Global Software Sector Update—Fall 2023

Higher for longer — three simple words that marked a disappointing conclusion to Q3 as expectations diminish for a return to more accommodating monetary policy. Recent economic data points to ongoing tension in labor markets and the Fed is signaling they will continue to be cautious in the fight against inflation. This dampened the outlook for a software market that was energized by public markets' recovery and ongoing AI hype built up over the summer.

Underlying trends from YTD 2023 that are expected to persist going into 2024:

• Both buyers and sellers continue to tread with caution, with notable exceptions for the best-performing and positioned assets which still attract intense competition
• Smaller, more strategic and easier-to-digest acquisitions, as demonstrated by Q3 deal volume (477) remaining steady in the face of declining disclosed values
• Underpriced public assets of scale arguably remain the most attractive targets as evidenced by the subdued but steady state of deals throughout the year, including the acquisitions of both Splunk and New Relic, two of the largest deals in recent months.
• The hurdle for new investments has remained high for financial sponsors with retention profile and capital efficiency carrying even more weight in assessments.

There is no doubt that the current “risk off” sentiment combined with rising returns on safe harbor assets will continue to weigh heavily on software M&A enthusiasm near term. However, there are some silver linings.

• A clear bottleneck is building up—both on the demand side as accumulated dry powder and Big Tech war chests are sitting idle and on the supply side as a long tail of businesses are coming out operationally stronger after 12-18 months of consolidation.
• The recent IPOs of ARM, Instacart and Klaviyo, while having failed to ignite further momentum, point to early signs of optimism. Ironically, it is a stronger signal of U.S. economic slowdown and a long-anticipated softening of the Fed’s stance that may be the spark that brings back momentum in deal activity.