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Software Startups: A Goldmine For Investors

Startups often struggle to get investment, but software companies buck the trend

27Sep

There is no ‘formula for success’ when it comes to startups. 90% of young companies fail, despite having creative ideas and a willingness to get it right. The reasons for this are many, but arguably the main one is an inability to raise initial capital.

The reasons companies fail to attract initial capital is not always that their business plan is wrong, rather it’s often that investors are extremely cautious about the risks, perspectives, and market behavior. However, while there is no universal investment model for startups, there is a sector where investors feel more comfortable with spending money - the software industry.

In the first quarter of 2016, according to PwC, venture capitalists invested $12.1 billion in 969 deals, with the software industry receiving the highest level of funding with $5.1 billion going into 376 deal. The Biotechnology industry was a distant second, with $1.8 billion going into 118 deals. From an investor’s perspective, no one wants to have anything with a business that doesn't have the potential to return capital and grow fast. Thus, when they consider early-stage startups, they have specific preferences and valuations. The latter includes the capability of a startup to survive in the industry it's in and its ability to balance supply and demand. It is also down to the level of willingness among the investors to make the deal and how desperate the entrepreneurs are to get the cash.

Often, regardless of how good the idea is, if the industry is not performing well in the market, startups can simply fail because of the risks in the whole sector - not because their idea is worthless. The more complicated and time-consuming the supply chain model is, the less chance a startup has to be funded - unless the idea has true disruptive potential and is worth the wait and effort. With software startups, investors feel more at ease due to the straightforward nature of the industry and the fact that they require relatively small funds to set up.

The boom in software was triggered by many different factors, including an increase in the number of industries dealing with big data, technology, and digital processes - three areas where software support is critical. Investing in companies that are capable of accelerating growth with small funding is nothing but a goldmine, which also means that investments can be spread across multiple projects of a similar nature at the same time, with financial risks being hedged in case of failure.

Aside from a small initial funding and only a little extra for maintenance, software startups also don't require building expensive facilities, nor do they need R&D departments and production lines. They usually have a straightforward subscription model that drives growth and builds a customer base. The software sector has seen high demand for both B2C and B2B models across the industry - from cloud storage to e-commerce solutions. Dropbox, Palantir, and Salesforce are just a few examples where software solutions have managed to ease and improve processes that seemed to be impossible 20 years ago. With digitization taking over the world and more people growing comfortable with the idea of moving life assets (from photographs to entire businesses) to the digital space - software platforms will continue being built, and the industry will continue growing.

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