected to grow 18% to $336 billion from $285 billion, while cloud spending is expected to grow even faster, scaling 56% over the same time frame from $171 billion to $267 billion. That’s a lot of money to compete for.
Driving those gains are more firms looking to spend more. The same dataset indicates that the fraction of U.S. corporates that anticipate growing IT budgets by 15% or more per year rose from 9.1% in 2021 to 12.7% this year, a figure that’s expected to hold steady.
More spending on software, more spending on cloud, and more firms looking to spend more over time? That’s a tailwind you can windsurf all the way to Wall Street (more on that shortly).
The good news
I’ve selected a handful of key metrics below that detail the good news in the market for SaaS founders. To prevent us from running on too long, we’ll proceed in bullet points:
- SaaS venture deal count is far from dead: SaaS deal-making in the United States tends to generate transactions that land around the mid-3,000 mark. That held up from 2013 through 2020. In 2021, however, the SaaS deal count spiked to 4,600 or so. This year? SVB anticipates nearly 3,800 deals worth $72 billion, far above the then-record $39 billion in 2020. Sure, 2021 had $96 billion worth of such transactions, but 2022 is shaping up to be a bang-up year compared to any other known period.
- Valuations are ticking higher: Median deal value at seed, Series A, Series B and Series C are up this year compared to 2021. The median seed valuation for a U.S SaaS company broke eight figures this year, for example, ticking up from $9.0 million in 2021 to $10.5 million. Series As also posted strong gains, with median valuations rising from $35 million in 2021 to $45 million in 2022. It’s a great time to raise, it appears.
- Down rounds are down: In contrast to what you might have expected, SaaS down rounds are, well, down. Just 7.9% of U.S. SaaS venture deals are down rounds this year, off from 11.7% last year. Both numbers are a hair better than U.S. venture aggregates.
To summarize: Huge tailwinds, the second-best venture velocity on record, at higher prices and with fewer down rounds. Not a bad time to build software.
So what?
The bad news column is relatively small. The Exchange noted in our read of the dataset that valuation step-ups are moderating this year, so if you are raising a proximate venture round, you can now only expect a 209% valuation gain at Series A, off from 245% last year. At Series C, the deceleration is sharper: In 2021, the median Series C valuation gain (from Series C to D, if you will) was 169%. That fell to 107% this year. Still, not bad.
Finally, software M&A is going to dip this year, from 484 deals last year to an anticipated 314 this year. But! The median valuation of those transactions is up! That’s good — even the bad news comes with a side of compensation.
Look, I won’t say that the 2022 venture capital market in my home country is unchanged. But rumors of its death have been greatly exaggerated, and I’m tired of folks claiming that the sky is falling when median valuations are rising.