Five areas influencing the B2B SaaS industry in 2023

1. Macro challenges translated to weaker company performance

Company performance from Q1 through to Q3 was weaker for most B2B software companies in the US and Europe. Many companies we evaluated increasingly missed their quarterly targets, had slower top line growth, longer sales cycles, experienced higher customer churn and a more challenging environment for upsell, resulting in deteriorated SaaS metrics.

These observations are echoed by our peers in the venture ecosystem, with Iconiq’s Growth report showing continued deterioration in top line performance throughout 2023. Iconiq’s report notes that average top line growth for companies between $50-100m ARR fell from 117% in H1 2021 to 72% in H1 2023. Net dollar retention similarly deteriorated, falling from 118% in H1 2021 to 109% in H1 2023, driven by elevated levels of churn and weakened customer expansion. Iconiq also observed that sales efficiency has declined as selling SaaS tools and platforms has become more challenging in the current macro environment. This can be seen in the decrease in net magic number, falling from 2.1x in H1 2021 to less than 1.0x in H1 2023, with longer customer acquisition payback period, going from 21 months in 2021 to 29 months in 2023.

The slowdown in top line growth has led to a greater focus on evaluating spend and cash burn (more on that below). Companies that managed to demonstrate strong metrics are generally selling “mission critical” software that did not get rationalised when enterprise budgets tightened, and have been able to attract capital more easily and at stronger valuations. . More than ever, software businesses need to focus on becoming more “mission critical” by including greater integration within customer workflows and driving stronger user adoption and engagement. 

2. Challenging fundraising and IPO environments

With a decline of nearly 20% in the number of late-stage VC deals globally this year compared to 2022, fewer companies were funded at lower valuations in 2023.Private company valuations have fallen following the public markets’ correction (with some exceptions, such as Generative AI companies) and a third of funding rounds in 2023 were at flat or lower valuations compared to previous funding rounds. Most founders and companies have had to accept the possibility of flat or down rounds compared to the highs of 2021. Financing rounds also appear to be increasingly led by internal investors, with Carta Q3 2023 data showing 39% of Series B rounds were internally led compared to a 22% average for Q2 2020-Q2 2023 and a similar trend for Series C. This resulted in a lot of “dry powder” – capital not yet deployed in PE and VC – sitting on the side lines driving high competition for top quality companies that demonstrated strong performance.

IPO activity was also significantly down in 2023. Less than 100 IPOs priced YTD 2023, compared to 250 in 2022 and over 500 in 2021 globally. IPO activity did show some signs of improvement after the summer, but with one third of the IPOs trading at a 50% discount compared to their offer price, aftermarket performance has been mixed. This trend is also evident from some of the largest tech IPOs in September 2023:

• Arm went public at a valuation of $52bn and traded 20% down in the first month and is now trading 21% up from its listing price as of November 23, 2023
• Klaviyo went public at a valuation of $8bn and is trading as of November 23, 2023 8% down from its listing price
• Instacart went public at a valuation of $8bn and is trading as of November 23, 2023 16% down from its listing price

The shaky IPO environment resulted in several planned IPOs being cancelled or postponed, including Reddit, Stripe and others. This created both a challenge and an opportunity for market participants. An opportunity for investors to back the best pre-IPO companies and a challenge for companies having to raise financing in challenging private market conditions in lieu of public offerings.

We anticipate this challenging fundraising and exit environment is likely to persist for the next several quarters, so companies must continue to adapt to the idea of a capital constrained landscape. A relentless commitment to operational efficiency and cost management is crucial, as investors are placing greater emphasis on financial discipline. This evolving market demands that companies are resilient, agile and strategic in their approach to secure funding and sustain growth. 

3. Strategics opened their cheque books and went on a small M&A shopping spree

Every challenge carries an opportunity. Numerous strategic acquirers recognized a chance to acquire valuable assets, enrich their product offerings and broaden their customer base. This was facilitated by lower market valuations and an increased willingness to sell amid challenging fundraising and macroeconomic conditions. According to Pitchbook, 2021’s particularly high volume of tech M&A has not seen a significant drop in subsequent years. Interestingly, European M&A deal count remained above US levels in the past two years, but these trended towards smaller transactions (under $100m deal size).

Cybersecurity is a key sector for us that has experienced heightened activity in M&A.  Cybersecurity M&A activity continued to be elevated, mostly in the sub-$500m price range, with exceptions such as the Splunk acquisition by Cisco for $28B and the Imperva acquisition by Thales for $3.6B. Some of the strategic rationale included continued platform building, product enhancements, opportunity for greater upsell to existing customer base and the relative resilience of cybersecurity budgets to a challenging macro environment. The list below is by no means exhaustive, but provides some explanation of the high activity: 

1. Check Point in discussions to acquire Atmosec for an undisclosed amount (SaaS / SSPM)
2. Palo Alto acquired Talon for an amount of $650m in Nov-23 (Secure Enterprise Browser)
3. Palo Alto acquired Dig Security for an amount of $350m in Oct-23 (Data Security)
4. SailPoint acquired Osirium for an amount of $9m in Oct-23 (PAM)
5. Tenable acquired Ermetic for $265m in Sep-23 (CIEM)

4. An increase in “on-prem” footprint is a surprising outcome

Companies have had to adjust to the new reality by shifting focus from growth-at-all-costs to profitability and reduction in cash burn by rationalising spend and reducing headcount. As reported by layoffs.fyi, the tech industry experienced a peak in layoffs in 2023 globally, particularly at the beginning of the year, with more than 167,000 employees being let go in Q1 out of a total 250,000 year to date – a significant increase from the 165,000 job cuts throughout 2022.

Another interesting trend we observed was companies (especially very large global enterprises) increasing the “on-prem” footprint to reduce cost and public cloud dependence. This is surprising given the strong emphasis on public cloud migration over the last decade. This repatriation trend is partly driven by cost, concerns related to data security and sovereignty, regulatory requirements, public cloud performance issues like high latency and difficulty of managing data on public clouds. At certain scale, falling costs of computer and storage equipment makes owning and maintaining one’s own hardware cheaper than ever-increasing cloud bills. Some of the largest enterprises we spoke to referenced plans to increase their “on-prem” footprint by as much as three or four times, citing high and unpredictable costs as one of the main considerations. Storage costs add up – several Fortune 100 companies mentioned that AWS S3 storage could be as much as four times more expensive than storing data on owned hardware in companies’ owned or leased premises. As such, moving some of the workloads (such as computer and data intensive AI workloads) to “on-prem” or embracing a hybrid strategy (a combination of “on-prem” and on-cloud) is a viable option for software companies looking to reduce costs.  

5. 2023 was the breakout for AI

2023 can arguably be labelled as “the year of AI”. This is evident in the significant investments made in AI companies like OpenAI, Anthropic, Hugging Face and Mistral, the merger and acquisition activities exemplified by Databricks acquisition of Mosaic ML (we are proud to have supported the former in the last funding round) and a pronounced surge in enterprise demand and early adoption of AI (with a notable shift of budgets from other areas to AI). Additional drivers were sustained advancements in research, the formation of fresh collaborations, significant activity across the Big Tech and hyperscalers and an ongoing surge in the creation of new AI companies and applications. AI’s disruptive potential is forcing tech companies, especially existing software providers, to integrate AI or risk obsolescence. This subject warrants its own dedicated blog post, so keep an eye out for more insights in later posts.

As the challenging macro conditions remain, we expect the headwinds facing software companies will continue well into the next year and beyond,. However, we remain cautiously optimistic and see promising glimmers of hope coming from ongoing technological innovations and the enduring resilience of the founders and ecosystems we are privileged to collaborate with. We think that some natural attrition and acquisition appetite will make the market stronger, which will create exciting opportunities for companies and investors. Software businesses will need to continue to adapt and navigate the challenging fundraising and IPO climate, while continuing to grow in a more efficient and agile way. Those that manage to do this well will not only survive, but thrive, emerging as stronger and more resilient businesses. 

^[1] By “on-prem” we are referring to both private clouds, i.e. third party cloud infrastructure dedicated to a single organisation, as well as owning and managing one’s own infrastructure.

Zaya Kadyrova is a Director at Teachers' Venture Growth (TVG), Ontario Teachers’ venture capital and growth equity arm. Based in London, she helps lead TVG's strategy for direct investments in high-growth European technology companies.