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A cursory glance at tech headlines may have you believe that the software-as-a-service (SaaS) business is humming along nicely. And for the most part, it is. However, some are questioning that assumption by looking deeper into the market鈥檚 younger companies and their prospects in an increasingly competitive field.

Victor Basta recently in TechCrunch which discusses a 鈥渜uiet, barely noticed implosion鈥� in early-stage venture capital investing worldwide. Broadly speaking, the data he draws on and the conclusions he makes echoes recent coverage on 附近上门 News. But Basta made some more specific claims about a few sectors, SaaS included, that are worth examining here.

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He asserts that VC investment into SaaS businesses has peaked, suggesting in his article that 鈥渨ith so many SaaS companies having been created in the past 10 years, it鈥檚 hard to justify, let alone back, new SaaS startups, which are by now competing against established SaaS players, not legacy perpetual license vendors.鈥�

And what about those more established SaaS players? From a valuation perspective, it turns out they鈥檙e doing remarkably well.

So what does this growing gap between early-stage SaaS companies and the established incumbents they aim to take on say about the market as a whole?

Let鈥檚 examine the recent performance of public SaaS companies and compare it to the rate of capital investment into still-private SaaS firms.

The Good: Public SaaS Companies

In the world of startups, founders almost always have to contend with competition. More often than not, a startup鈥檚 biggest competitor is a large public company. And in some cases, the public company in question is a lumbering and clumsy foe; however, that鈥檚 not typically true in the SaaS business. Indeed, most publicly traded SaaS companies were themselves startups just a few years ago, and many of them maintain rapid growth trajectories that make them truly capable competition.

It鈥檚 these qualities that have put public SaaS companies and their valuations at or near all-time highs, which gives some credence to Basta鈥檚 argument that incumbents in the space are more formidable now than in the past. These companies鈥� high and still-growing valuations suggest that they have won the battle for particular market segments. Therefore, competing with these incumbents would likely result in a costly and protracted war for market turf.

Underscoring that point, , an old-school Silicon Valley venture capital firm with over $4 billion under management, compiled . The index currently tracks 56 companies, and here are the top five by market capitalization at the time of writing.

We鈥檙e using the BVP Cloud Index as a decent proxy for SaaS鈥檚 incumbent class. That鈥檚 because the overwhelming majority of the companies it lists 鈥� including the top five by market capitalization 鈥� offer their software on a subscription basis.

Here鈥檚 how the cloud computing index compares to broader public market indices going back to January 2011, the earliest date listed in the index. To make the comparison as similar as possible, Bessemer indexed all values to the same starting point (zero) to show relative performance over time. Accordingly, it鈥檚 easy to see which index stands out from the rest.

In case it wasn鈥檛 obvious, cloud stocks are the gold line on top. This is not the first time that 附近上门 News has covered this data. Cloud stock valuations were at or near all-time highs as of the end of October 2017, the last date listed in the index data. In just the last week or two, following a somewhat tough earnings season, some of the companies in the index have pulled back slightly from their highs. But regardless of these short-term movements, public SaaS companies outperformed the broader market by roughly a factor of three over the past seven years.

This sustained bull run serves to support the idea that incumbent SaaS companies have only become more deeply entrenched over time, potentially leaving less room for newer companies to achieve similar scale. This changing market landscape, as we will go over, may be a contributing factor to declining investor interest in SaaS upstarts.

The Bad: Private Funding Into Early-Stage SaaS Startups

Looking at public market performance alone, one could be forgiven for thinking that everything is coming up roses for SaaS as a whole. To be fair, the companies in Bessemer鈥檚 Cloud Computing Index no doubt control large chunks of the revenues in their respective markets. Therefore, SaaS as a sector is doing well, but for upstarts, times may be tough.

So is there a slowdown in seed and early-stage SaaS funding as Basta鈥檚 article suggested?

In an effort to quantify how the SaaS market is shaping up for these upstarts, we looked at the funding rounds raised by over 8,700 companies from around the world in . In this analysis, we are specifically focusing on the period between January 2011 and today to mirror the time period covered by the Bessemer Cloud Index. The chart below shows venture investment deal volume over time.

Across all stages of funding, venture deal volume is down for SaaS companies as a whole. Seed and late-stage deal volume both hit local maxima in 2015, and early-stage deal volume peaked in 2016 before a precipitous decline for this year. On a year-over-year basis, only late-stage deal volume grew between 2016 and 2017 year to date. And, overall, venture deal volume in the SaaS space has declined roughly forty percent between 2015 highs and early December 2017.

This being said, overall venture dollar volume is up. Here鈥檚 a chart displaying overall global venture dollar volume in 附近上门鈥檚 SaaS category, subdivided by stage.

The amount of money invested in SaaS startups has generally grown over the past seven years.

However, since 2014, that growth has been driven by late-stage venture deals. Harkening back to Basta鈥檚 argument, It seems that new SaaS startups aren鈥檛 just competing against publicly traded companies flirting with all-time highs. SaaS startups are now required to contend with increasingly well-capitalized late-stage private companies as well.

The data suggest that this decline in SaaS funding is driven by a kind of hollowing out in seed and early-stage investment. Below, you鈥檒l find a chart displaying both deal and dollar volume for seed and angel deals struck with SaaS companies around the globe.

And as we alluded to above, early-stage venture deal and dollar volume retreated from previous highs. However, such a retreat is not yet demonstrated to be a sustained pattern. It could just be a one-year dip.

For seed and early-stage SaaS startups, both deal and dollar volume are off previous highs. Again, this corresponds to an apparent generalized decline in venture investment at these stages, which 附近上门 News has documented in recent coverage. But in the case of the SaaS business, in particular, are there more unique factors influencing investor interest (or disinterest, in this case) in the sector?

, founder and investor at , a media company, conference series, and tailored to the SaaS community, offered 附近上门 News his opinions on the matter. Regarding a generalized decline in seed and early-stage funding activity, he doesn鈥檛 see it.

鈥淭here are 200+ new seed funds raised in the past 18 months, and I see them actively in market,鈥� Lemkin told 附近上门 News. 鈥淎ll the deals I’ve been involved in have been funded very quickly.鈥�

However, in the case of SaaS in particular, he suggested that if there is indeed a slowdown, 鈥渋nvestor fatigue鈥� could be to blame.

鈥淢any VCs came into SaaS [without prior investing experience in that market between] 2013 and 2015, and their portfolios are full of 鈥榞ood but not great鈥� SaaS startups,鈥� Lemkin explained. 鈥淕ood companies, but ones that will never return the fund. This has created a lot of investor fatigue in the space.鈥�

Despite this, Lemkin remains quite bullish about SaaS startups, saying that 鈥渋t is still early.鈥�

The Ugly: A Future Pipeline Problem

Fewer early-stage companies today may mean fewer late-stage companies a few years down the road. By the same logic, fewer late-stage companies could result in fewer IPOs as well.

The current state of the SaaS market may sound similar to other big technology sectors. Most of the big, generalized problems are already addressed by a previous generation of companies which have since gone on to do business at massive scale. In other words, an older generation of startups already sucked the air out of many big markets, a topic 附近上门 News has addressed before.

Lemkin observed that some of the once-popular markets for SaaS businesses have seemingly been tapped out. Although markets like sales, marketing, and HR may be 鈥渙ut of fashion,鈥� as he described it, there are emerging areas for SaaS companies that 鈥淸remain] very hot.鈥� He cites APIs and business-to-developer (B2D) as examples of active areas today. To paraphrase Lemkin, vertical-specific SaaS businesses like these require some amount of domain expertise on the part of founding team; therefore, they鈥檙e not that much more difficult to get off the ground than more run-of-the-mill SaaS businesses.

The business of providing software as a service is a challenging one. Our findings suggest that the uphill climb to business success is getting steeper for some early-stage SaaS companies. No doubt, there are plenty of big markets still out there for SaaS founders. But much like casting out in an overfished lake, it鈥檒l take more patience and luck to reel in a great opportunity. Maybe that鈥檚 why VCs are also having a hard time finding new SaaS businesses to invest in.

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