Software VC Outlook: A Flight to Quality
An analysis of the latest statistics finds new economics, new technologies and newfound restraint will drive software venture investing in 2006.
By Matt Miller, Walden VC
Mar. 12, 2006
Ask any venture capitalist to rank their favorite investment sectors and you'd be pressed to find any lists with "enterprise software" at the top.
The mood among VCs remains hesitant about enterprise software startups. Competing against today's megavendors is tough. The last investment "bubble" funded plenty of strong small and mid-sized vendors who are still waiting to be acquired with many stagnating. Perpetual license models are a slowly dying business model, but the much-hyped Software as a Service (SaaS) model is still more conjecture than reality in the core software sectors.
Yet software companies received $4.7 billion in venture capital investment during 2006. That's more than biotech, alternative energy, or any other sector.
Sure, you hear about some software VCs moving on to clean energy, digital media or consumer plays. But most remain committed to software. Why? Because even in today's rapidly evolving industry, software startups offer backers high margins and high growth rates - a combination that few VCs can ignore. Moreover, the sector has become more capital-efficient in the last 10 years. (More on that to follow.)
Of course, certain software sectors are more promising than others. An in-depth look at the latest statistics on financing trends shows software venture capital is on solid ground with several "hot" sectors, lots of interesting startups and a stable of active investors.
No Bubble in Sight
Despite media buzz about a resurgence in VC investment, software funding slipped 8 percent in 2005 (see Software VC Trend chart). To me, that's great news. We may be regaining some balance after the excesses of the 2000 period. Enterprise software is not getting left behind: The data show investment is healthy and stable.
As venture-backed M&A skyrocketed in 2005 and the possibility of a lucrative exit becomes a reality again, there has been a worry in the venture community that another speculative bubble would emerge, similar to the one during 1998-2000 (see Software VC-Backed M&A Trend chart). While not truly overheated, there continues to be far too much VC money out there chasing deals.
2006 looks like it will be a solid year for software investment for two reasons. One, we aren't yet seeing a bubble that is funding a lot of unworthy companies. And two, we aren't yet overfunding hot categories.
Venture capitalists tend think as a group today. This seems much different than when I first worked in the Silicon Valley in the late 1980s. At that time, if there was a really hot market segment - take visual tools for databases, for example - there would be a small number of startups funded in the area - maybe five, or so.
The mood among VCs remains hesitant about enterprise software startups. Competing against today's megavendors is tough. The last investment "bubble" funded plenty of strong small and mid-sized vendors who are still waiting to be acquired with many stagnating. Perpetual license models are a slowly dying business model, but the much-hyped Software as a Service (SaaS) model is still more conjecture than reality in the core software sectors.
Yet software companies received $4.7 billion in venture capital investment during 2006. That's more than biotech, alternative energy, or any other sector.
Sure, you hear about some software VCs moving on to clean energy, digital media or consumer plays. But most remain committed to software. Why? Because even in today's rapidly evolving industry, software startups offer backers high margins and high growth rates - a combination that few VCs can ignore. Moreover, the sector has become more capital-efficient in the last 10 years. (More on that to follow.)
Of course, certain software sectors are more promising than others. An in-depth look at the latest statistics on financing trends shows software venture capital is on solid ground with several "hot" sectors, lots of interesting startups and a stable of active investors.
No Bubble in Sight
Despite media buzz about a resurgence in VC investment, software funding slipped 8 percent in 2005 (see Software VC Trend chart). To me, that's great news. We may be regaining some balance after the excesses of the 2000 period. Enterprise software is not getting left behind: The data show investment is healthy and stable.
As venture-backed M&A skyrocketed in 2005 and the possibility of a lucrative exit becomes a reality again, there has been a worry in the venture community that another speculative bubble would emerge, similar to the one during 1998-2000 (see Software VC-Backed M&A Trend chart). While not truly overheated, there continues to be far too much VC money out there chasing deals.
2006 looks like it will be a solid year for software investment for two reasons. One, we aren't yet seeing a bubble that is funding a lot of unworthy companies. And two, we aren't yet overfunding hot categories.
Venture capitalists tend think as a group today. This seems much different than when I first worked in the Silicon Valley in the late 1980s. At that time, if there was a really hot market segment - take visual tools for databases, for example - there would be a small number of startups funded in the area - maybe five, or so.
