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​Halving R&D with AI & the Impact to Valuation​

Engineering teams within AI application startups are much smaller than a classic software company - maybe half the size or less.

Let’s run an experiment : let’s assume every public software company benefits immediately to the same extent & cuts R&D spending by half.¹

How would the value of these businesses change?²

72% of unprofitable SaaS companies would become profitable.

The typical SaaS company would increase from 4.4% net income margin to 15.8%.

And the total impact? $465b of increased enterprise value from $14.9t to $15.4t. That may sound like a lot, but it’s about a 3% improvement.

Because software companies aren’t valued on profitability - true within the venture capital & public markets alike - the cost savings from halving engineering teams aren’t that impactful.

Much better would be to focus those teams on revenue generating products to boost revenue growth.

A 30% increase in revenue growth would increase enterprise value by $2.3t - 5x the impact of cuts.

Yet another reminder that in software, growth is king.

¹My goal is to understand the financial impacts of such a move. To be clear, I’m not advocating for this. It’s a hypothetical thought experiment.

²Software companies trade on Enterprise Value (EV) to Forward Revenue (projected revenue in the next 12 months) multiple. I created a linear regression of these companies’ valuation based on revenue growth, gross margin, net income margin, & cash flow from operations margin (R^2 of 0.23 - not hugely predictive, but p < 0.001). Revenue growth is the most important determinant factor.

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