The NASDAQ Sell-Off and its Likely Impact on Software VC and M&A Valuations — Sampford Advisors - Expert Tech M&A Advisor (Software, IT Services, SaaS, Hardware)

Since the start of the pandemic, major public indices have risen significantly as investors flooded to high-growth technology companies, ballooning valuations and pushing market prices to all-time highs. However, in the latter months of 2021 and the start of the new year, public markets have seen a sharp selloff in value as these same technology companies face strong headwinds from the changing macroeconomic landscape. Driven by rising inflation, tightening of monetary policy, and geopolitical tensions, public markets have entered “correction” territory as investors move away from high-growth, high-risk companies into more stable, cash-flow generating businesses. This can be seen in the chart below, which illustrates historical Nasdaq returns from 2014 – YTD 2022:

Figure 1 - NASDAQ Returns

Moreover, within the last decade, there have been few instances of public market corrections resulting in market multiples contracting by 40% or more. However, as of January 31, 2022, the prices of publicly-traded software companies fell more than 15%, with forward-looking PE multiples decreasing by a remarkable 53%[1]. Now, the question remains, what will the impact be on the private markets?

Recent Trends in Late-Stage VC Multiples
Historically, VC fundraising has followed a similar pattern to public market trends, with boom cycles enabling investors to deploy dry powder into risker assets and bear markets forcing investors to flee to safer investments that hold a higher certainty of return. This was particularly evident during the stock market run from 2019 – 2021 as late-stage VC multiples benefited from higher public market valuations. The chart below outlines this:

Figure 2 - Late-Stage VC Valuation Trends

As we can see, valuation multiples in this segment of the VC market nearly tripled from 7.7x in 2019 to 21.5x in 2021. This dramatic rise could largely be attributed to the “unicorn” phenomenon, whereby a greater number of technology companies were being valued at north of US$1bn prior to becoming public. At the end of 2021, 959 companies held “unicorn” status, up 69% from the year prior. Even more astonishing, venture-backed technology start-ups raised US$621bn in 2021, a record year for fundraising across all stages[2]. Additionally, as the pandemic highlighted the mission-critical nature and scalability of software companies, a greater number of investors wanted a piece of the next big disruptor and this pushed multiples even higher.

On the other hand, as markets cool and valuation multiples wane, late-stage VC companies are subject to the greatest amount of downside risk when it comes to fundraising. This is primarily due to timing, as investors turn to safer assets resulting in postponed IPOs and term sheets being renegotiated or sometimes pulled altogether. As liquidity conditions continue to tighten, we expect late-stage VC multiples to fall more dramatically than other VC-backed companies, and this will be further exacerbated by the steep increase in multiples seen from 2019 – 2021.

How Will This Impact the Software M&A Market?

Alongside the public and VC markets, M&A activity over the last two years has risen to unforeseen heights as strategic buyers and financial sponsors look to utilize their dry powder and capitalize on accretive acquisitions. This has resulted in multiple expansion in the software space as investors take advantage of significant market fragmentation, sizeable future growth potential as companies continue to embrace digitization, and the attractiveness of a recurring revenue stream as can be seen in the chart below:

Figure 3 - SaaS M&A Valuation Trends

However, one important distinction is the difference in growth in multiple expansion from 2019 – 2021 between late-stage VC and SaaS valuations. As can be seen above, SaaS multiples grew ~1.5x relative to late-stage VC growing 3x, and this could be predictive of SaaS multiples falling significantly less relative to late-stage VC multiples. Although public markets may be going through a free fall, investors continue to have significant amounts of dry powder to deploy which could be of benefit to the M&A markets. More specifically, rather than spending their cash on large, higher-risk companies that are waiting to be public, strategic buyers and financial sponsors could turn to M&A as a means of capital deployment.

Final Thoughts

As we head further into a bear market and public market multiples correct to fair market value, we see software M&A activity softening but not to the extent as other areas of the market. Additionally, due to the large amounts of dry powder at the buyers’ disposal, we expect deal volumes to keep increasing, albeit at a slower speed and at lower valuation multiples. But most importantly, we don’t expect the dramatic decrease as can be seen in major public indices and late-stage VC, which will prove once again the robustness of the M&A markets.

Written by Chris Lor of Sampford Advisors.

About Sampford Advisors

Sampford Advisors is a boutique investment bank exclusively focused on mid-market mergers and acquisitions (M&A) for technology, media and telecom (TMT) companies. We have offices in Toronto, ON, Ottawa, ON, and Austin, TX and have done more Canadian mid-market tech M&A transactions than any other adviser.

[1] Thomas Tunguz: How Will the 52% Market Correction in the Stock Market Impact the Startup Fundraising Market?

[2] CNBC: The Tech Sell-Off Has Some Venture Capitalists Worried the Good Times May be Coming to an End.

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