July 16, 2024
Enterprise SaaS investment makes a comeback — but not where you'd expect

The global market for software is growing quickly. Gartner data indicates that software spend is the fastest-expanding segment of IT spend and that its pace of growth has accelerated in recent years. If Gartner’s forecasts bear out, the software portion of global IT spend could crest $1 trillion in 2024.

Startups mostly build software. And with the subscription business model shift now historical fact more than emerging trend, many startups today approach the market with the software-as-a-service (SaaS) model. Thus, SaaS startups are not category-specific, instead sharing a business model approach more than any particular industry focus. Among myriad SaaS startups, those focused on selling to business clients — a group often called enterprise SaaS — are a magnet for venture capital.

Or at least they were until the last venture and startup boom burst. Since then, investment into enterprise SaaS startups has slowed. But new data from PitchBook shows that while the charts have largely pointed down lately, there are some glimmers of good hope for founders looking to raise to build the next great enterprise software company.

Green shoots

Last year was another down year for venture investment into enterprise SaaS. Global data per PitchBook shows that the number of enterprise SaaS venture deals fell 32% to 2,764 last year, while the value of those transactions slipped by 33.3% to $72.9 billion. Even worse, 2023 results for enterprise SaaS startups were down from what the market recorded in 2022 ($109.2 billion across 4,052 deals) but even further from what we saw in 2021 ($136.0 billion across 4,773 deals).

Enterprise SaaS startups raised $21.9 billion, $45.0 billion, $55.1 billion and $58.3 billion in 2017, 2018, 2019 and 2020, respectively. That makes last year’s more than $70 billion worth of investment into the startup category seem sunny in comparison.

Even more importantly, while enterprise SaaS deal volume continued to decline through the end of 2023, the total dollars invested into them perked up in the fourth quarter. The gains are modest, but not so slight as to escape attention. In the third quarter of 2023, PitchBook counted $12.5 billion worth of enterprise SaaS deals, a figure that scaled to $14.0 billion in the fourth quarter. That’s a 12% gain in one quarter’s time during the holiday period; that is no mean feat.

The only other quarter since Q4 2021 that recorded a gain in total enterprise SaaS investment was the first quarter of 2023, but that quarter was so heavily influenced by the Microsoft-OpenAI deal that we almost want to discount it. Q4 2023 is all but unique in the wake of the last venture boom and bust in turning around the steady declines in capital disbursed to enterprise SaaS companies.

Now, who raised that capital and what are they building? The answer surprised us, but there’s some nuance to unpack.

WTF these categories are surprising!

If you asked us which categories were on an upswing in the final months of 2023, customer relationship management probably wouldn’t have been at the top of the pile. Yet PitchBook reported that CRM was the leading growth category in enterprise SaaS in Q4 2023:

Among segments, customer relationship management (CRM) was a standout with a brisk QoQ increase (up 72.5%) compared with the overall enterprise SaaS average, which was up 11.9%. Other positive standouts were supply chain management (SCM), up 44.8% QoQ, and knowledge management systems (KMS), up 31.6% QoQ.

CRM in its purest form, keeping a database of customer information, would seem to be for the most part a long-solved problem. One of the earliest enterprise SaaS companies, and certainly the most successful, Salesforce controls that market. It doesn’t mean it can’t be disrupted as all incumbents can, but the CRM database hasn’t changed all that much in the 25 years since Salesforce opened its doors and dragged the SaaS model into the business mainstream.

But PitchBook has a bit more liberal definition of CRM than purely tracking customer data, including marketing automation, sales enablement, customer service and e-commerce. From that perspective, CRM makes a bit more sense.

But if you had asked us (and nobody did), we would have pointed to data applications, software that helps companies track, understand and manage copious amounts of data in the enterprise. This category, which PitchBook tracks under “analytics platforms,” has become especially crucial given the importance of data to AI and large language models, which require lots of data to train them.

So while PitchBook’s data didn’t track with our admittedly anecdotal data, it was still a surprise that data and AI-adjacent investments didn’t fare better in the report, barely garnering a mention, while CRM, supply chain management and knowledge management led the way in this quarter’s numbers.

Stocks, venture and how to build in today’s market

There are several likely reasons why software investment is picking back up, category-specific inquiries aside. The great hunt for cloud spend “efficiency” seems to be fading, per several public software company earnings reports. That means that net retention at many software companies is likely improving after being beaten down thanks to customer parsimony and a hunt to wring expense out of operations in a higher interest rate environment.

That and the fact that the stock market has itself rebounded, with the tech-heavy Nasdaq closing at a record high last month. That makes eventual startup exits more likely to occur at a price that venture investors like, which in turn may loosen their purse strings.

But with average revenue multiples for public software companies sticking around like an unwelcome guest, startups are hardly out of the woods yet. Some macroeconomic relief and a clearer exit pathway are great, but it’s far harder to build a venture-backed software startup if you are staring down high single-digit or very low double-digit multiples when it’s time to exit. Venture capital is expensive in equity terms, sure, but the venture model also incentivizes high spend to bolster growth. When that growth is worth less, the entire calculus of raising and spending external funds shifts. It’s way easier to make venture math work at 20x revenues than 10x, or even 8x.

Startups are not out of the woods yet. Perhaps a rate cut or two and a strong enterprise IPO are the tonic required to really reignite venture investment into enterprise SaaS. But today there are several reasons to be more optimistic than we were just a few quarters back. For founders waiting for the good times to return, that’s welcome news.

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