Software a winner as VC market heads to biggest year since dot-com era

Software as a service attracts investors

atm cash machine money
Credit: Tax Credits

Venture capitalists are investing more money in private companies than at any time since the dot-com bust, with software companies grabbing the biggest slice of the pie.

In the third quarter this year, the software sector received the highest level of funding of all industries in the U.S., scooping up US$5.8 billion in 412 deals, according to the latest MoneyTree Report.

Venture capitalists also invested $5 billion in 242 of what the report calls "Internet-specific" companies, a classification for companies with business models that are fundamentally dependent on the Internet, according to the report, put out by  PriceWaterhouseCoopers (PwC) and the National Venture Capital Association, based on data provided by Thomson Reuters.

Within the software arena, social-oriented companies and software as a service business models appear to be hot. "We're seeing a lot of Saas models, a lot in the on-demand category because it's not capital intensive, it's not people-intensive, it has a recurring revenue stream and once people get their hands on the product, hopefully they keep using it," said Tom Ciccolella, U.S. venture capital market leader at PwC.

The top 10 VC deals of the third quarter included a $450 million investment in data analysis company Palantir Technologies; a $251 million deal with software services site GitHub; and a $150 million cash injection into customer experience management software maker Medallia. Also in the top 10, Avidxchange, an IT services company specializing in accounts payable and payment technology, snapped up about $225 million in VC money.

The $47.2 billion invested in all company categories in the first three quarters of 2015 is higher than full-year totals for 17 of the last 20 years. In the third quarter alone, the figure was $16.3 billion. That's 5 percent lower than the second quarter, but the VC market is on a path to be bigger than for any year since 2000, when the dot-com craze flamed out.

The inevitable question is whether it amounts to a bubble that's about to burst. There are, however, rational reasons for the increase in VC funding, points out Ciccolella.

First of all, there are more players, and therefore more competition, in the VC market these days, with non-traditional players like hedge funds getting into the private-investment game. In addition, some of these companies may be taking a long view and not necessarily be looking for a quick initial public offering (IPO). Many private companies are electing to take advantage of the situation and receive late-stage funding rather than going public.

"Private companies don't have analysts looking at their quarterly results to see if they missed expectations," and can focus on improving their products, Ciccolella said.

Software companies, meanwhile, are relatively low-risk. "The barriers to entry in software are lower than in other types of businesses," Ciccolella said. Software companies, for example, don't need to worry about manufacturing plants and the material costs of hardware.

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