As we see valuations soften in many parts of the market today, it can feel like an uncertain time for investors, especially in technology.
However, on close examination, 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, the same way past dislocations have done. Several factors play into this scenario.
As we have seen, enterprise software is a disruptive force with the potential to unlock unprecedented productivity and innovation. Like the physical assets that propelled the business world in centuries past, software and tech-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, conduct meetings and facilitate payments. This has led to a fundamental shift in business practices and a reprioritization of the expenses that companies consider core to their operations.
The pandemic also set into motion an unprecedented environment for valuations as 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 their deployment pace and exhausting funds over a small window of time. I suspect those who took this approach may have left themselves overly exposed to changes in the market.
Not all technology is created equal. Consumer software is subject to individuals' spending habits, which naturally tighten during inflationary times.
Conversely, as more businesses face commodity and wage inflation, they recognize the value that enterprise software can deliver to help manage the cost of day-to-day workflows while increasing efficiency. Businesses 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 this dynamic at play as consumer-driven stocks have been harder hit than their B2B counterparts.
According to an Evercore ISI study, 92% of respondents are expecting to increase their IT spending over the next six to nine months – up from their January survey (83%). This indicates that IT spending is less discretionary today than in previous cycles. As a result, it's expected that software will continue to be the fastest-growing sector in the economy with a market capitalization of $34 trillion by 2025, Vista Equity Partners found.
Shifting economic conditions do not change the structural advantages of investing in the private markets, particularly within enterprise software, where about 97% of companies are private, according to Vista. The 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 all costs.
Conversely, privately held companies benefit from patient, strategic ownership where they can implement operational best practices with an eye toward sustainable, long-term value creation.
That said, even in the private markets, generating favorable outcomes in turbulent times requires investors to execute 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 valuations environment determining a fair price requires a discerning eye, rigorous due diligence, and unwavering discipline.
It means knowing the difference between a fundamentally sound company versus a business that might look promising but is loaded with less obvious issues like technical debt, which can slow – or jeopardize – the integrity and growth of software and therefore an investment.
Beyond asset selection, a true partnership approach between an investor and a founder or management team must exist to ensure an investment reaches its full potential. Investors with experience and expertise in the industry understand how software companies operate, the systems needed for success, what makes a successful management team and how to scale and grow these businesses. They can help the management team enhance their position by accelerating operational excellence, identifying M&A opportunities, investing in product innovation and enabling a path for sustainable growth.
On the flip side, there is no replacement 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 is not just felt by those sitting in boardrooms – it's apparent throughout the whole company, creating a workplace dynamic that cultivates and retains the best talent.
As the digital economy continues to expand, governments and consumers globally have embraced the potential opportunities that technology offers. Enterprise software will be crucial in shaping the future. When partnered with private capital, the result will be a stronger economy with an innovative and adaptable infrastructure — one that's ready to tackle the challenges of this century and to define the possibilities of the next.
Robert F. Smith is the founder, chairman and CEO of Vista Equity Partners, a leading global investment firm that invests in enterprise software, data and technology-enabled businesses. The firm has over $94 billion in assets under management as of June 30 and a portfolio of 85 companies that serve over 300 million users and employ over 90,000 people worldwide.