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.
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A market bifurcation is underway where investors prioritize AI startups with extreme growth rates over traditional SaaS companies. This creates a "changing of the guard," forcing established SaaS players to adopt AI aggressively or risk being devalued as legacy assets, while AI-native firms command premium valuations.
While AI expands software's capabilities, vendors may not capture the value. Companies could use AI to build solutions in-house more cheaply. Furthermore, traditional "per-seat" pricing models are undermined when AI reduces the number of employees required, potentially shrinking revenue even as the software delivers more value.
For established software companies with sluggish growth, the path forward is clear: find a way to become relevant in the age of AI. While they may not become the next Harvey, attaching to AI spend can boost growth from 15% to 25%, the difference between a viable public company and a sale to a private equity firm.
The historical advantage of being first to market has evaporated. It once took years for large companies to clone a successful startup, but AI development tools now enable clones to be built in weeks. This accelerates commoditization, meaning a company's competitive edge is now measured in months, not years, demanding a much faster pace of innovation.
Private Equity value creation has evolved. In the 2000s, it was driven by leverage; in the 2010s, by digital transformation. Today, AI serves as the new foundational "operating system" for growth, embedding intelligence into every process, contract, and customer touchpoint to drive returns.
The long-held belief that a complex codebase provides a durable competitive advantage is becoming obsolete due to AI. As software becomes easier to replicate, defensibility shifts away from the technology itself and back toward classic business moats like network effects, brand reputation, and deep industry integration.
Unlike mobile or internet shifts that created openings for startups, AI is an "accelerating technology." Large companies can integrate it quickly, closing the competitive window for new entrants much faster than in previous platform shifts. The moat is no longer product execution but customer insight.
AI is making core software functionality nearly free, creating an existential crisis for traditional SaaS companies. The old model of 90%+ gross margins is disappearing. The future will be dominated by a few large AI players with lower margins, alongside a strategic shift towards monetizing high-value services.
Recent acquisitions of slow-growth public SaaS companies are not just value grabs but turnaround plays. Acquirers believe these companies' distribution can be revitalized by injecting AI-native products, creating a path back to high growth and higher multiples.
Permira's AI strategy uses a clear framework: invest in the 'picks and shovels' of compute (data centers) and in applications with unique, proprietary data sets. They deliberately avoid the hyper-competitive model layer, viewing it as a scale game best left to venture capital and strategic giants.
