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Sapphire Ventures - August 2024 Market Memo.pdf

Key Takeaway

• For entrepreneurs: Despite current challenges, the future of software remains promising, with AI expected to expand software's total addressable market (TAM) and enable more efficient company building.
• For investors: The underperformance of public software stocks is cyclical rather than structural, suggesting long-term opportunities in the sector as AI drives innovation and growth.

Summary

The August 2024 Market Memo by Sapphire Ventures discusses the current state of the venture capital market, focusing on the software sector. It addresses the question, "Is Software Dead?" and concludes that AI will not kill software but instead expand its capabilities and market. The memo highlights the cyclical nature of the current underperformance of public software stocks, attributing it to slower growth rates and other macroeconomic factors. It also emphasizes the potential of AI to drive new growth opportunities in software, particularly through AI-native products and agentic systems.

Insights

• Venture Capital Trends:
  • Venture capital investment in August 2024 totaled $19B across 1.4K deals, a 25% decrease in capital invested and a 41% decline in deal count year-on-year.
  • Sapphire's software focus areas saw a 31% decrease in capital invested and a 56% decline in deal count YoY.
• Public Software Stocks:
  • Public software stocks are underperforming the broader market, with the Sapphire Broad Software Index up only 9.4% year-to-date, compared to gains of 18% for the S&P 500 and 18% for the Nasdaq.
  • The underperformance is primarily due to slower growth rates, with 83% of tracked software companies growing slower than 20% YoY.
• AI and Software:
  • AI is expected to expand software's TAM by targeting additional spend in IT services and labor across various information worker functions.
  • AI-native products will drive a new best-of-breed cycle, offering advanced capabilities and better pricing.
  • Agentic systems could displace many legacy applications by consolidating multiple capabilities and workflows into single services.
• Private Market Growth:
  • Private software companies are showing high growth rates, with at least 26 companies publicly disclosing ARR north of $100M and growth rates higher than 30%.
  • These companies could lift the sector growth rate and invite new investors when they enter the public markets.

Implications

• Cyclical Challenges: The current underperformance of public software stocks is seen as cyclical rather than structural, suggesting that the sector will recover.
• AI-Driven Opportunities: AI will create new opportunities for software growth, particularly through AI-native products and agentic systems.
• Investment Strategies: Investors should consider the long-term potential of software, focusing on companies that can leverage AI to drive innovation and efficiency.
• Entrepreneurial Opportunities: Entrepreneurs can capitalize on AI to build leaner companies and develop AI-native products that offer competitive advantages.