Why Are Software Companies So Expensive (Highly Valued)?
If you’ve ever looked at a software company selling “just subscriptions” and wondered why investors value it like a money-printing machine, it comes down to one simple idea:
Software can turn one-time effort into recurring, scalable cash flow.
That combination is rare in business, and markets pay a premium for it.
1) Recurring revenue is more predictable than most businesses
A classic software/SaaS product sells subscriptions: monthly or yearly contracts that renew.
That means investors don’t have to “guess” next quarter from scratch. They model:
current recurring revenue
retention (how many customers stay)
expansion (customers who upgrade)
new sales growth
Predictability reduces risk, and lower risk increases valuation.
2) High gross margins (because the cost to serve the next customer is low)
Once the software is built, the incremental cost of another customer is usually small (hosting + support).
That’s why many SaaS businesses target high gross margins (often ~70–90% depending on stage and model). High gross margin signals scalability: revenue can grow faster than direct costs.
3) Software scales globally without scaling headcount the same way
A service business (agency, consulting, legal, accounting) tends to scale with people.
Software can scale with:
servers / cloud spend (often efficiently)
automation
self-serve onboarding
product-led growth
So a strong product can go from 1,000 customers to 100,000 customers without hiring 100× more staff.
That “non-linear scaling” is why software companies can become very large relative to their headcount.
4) The “compounding” effect: retention + expansion
Many good SaaS companies don’t just keep customers — they earn more from the same customers over time via:
more seats
premium tiers
add-ons
usage expansion
This is why metrics like net revenue retention (NRR) matter: if customers expand faster than churn, revenue compounds even before new sales.
5) Switching costs and workflow lock-in create durable moats
If your software becomes part of a company’s daily workflow (CRM, analytics, finance, dev tools, operations), switching is painful:
retraining teams
migrating data
rewriting processes
integration work
Durable “stickiness” makes future cash flows more reliable, which increases valuation.
6) Valuation math: investors pay for future cash flows, not today’s product
In theory, the value is a discounted sum of future cash flows (DCF).
In practice, markets often use shortcuts like:
EV / Revenue multiples (common for SaaS)
EV / EBITDA (more common once mature)
Multiples rise when growth is strong and capital is cheap, and fall when growth slows or interest rates rise.
For example, one advisor dataset shows the median public SaaS EV/Revenue multiple around 6.1x by Aug 2025 (well below the 2021 peak).
And SaaS Capital’s private SaaS index cited a median multiple around 7.0x entering 2025.
(Exact multiples vary hugely by growth rate, margins, retention, and market category.)
7) The “Rule of 40” is a popular shortcut for quality
Investors love software companies that balance growth and profitability.
A common rule of thumb is:
Rule of 40 = growth rate + profit margin ≥ 40
It’s not a law, but it’s a quick signal that the company is not buying growth at any cost.
Why valuations sometimes crash (and why some SaaS is “overpriced”)
Software isn’t automatically valuable. Valuations fall fast when:
churn rises (customers leave)
expansion slows
competition commoditizes pricing
growth decelerates
margins compress (cloud costs + heavy support)
a new platform shift changes the rules (AI is one current pressure)
There’s real discussion that AI could pressure traditional SaaS pricing power and predictability (e.g., pushing toward usage-based models and faster competition).
A simple mental model
Software companies are valued highly when they look like:
Predictable recurring revenue
× High gross margin
× Strong retention + expansion
× Large market + scalable distribution
× Durable moat (workflow + integrations)
If one of those breaks (especially retention or growth), the valuation multiple often compresses quickly.