If SaaS is a bubble, how could it burst?

SaaS isn’t in a bubble. The best SaaS companies are scaling and growing revenues faster than ever.  Much faster.  This is a secular trend of webifying all basic business processes and we’re only in about the 3rd inning here.  Only about 5-10% of core business processes than can be webified, are webified today.  And even in those markets, we still see acceleration (e.g., Salesforce at $5 billion in ARR still growing +-35-40%).

When revenues keep growing faster and faster, calling it a “Bubble” makes no sense.  This isn’t tulips or eyeballs we’re talking about.  It’s revenue.
However, we are in a phase where valuations have grown from 2-5x where they were 5 years ago.  And back then, those valuations seemed expensive compared to traditional software.

When valuations fall after the next correction, the entire way many SaaS companies are funded today will have to radically change.  And it will change fast.
So what will happen, is:

  • That there will be a Nasdaq correction at some point.  Maybe ’16, Maybe ’17.  Maybe next quarter.  It is inevitable and always comes.  So it has always been.
  • When a correction comes, my operating assumption is that multiples in SaaS might revert to 4-5x or so ARR for Very Good SaaS Companies — and Pretty Good SaaS Companies may become structurally unfundable.
  • This will lead to a crumbling of the segmentation of the venture market, where firms have segmented around $10m, $20m, $40m, $100m type ARR ranges, that each invest 8-15 months after each other at 2x step ups.
  • This will lead to the failure of a number of high-burn SaaS start-ups that can’t correct.  There are many SaaS start-ups burning $500k or more a month, or $1m a month or more later stage, that cannot sustain that growth without large infusions of annual capital. Venture Capital is Nasdaq on steroids.  All that mega-late-ish-round funding in the prior bullet point will evaporate because the valuations won’t support it anymore.
  • This won’t really impact medium-to-low burn SaaS start-ups that much.  We didn’t even see any big impact at an operational level after Lehman brothers and the 60%+ drop in the markets.  Because the markets kept growing.

This is what I see.  But, I see no clouds on the horizon.

No bubble (A Passion for Research):

The growth is there, and it’s epic (Salesforce):

But, huge multiple expansion for Best-of-Breed SaaS players (chart from here: SaaS Multiples: Recovery or Bubble?) will lead to a 50-70% Valuation Deflation as measured by multiples when market corrects:

And then, probably, a little time will go by … and we’ll see reinflation.


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