We continue to see signs that the VC winter, or at least some aspects, is thawing. The latest comes from PitchBook, which reports that software valuations in the first half of 2024 have returned to pre-slump (pre-Q1 2022) levels. Median valuations for early and late-stage deals have even reached new highs.
But there’s a catch: fewer deals. The first half of 2024 continued to see the tepid volume of funding rounds that are characteristic of the past two years. So though some valuations have been robust, the aggregate amount raised continues to lag behind the Covid boom years in software, especially SaaS.
Speaking of sector performance, another explanation for these figures is AI. AI startup valuations tend to skew the average as VCs continue to adjust their portfolios to be AI-heavy. The relatively few AI players that do make the cut see larger rounds, so the end result is bigger valuations for fewer companies.
Land Grab
Beyond supply and demand dynamics, disproportionate deal sizes for AI companies are furthered by practical realities. Specifically, as we discussed on a recent episode of This Week in Local, AI companies are capital-intensive due to the cost to develop and rapidly evolve differentiated AI tech stacks.
In fact, one of the key differentiators in the AI realm is deep-tech startups as opposed to those that apply a thin layer of UX on top of ChatGPT or some other common AI platform. Those deep-tech startups require ample capital, while the thin-layer players are far less compelling to investors.
Beyond the AI land grab, another explanation behind larger valuations for fewer companies is the data being reported by startups and venture funds. Larger valuations – a sign of strength – tend to be celebrated, whereas down rounds – which are all too common these days – don’t get press releases.
Similarly missing from PitchBook’s data are other phenomena, such as startups that took unpriced rounds through convertible notes. There are also insider rounds, companies that delayed raising capital, or those that died because they were unable to do so. All these factors paint a less rosy picture.
Return to Fundamentals
Back to positive news, some of the larger valuations are due to tighter operations. The return to fundamentals and cultural shifts among SaaS players over the past two years have meant more prudent spending and cost-cutting. That in turn boosts P&L elements that influence valuations and appease VCs.
Panning back further, and sticking with the positive view, other factors point to a market recovery in software markets. As Circumference Group’s Luca Sechi told us recently, we’re in the 10-consecutive-quarter range of depressed funding that historically (dot-com bust, financial crisis) sees a turnaround.
Though they won’t look exactly like they did in 2020-2021, software startup valuations and other health signals could be primed for a rebound. It will be more AI and less fintech but innovators will course-correct. And the remainder of 2024 will offer more puzzle pieces, including the fate of interest rates.
