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The old playbook
Software careers were built on a simple loop: lay out a plan, execute it relentlessly, hit it or beat it, and compound the value. CEOs and management teams learned it before AI, and it worked. The message to software companies a few years ago was blunter: get to AI or be worth three times revenue. Public software companies now trade at around six times revenue, where in 2021 they went for 30 times.
The shrinking math
Picture a company that has quadrupled in size since then and reached break-even. The multiple on its revenue fell by a large factor, so it is worth less today than it was, despite all that growth. Every day it hits its plan, it is destroying equity value.
The better split
Telling CEOs this was meant to set them free. Many of them, running businesses at hundreds of millions in revenue, worked on the core business from 8 a.m. to 5 p.m. and tried AI from 5 to 8 in the evenings. The better split is the inverse, and the training, muscle memory, and inertia of a career spent climbing one hill make that hard to do.
Why did software multiples fall so far?
A revenue multiple reflects what investors expect a company to earn years from now, discounted back to today. When interest rates rise, distant profits are worth less, and the multiples of fast-growing software companies compress the most. The US Federal Reserve raised its benchmark rate from near zero in March 2022 to above 5 percent by mid-2023. Software multiples had peaked in 2021, when rates sat at their floor.
Why do long careers resist this kind of change?
Clayton Christensen argued in The Innovator's Dilemma, published in 1997, that well-run companies fail by doing what has always worked: listening to current customers and improving the existing business. Habits, incentives, and metrics all reward that behavior until the ground shifts. Managers who rose by hitting plans have the strongest muscle memory for it. Christensen based the book on his study of the disk drive industry.
Why did software earn such high multiples?
Software sold by subscription brings in recurring revenue, and copying a program for one more customer costs almost nothing. That gave public software companies gross margins commonly in the range of 70 to 80 percent. Investors paid for the long stream of predictable future revenue. The model's name, software as a service, spread after Salesforce launched in 1999.
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