Software Startups: 7 Signs The Industry Is Doing Well

Written By: Dharmesh Shah May 2, 2007
I've been reading through the Q1 2007 Software Industry Equity Report
Though the public markets are very different from the world of software startups, I think it is helpful for startup entrepreneurs to get a sense of how the larger market is doing.  A healthy public market for software companies can often have a positive effect on valuations and potential M&A deals for private companies.  As such, I've found it useful to keep track of the market. 
Note:  SEG Software Index is a tracking index that refers to about 263 publicly traded software companies.
7 Signs The Software Industry Is Doing Well
1. Median Valuation: The median enterprise valuation of the SEG Software index ended up 2.8% after rising to a high of 5.8% and dipping to a low of -1.4%.
2.  Overall Growth: Median trailing twelve-month revenue of companies grew 11.6% from Q1 2006 to Q1 2007.  Earnings gained 7.3%.  Median valuation gained 9.1%.
3.  Specific Categories: HR management and web analytics software led all other categories where companies providing solutions for eCommerce enablement, education and computer-based training lagged far behind.
4.  SaaS Doing Well: The SEG SaaS Index (including 10 public companies providing Software as a Service) continued to outperform the industry with median revenue growth of 43.5% over the same quarter last year.  These companies are also valued higher (5.3x vs.  2.4x)
5.  M&A: 425 M&A Transactions were posted in Q1 2007 in the software and IT services sector -- near identical to Q1 2006 with 426 deals.  However, aggregate spending increased by 92%.  Software M&A is up 43% year-over-year.  Security software was the most active M&A category.
6.  Vertical vs. Horizontal: Median valuations for vertical software solutions providers was 1.8x TTM (trailing twelve months) revenue whereas that for horizontal solutions commanded 2.5x.
7.  Saas Valution Premium: Buyers today are placing an inordinately high value of pure-play SaaS company exits based on recurring revenue streams, bookings and profitability levels.  For example, WebEx was acquired by Cisco for 8.4x revenue.
Of course, these are some of the "hilights" that I found interesting.  The overall sense that I got was that the software industry continues to be healthy.  If you're a software startup founder, this should be encouraging news.  If you're like me and working on a pure-play SaaS startup (my company HubSpot is in this category), the news is particularly encouraging as buyers are valuing the recurring revenue well).
Let me know if you have thoughts or insights on the data.  I encourage you to read the full report if you have the time.  Lots of detailed information on various sectors within the industry and the key M&A transactions.

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