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Private capital loved software —or it did for about a decade, during which capital deployment skyrocketed.

In more recent quarters, software markets have reflected global macroeconomic uncertainty. Publicly listed companies’ multiples swooned; access to debt markets tightened; and private markets continued to hold large amounts of dry powder. Developments in banking that have affected major tech-financing entities may also affect capital raises for software.

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But tech is only becoming more important in business, while also becoming more complex. Technology continues to blossom and is being used to transform operating models, increase efficiency, boost innovation, and address pressing challenges such as climate change. It has also become more complex as technological advances have stimulated new waves of software development. Examine, for instance, the leaps in fields such as fifth-generation technology, AI, automation, and edge and cloud computing.

Macroeconomic trends suggest that cybersecurity, payments, industrial software, human capital management, supply chain management, and data and analytics will be especially significant for the software sector in coming years.

A ten-year streak of growth

Private capital in software grew by more than 24 percent per year, even doubling from 2020 to 2021 as the sector recovered from the acute phase of the COVID-19 pandemic and completed deals that had been postponed. Our analysis shows that investments in 2022 were driven by large private equity (PE) transactions, including three valued at more than $10 billion.[[footnote 1]] However, growth-focused private capital shrank from 2021 to 2022. Two major investors became more watchful of valuations and cautious about deploying capital. They ended up deploying less than 10 percent of their available funds in 2022 (Exhibit 1).

[[Exhibit 1]]

Multiples have grown more quickly for software companies than for non-software peers

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Demand for software from clients of all sizes has increased steadily with digitalization, giving the sector a structural boost. The rise of software-as-a-service (SaaS) business models also builds in recurring revenue.

Software is very good at generating cash thanks to its scalability. Its connectivity enables remote operations; processing power and visualization and dashboard capabilities support accelerated decision making.

These characteristics have buoyed software multiples (here, we use enterprise value divided by revenue) since 2005, reaching a peak of 8.3 in 2021 after the acute phase of the COVID-19 crisis. Recent increases in the cost of capital have compressed technology company multiples, which remain significantly higher than those of non-software companies (Exhibit 2).

[[Exhibit 2]]

Significant dry powder is set to fuel future software investments

In pursuit of outsize returns, a significant amount of dry powder in tech-focused PE funds has been channeled toward software. After slowing in 2021, growth in dry-powder levels jumped again, rising by $68 billion from 2021 to 2023. This suggests continued interest in software investments. However, the impact of challenges in the banking sector in 2023 remains unclear (Exhibit 3).

[[Exhibit 3]]

Six areas that may shape the future of the sector

No one can predict the future. But decision makers interested in software can use a set of criteria to identify areas that will become more important. Decision makers can consider companies that serve global demand, which is projected to grow for structural reasons; companies that help businesses—particularly small and medium-size enterprises (SMEs)—by providing protection and productivity aids; and companies that occupy fragmented ecosystems. With those considerations in mind, here are six areas that seem likely to have an outsize commercial economic effect.

Cybersecurity is increasingly relevant because of the rising number of threats and attacks. Regulatory requirements have also sprung up in response to those incidents, which would likely make the sector resilient. In informal interactions, chief investment officers (CIOs) say they are on the hunt for software offerings with high short-term ROI, and demand is growing from both enterprise and SME customers. But cybersecurity talent is scarce, so customers rely heavily on independent software vendors and tech services partners as providers of services and solutions. The ecosystem is also fragmented, which paves the way for a strong cybersecurity company to grow through acquisitions.

Payments software fuels everything from online checkouts to cryptocurrencies, so the market is large, with accelerating growth and a variety of scalable products. What’s more, payments software has become a significant creator of value in the financial industry, especially compared to traditional banks. This area also continues to draw a high level of interest compared with its fintech counterparts.[[footnote 2]]

Industrial software, such as product design and engineering solutions, is growing quickly, partly because enabling technologies such as the Internet of Things and edge and cloud computing have grown enough to boost the number of uses for it. A related reason is that customers’ needs are evolving as they look to develop digital capabilities in addition to their hardware products. Industrial software has responded to this demand with solutions such as democratized computer-aided engineering, a new generation of product life cycle management solutions, and smart manufacturing platforms dedicated to midsize customers.

The market is still fairly fragmented, and there will likely be opportunities to transform legacy entities, vertically integrate, or implement subscription-based business models, which are still subscale in industrials.

Human capital management software is growing as HR continues its evolution from a personnel management function to a cross-functional business partner that integrates talent management, employee experience, employee productivity, and talent processes and service delivery. As the function evolved, so did the software that supports it. HR software now encompasses an ecosystem of often interconnected solutions that respond to changes in customer and regulatory demands. This market segment may remain resilient even in times of uncertainty because most CIOs plan to maintain essential HR-related spending.[[footnote 3]]

Supply chain management has become an enduring concern after the onset of the COVID-19 crisis. Even SMEs are increasingly expressing interest. The market for supply chain software will likely grow in the long run because of the need for supply chain optimization, end-to-end integration, and automation in areas such as productivity, cost, and sustainability.[[footnote 4]]

Data and analytics is a broad umbrella that covers areas such as data privacy—which our research shows has seen double-digit growth in investments and revenue—and data management. This part of the market is growing thanks to innovations in areas such as cloud infrastructure, AI, and machine learning. Structural changes such as efficiency gains from data operations also add fuel. These solutions will likely be buoyant even during an economic downturn because they provide high short-term ROI for CIOs.

Available data suggests that the slowdown in software investment is a short-term problem. Cybersecurity, payments, industrial software, human capital management, supply chain management, and data and analytics may be the areas to watch for the software sector.