Venture capitalists eye SaaS companies

Venture capitalists looking ahead to 2007 are optimistic about the financial potential of software as a service (SaaS), even though industry data shows that total investments in software companies are declining.

SaaS, which allows companies to access applications remotely via the Internet, typically while paying monthly fees, offers a more predictable revenue stream and lower research and development expenses to software vendors than packaged software products, says Jeff Horing, co-founder and managing director of Insight Venture Partners in New York.

“Overall, if you can build a successful company it’s a much better business model than license sales,” Horing says.

Total venture capital dollars invested in software declined 19% between the second and third quarters of 2006, and the number of software deals reached its lowest point in a decade, according to the Q3 2006 MoneyTree Report, compiled by PricewaterhouseCoopers and the National Venture Capital Association. The software investment figures do not include software as a service. SaaS is listed under IT services, which also saw a decline in investment dollars.

Horing says he and other investors at his firm are skeptical about growth for companies looking to make their mark by selling enterprise software applications, as opposed to those that market the SaaS model.

“From our view, convincing lots of Fortune 500 companies to buy a complex piece of application software is very difficult,” he says.

Horing would rather invest in established companies that are looking to enhance profitability through buyouts, rather than growth, he says. To that end, Insight Venture financed a recent deal that allowed Primavera Systems to bolster its lineup of project management software by purchasing two smaller companies.

Warren Weiss, general partner at Foundation Capital in Menlo, Park, Calif., also is skeptical about investing in companies that sell packaged software applications. Weiss prefers investing in SaaS models that cater to customers that don’t want to deal with a large systems integration project.

“Software as a service is clearly a very interesting area because of the ease of selling into these types of environments where users can use it without a big IT implementation,” Weiss says.

Weiss says he looks for products with the user-friendly features of Amazon.com. Foundation Capital has invested in Rearden Commerce of San Mateo, Calif., which provides travel services for businesses, and BoardVantage, a Menlo Park company that provides hosted applications to boards of directors.

“We have about 11 of these types of (SaaS) investments and they’re doing very well,” Weiss says. “We’re looking for new investments in that area.”

SaaS is catching on partly because it allows small companies to gain the functionalities of large enterprises, he says.

“It gives them a chance to level the playing field against their bigger competitors,” he says.

Foundation Capital does plan more investments in traditional software in the Internet infrastructure realm. Security and storage software, middleware integration, and networking software are among the potential investments, Weiss says.