SaaS Underperformance Drags Down Tech M&A in Early 2025

Hypergrowth for software may in fact be over. Microsoft, Oracle, and Adobe went public in 1986, raising a combined $100M. Since then, the software industry, like no other in history, has been at hypergrowth of over 25% for almost 40 years. However, over the last 4 years, that growth has been declining rapidly, falling all the way down to 12%, where it has been stuck for the last 3 quarters. Demand for software coming out of COVID drove extraordinary technology adoption to the point of excesses, including cannibalization of future consumption. After all these years of selling software to businesses, there is definitely saturation in many large end markets. Software now looks awfully similar to the other big tech waves we have seen run hot for a sustained period and then fall to GDP growth rates, like PCs, the internet, and smart phones. Global software sales, however, unlike these other tech waves, has a lot more room to grow into the future, particularly with the oncoming tsunami of AI.

While software solutions have been adopted in so much of what we do both on business and home fronts, there is still so much more untapped opportunity. Gartner estimates that only 25% of software revenue is SaaS. As long and as impactful as cloud computing has been around, it is still only 14% of the total software industry market today. The adoption of AI will harness vast amounts of untapped data, significantly improve operating efficiencies, and in so doing, expand the software TAM.

However, tariff turmoil, continued slower growth, and general SaaS underperformance has driven tech M&A even lower. '25 YTD tech M&A on a dollar value basis is at a $230B run rate, which is even lower than '23 and '24 performance, and roughly half of pre-COVID levels. AI has also added risk to the market, freezing some sectors and deals. The slowdown has been almost suffocating in the PE and VC worlds where GPs are unwilling to sell off companies that will turn the corner anytime now, and in so doing, generate a more respectable return for LPs and overall fund returns. So for now, GPs are holding tight on most of their PortCos as the number of portfolio companies continues to build along with the dry powder of investible funds.

Vertical SaaS companies command a higher EV/Revenue (7.0x vs. 4.8x) and higher EV/EBITDA (23.9x vs. 18.2x) than their horizontal counterparts. This valuation premium exists despite generating lower median revenue ($703M vs. $1,018M) and EBITDA ($174M vs. $265M). This suggests investors place a strategic premium on vertical focus, due to higher barriers to entry from deep industry integration, stickier customers due to workflow lock-in and industry-specific compliance, and lower churn relative to horizontal solutions. Both segments show almost identical Ro40 (36% vs. 38%), and near-identical revenue growth (11% vs. 12%) and EBITDA margins (24% vs. 23%). This undermines the idea that growth alone is driving vertical SaaS's higher multiple. Instead, it highlights that business model quality and defensibility, not just performance, are influencing valuations. Given the impending onslaught of AI solutions into the software world, the question of market defensibility is the Holy Grail.

Revenue growth came easy in '21 & '22 and public investors were happy to pay for growth over profits. When growth slowed in '22, profits were squeezed and investors in turn pushed CFOs for better margins. Public and private software margins peaked in Q2 '24, but poor revenue growth has caused margins to start falling. From here, improving margins and growth will be difficult, putting even more pressure on valuations. One might ask, if EBITDA multiples were in the mid 20s when software growth was forever also in the mid 20s, then why are EBITDA multiples still at that level when software growth has been cut in half to 12%?

Continuation vehicles are expected to double in size over the next four years as they become an increasingly popular solution for sponsors and presumably LPs ☺. CVs offer several advantages: they allow GPs to markup assets, provide DPI to LPs and employees, retain control of top-performing companies, and generate new management fee income. However, they also come with risks. There can be conflicts of interest, as GPs may have incentives to over- or under-value the asset. Some GPs and market observers note that CVs may delay difficult exit decisions and do not provide a true and transparent auction generated valuation for these pristine assets. Essentially the GP owner is selling control from an existing fund to a new fund that they still control with a fresh investor base that is made up of new, and in some cases, existing LPs. However, the underlying company or companies are not offered for sale to a third-party buyer, whether that be a strategic or PE platform. Either way, they have clearly become one of the go-to tools in the PE playbook.

Meanwhile, fund-to-fund transfers have become an increasingly strategic option for PE sponsors seeking liquidity without giving up control. In these transactions, a GP sells all or part of a portfolio company from an older fund into one or more of its newer funds, typically at a premium valuation and often alongside a new minority investor. Legacy LPs receive a liquidity event, while the GP re-invests through its newer vehicles, allowing continued ownership of a familiar, high-performing asset. These deals can sidestep the challenges of traditional IPO or M&A exits, preserve capital structure, and reward LPs with DPI. However, they may raise valuation concerns because the company is not being auctioned to third-party buyers. Recent examples include Thoma Bravo moving Qlik from Fund XII into Funds XV and XVI with ADIA joining as co-investor, and EQT selling 100% from Fund VII & IX to Fund X along with a $3B stake in IFS to a group including ADIA. A $15B sale at 12x revenue on a slower growing SaaS company is quite impressive. Either way, fund-to-fund transfers have quickly become a core part of the PE liquidity playbook.

Not to forget about the tech VC world, which is ginormous with 89,000 companies across the world and 21,000 new financings in 2024. Wiz is what the VC world is chasing. The problem is, there are not many companies like Wiz out there, and US and European antitrust watchdogs are scaring many of the large would be buyers away. Honestly, things have remained pretty much the same over the past three years in VC land, where all the juice is in 15 of the 100 companies in a typical VC fund, and in most regards, the other 85 companies do not matter. So, while the tech VC world is waiting for liquidity on their pristine investments, the rest of the portfolio remains stuck in the mud. In many VC company situations, there is management and four non-controlling investors, all kicking the can down the road, board meeting after board meeting, in the hopes that the company miraculously changes its DNA and becomes top tier from its middling status. In the meantime, these VC companies build more investment debt and become less attractive to buyers, both strategic and PE. At some point, this massive VC asset base will begin to transact, but not for now.

In the public markets, Rule of 40 is now, more than ever, critical in driving valuations resulting in a significant drop off in revenue multiples for companies that have not achieved Rule of 20+. Rule of 40 companies trade at a median of 9.6x while companies in the rule of 20 bracket trade 7 turns lower at 2.4x. Growth still drives valuation, with the fastest growers trading at 16x revenue.

In addition, public large cap companies trade at a 150% premium to their small cap peers. Public institutional investors tend to steer clear of the sub-$10B market cap tech companies because (i) the companies underperform the larger peers over time, (ii) there is not enough liquidity in the stocks, so large block transactions are difficult without major price movement, and (iii) it is difficult to get a meaningful position, making it worthy of the institutional investor's time.

There have been only 11 software IPOs in the last 3+ years, marking the worst tech IPO drought since Microsoft went public in 1986, raising just $61M. This recent IPO class is up 21% since January 2024, while the S&P 500 is up 24% over the same period. During COVID, there were 116 IPOs, 105 of which are now trading below their IPO price or have already been taken private. Back in the late 1990s when I was at Montgomery Securities, the public markets had the infrastructure to support 100 small IPOs per year—today, that infrastructure no longer exists. Sub-$5B IPOs are undercovered, underappreciated, and most importantly, undervalued on Wall Street. If companies continue to linger at these valuation levels, we will likely see more take-private transactions.

On the brighter side, AGC Partners just finished its best quarter in two and a half years. We announced 8 transactions with a median revenue multiple of 9x on deals spread across the U.S., Australia, Israel, and Europe. With another 23 new engagement wins YTD, the market is clearly signaling that it wants to get going again. So, despite macro uncertainty and structural shifts in software, the ingredients for deal acceleration are falling into place. There are over 10,000 sponsor-backed software companies with many of them eager to transact. Valuations are resetting, companies are healthier, public strategics are back in the game, and PE firms are sitting on record dry powder with mounting pressure to deploy. With three years of DPI backlog, a renewed push from LPs, and a better-aligned buyer-seller dynamic, late 2025 is shaping up to be a turning point for software M&A and will hopefully lift us out of the mud ☺.