Measuring the Depth of the Software Industry Iceberg
Quantifying Patio11’s Law Across 3,000 Companies and Three Years
If you read the mainstream tech press, it feels like there is a constant stream of startup acquisitions in the news. The sheer volume of these stories can make you think that you hear about most of the startup acquisitions that happen.
However, our friend (and TinySeed mentor & investor) Patrick McKenzie recently made an observation that counters this notion, and instead argues that the software industry is likely much bigger and varied than a casual observer might guess:
People do not widely assume in the software industry that they would be able to name every legal firm with $10M in revenue, but they assume that every software company with $10M in revenue is on the top of HN or TechCrunch at least weekly, and that just isn’t true.
— Patrick McKenzie (@patio11) May 12, 2020
This resonated strongly with us, as TinySeed invests broadly in the earliest stages of what we call Independent SaaS companies (capital efficient, B2B SaaS companies not dependent on fresh funding every 18 months), and so we see a lot of software companies (our two most recent application windows received almost 1600 applicants).
Although our gut feel was that the software industry was much larger than most assume, we didn’t really have a good grasp of how much larger. So we decided to find out.
In order to quantify how much of the software industry iceberg is beneath the surface, we gathered a set of more than 3000 software acquisitions between 2017 and 2019. These were acquisitions that were publicly announced (usually with a press release), and we decided to look at how many of them garnered any mainstream technology press mentions.
In order to achieve that, we searched for any mention of the acquisition in mainstream technology press outlets, including places like Hacker News, TechCrunch, Recode, PandoDaily, Venture Beat, Wired, Gizmodo, The Verge, NYT Bits and Mashable. The goal was to determine if someone who followed the software sector pretty closely was likely to have heard of the acquisition.
Figure 1: ~7% of software acquisitions get any kind of mainstream tech press mention.
A very small percentage of acquisitions receive tech press
Our results were surprising — only 7% of acquisitions get any mainstream tech press mention at all. And keep in mind, these are acquisitions – not new product releases or other less foundational news pieces about a software company.
The implications of this are pretty profound – it means that there are nearly 15x software company acquisitions happening than even a pretty dedicated reader of technology news might assume. For every transaction like Facebook’s widely reported acquisition of Giphy ($400m) there could be nearly 15 transactions like Proactis’s acquisition of Perfect Commerce ($132.5m) that do not get much of a mention outside the press release or very narrowly focused news sites.
Less than 1/3 of acquired companies received traditional funding
Okay, so the software industry is much larger than the casual (or even keen) observer might assume. What about funding? News of fundraises and (sometimes eye watering) valuations seemingly makes the news every day, but what percentage of companies that are being acquired have actually received “traditional” venture funding?
Figure 2: Less than 1/3rd of the companies being acquired had taken traditional venture financing.
Using the same data set as above, we looked at fundraising histories for the acquired companies using Crunchbase data. We defined companies that did not have “traditional venture funding” as companies that either had zero recorded fundraising rounds (by far the vast majority) or companies that only raised one round of less than $500k total. It turns out that less than 1/3rd of the acquired companies had raised traditional funding, as shown in Figure 2.
This is again quite surprising, particularly when you realize that in 2019, Crunchbase estimates that nearly $7bn was invested at the Seed and Angel stage in North America alone. It suggests that bootstrapping, self financing and low key friends and family rounds account for the vast majority of financing volume for software companies, perhaps to the tune of more than $10bn/year.
Given all of this, you might ask yourself: where are all these companies?
Venture capital invests in tech hubs — but independent SaaS founders are everywhere
For traditional venture backed companies, it’s pretty well understood that they tend to cluster in places like Silicon Valley. In the United States specifically, many venture capitalists do not invest outside of the major tech hubs, which is reflected in the amount of venture capital concentrated in California (specifically Silicon Valley) and to a lesser extent in New York, with most other states receiving comparatively paltry amounts (see Figure 3 — 2016 data: Wikipedia).
Figure 3: Venture capitalists largely do not invest outside major tech hubs.
In contrast, the State of Independent SaaS report, indicates that founders who eschew traditional fundraising, such as the Independent SaaS founders that is our focus, live everywhere — not just in major tech hubs. For example, the most popular city (London) holds only 4% of respondents and the top 10 cities capture only 20% of companies.
Figure 4 shows the distribution of HQs for respondents based in the United States to the State of Independent SaaS report.
Figure 4: Founders who eschew traditional funding live everywhere — not just in major tech hubs.
Independent SaaS companies are a much larger share of the industry than most people realize
Overall, we find pretty strong evidence that software firms in general, including the type of independent SaaS companies we invest in, are a much larger share of the industry than most people realize. In addition, they are mostly ignored by the mainstream tech press and often ill-served by traditional venture capital.
We believe that it is possible to support and fund these types of companies, and not only get “venture type” returns, but to do so in a way that has less than venture risk. If you’re interested in hearing more of our thinking behind that, click here for more information on how to invest in TinySeed
