The Plane Has Landed

There has been an ongoing debate about whether the U.S. economy is headed for a soft landing or a hard landing.  Recent news regarding rates remaining unchanged (and future rate cuts in 2024), low unemployment and a surge in the public markets, has led to a trend in the media predicting that a soft landing is headed our way.

This entirely misses the point.  The plane already landed.  The only remaining question is whether we are headed for another takeoff.

When the Fed began tightening rates and tapering its balance sheet in Q1 2022, the markets plunged, with the NASDAQ hitting a trough, down 35% by Q4 2022. Private company M&A and venture activity in the software segment slowed and valuations dropped in unison with the public markets. This led the private equity (PE) community to focus less on annual recurring revenue (ARR) growth and more on right-sizing their portfolio companies, reducing cash burn and increasing profitability.  

We have seen a rebound for software companies in the public markets in 2023, with the NASDAQ gaining 40% this year. Similar to their public company counterparts, private software companies that made it through the downturn and were able to become cash flow positive with reasonable growth, are now headed to market with healthy (but not irrational) valuation expectations.

In recent months, we have seen a capitulation to the new reality for companies that were not able to pivot away from a sole focus on increasing ARR toward a reduction in cash burn and increasing profitability. PE and venture investors are cutting their losses and selling these companies for whatever the market will pay for them.  While this is not good news for founders or limited partner (LP) returns, this capitulation is healthy for the private markets as it allows investors to focus on new money and new deals heading into 2024.

My prediction is that we will see a substantial up-tick in M&A activity in 2024, but it will be the tale of two cities.  There will be strong competition for healthy, profitable companies that will command high, but pre-2021, multiples. For cash burning companies running out of runway, they will have to sell for lower valuations, in many cases for less than invested capital, or close up shop.

Here's hoping for a smoother ride in 2024. Happy New Year!