Private equity firms, which heavily invested in software companies for their stable earnings, are now in a bind. The AI threat devalues these assets and complicates exits, forcing them away from traditional IPOs and toward more complex M&A strategies.
Related Insights
The downturn in software stocks isn't tied to current earnings. Instead, investors are repricing the entire sector, removing the premium they once paid for its perceived safety and stable, long-term contracts, which are now threatened by AI disruption.
A significant shift has occurred: private equity firms are no longer actively pursuing acquisitions of solid SaaS companies that fall short of IPO scale. This disappearance of a reliable exit path forces VCs and founders to find new strategies for liquidity and growth.
The rapid evolution of AI means traditional private equity M&A timelines are too slow. PE firms and their portfolio companies must now behave more like venture capitalists, acquiring earlier-stage, riskier AI companies to secure necessary technology before it becomes unaffordable or obsolete.
Investor Jason Lemkin claims that private equity firms and strategic acquirers are no longer interested in buying B2B SaaS companies in the $50M to $800M ARR range that lack a strong AI narrative. Even if profitable, these companies are seen as existentially threatened, effectively closing a once-reliable exit path for founders and investors.
AI's ability to reduce the cost of software development erodes competitive moats, threatening the multiple-expansion strategy of growth-focused PE firms. However, firms like Constellation Software, which buy and hold for free cash flow (FCF), are better positioned. AI can simultaneously increase net retention and lower operating expenses, directly boosting the FCF that drives their returns.
According to Manny Roman, AI will empower large companies to build their own software solutions in-house, replacing expensive third-party contracts. This poses a significant threat to the predictable revenue streams of many enterprise software companies, potentially upending private equity investments that rely on those cash flows.
For over a decade, SaaS products remained relatively unchanged, allowing PE firms to acquire them and profit from high NRR. AI destroys this model. The rate of product change is now unprecedented, meaning products can't be static, introducing a technology risk that PE models are not built for.
Private credit funds have taken massive market share by heavily lending to SaaS companies. This concentration, often 30-40% of public BDC portfolios, now poses a significant, underappreciated risk as AI threatens to disintermediate the cash flows of these legacy software businesses.
For years, founders of profitable but slow-growing SaaS companies could rely on a private equity acquisition as a viable exit. That safety net is gone. PE firms are now just as wary of AI disruption and growth decay as VCs, leaving many 'pretty good' SaaS companies with no buyers.
Roughly one-third of the private credit and syndicated loan markets consist of software LBOs financed before the AI boom. Goodwin argues this concentration is "horrendous portfolio construction." As AI disrupts business models, these highly levered portfolios face clustered defaults with poor recoveries, a risk many are ignoring.
