Traders on the floor of the NYSE, Sept. 14, 2022.
As we see valuations soften across the market today, it can be an uncertain time for investors, especially in technology.
However, on closer inspection, investing specifically in enterprise software will continue to be one of the best uses of capital anywhere in the financial and technology markets. The current environment will likely continue to create opportunities, in the same way that previous displacements have. Several factors play into this scenario.
As we’ve seen, enterprise software is a disruptive force with the potential to unlock unprecedented productivity and innovation. Like the physical assets that powered the business world in past centuries, software and technology-enabled solutions are transforming the way we live, work and learn, revolutionizing our economy in the process.
The pandemic accelerated reliance on enterprise software, as companies turned to technology to connect employees and customers, hold meetings and facilitate payments. This has led to fundamental changes in business practices and a reprioritization of the expenses that companies consider core to their operations.
The pandemic also set in motion an unprecedented valuation environment where less selective, inexperienced investors focused on the potential for multiple expansions and short-term returns over the underlying quality of companies. At the same time, many general partners sacrificed discipline to chase frothy valuations, rapidly increasing the speed of their distribution and draining funds in a short period of time. I suspect that those who took this approach may have exposed themselves too much to changes in the market.
Not all technology is created equal
Not all technology is created equal. Consumer software depends on the spending habits of individuals, which naturally tightens in times of inflation.
Conversely, as more companies face product and wage inflation, they are recognizing the value that enterprise software can deliver to help manage costs in their daily workflow while increasing efficiency. Companies will continue to implement software that directly enhances their operations – in areas such as business continuity, data protection, secure remote access and automation. We can already see these forces in play as consumer-driven stocks have been hit harder than their B2B counterparts.
According to an Evercore ISI study, 92% of respondents expect to increase IT spending in the next six to nine months – up from the January survey (83%). This suggests that IT spending is less discretionary today than in previous cycles. As a result, software is expected to remain the fastest-growing sector of the economy with a market value of $34 trillion by 2025, Vista Equity Partners found.
Advantages of private markets and enterprise software
Changing economic conditions do not change the strategic advantages of investing in the public markets, especially within enterprise software, where about 97% of companies are privately held, according to Vista. Public markets often hold even the most dynamic and visionary founders and CEOs to impossible timelines and unrealistic quarterly expectations. They demand short-term growth at any cost.
Conversely, private companies benefit from patient, strategic ownership where they can implement operational best practices with an eye toward sustainable, long-term value creation.
Choosing the right investments
That said, even in mainstream markets, generating favorable results during turbulent times requires investors to perform against two factors.
First, they must know what to buy. Second, they must understand how to scale an organization. It sounds simple, but in a changing valuation environment, determining a fair price requires a clear eye, rigorous due diligence and unwavering discipline.
That means knowing the difference between a fundamentally sound company versus one that might look promising but is saddled with less obvious issues like technical debt, which can slow—or challenge—software integrity and growth, and therefore investment.
Partnership with private capital
In addition to asset selection, a genuine collaborative approach between the investor and the founder or management must be in place to ensure that an investment reaches its full potential. Investors with industry experience and expertise understand how software companies operate, the systems needed to succeed, what makes a successful management team, and how to scale and grow these companies. They can help managers improve their position by accelerating operational excellence, identifying M&A opportunities, investing in product innovation, and paving the way for sustainable growth.
On the other hand, there is no substitute for a founder’s passion, vision and innate understanding of their business. The best investors know how to channel this knowledge and arm the founder with the right tools and processes to thrive. When it works, the positive dynamic isn’t just found in boardrooms—it’s evident throughout the company, creating workplace dynamics that cultivate and retain the best talent.
As the digital economy continues to expand, governments and consumers globally have embraced the potential opportunities the technology presents. Enterprise software will be crucial in shaping the future. In partnership with private capital, the result will be a stronger economy with an innovative and adaptive infrastructure—one that is ready to meet the challenges of this century and define the possibilities of the next.
Robert F. Smith is the founder, chairman and CEO of Vista Equity Partners, a leading global investment firm investing in enterprise software, data and technology-enabled companies. The company has over $94 billion in assets under management as of June 30 and a portfolio of 85 companies serving over 300 million users and employing over 90,000 people worldwide.