What's a Software Company Worth?

This episode explores the valuation of software companies, examining what factors contribute to their worth. Against the backdrop of historical data spanning 20 years (2003-2022), the discussion analyzes two distinct indices: a growth equity index (high-growth, regardless of profitability) and a middle-market index (moderate growth with at least 10% EBITDA margins). More significantly, the analysis reveals that while high-growth companies experienced periods of exceptionally high valuations, these were often outliers, and overall valuations converged more frequently than expected. For instance, the study found that the average revenue multiple for growth equity companies over 20 years was 8.4 times, while the middle-market average was 4.8 times, highlighting a tighter range than initially anticipated. As the discussion pivoted to profitability, it was surprising to find that a significant portion of high-growth companies became unprofitable after 2012, a trend that reversed in 2022. In contrast, middle-market companies consistently maintained high EBITDA margins, suggesting a preference for predictable, profitable businesses in the long run. This means for private equity investors that a focus on profitability and moderate growth offers a steadier path to success, while high-growth strategies require precise market timing to mitigate significant risk.