The software valuation gap, walking away post-LOI, and AI8

The Carry · July 19th. 6 min 48 sec.

Cold open

Public buyers are straight up beating private equity at the software game right now. They are doing it by manufacturing their own effective multiples. While sponsors sit around hoping for pricing to rationalize, strategic buyers are paying headline prices and aggressively offshoring the integration to hit their targets. The arbitrage happens post close.

Intro

This is The Carry for July 19th. I went through the top private equity podcasts this week so you do not have to. Here is what actually mattered for your deal pipeline. I am West. Let us get into the tape.

Manufacturing Multiples

Let us talk about the software valuation gap. You know the exact pain I am talking about. Multiples remain completely elevated. Deals stall out constantly. Smart capital is finding a back door. They focus entirely on internal returns. Take Jeremy Segal at Progress. He was just on M&A Science breaking down exactly how they outbid private equity for software assets. They pay the headline price willingly. They clear the market to win the deal. The moment the ink dries, they shift high cost engineering straight to Bangalore. They knew a lot of the things the target was doing in expensive geographies could be done much cheaper offshore. That immediate integration pushes their effective EBITDA multiple down into their strict target zone. It is a manufactured margin. This connects directly to what Pat Dorsey told Capital Allocators. He runs a concentrated global portfolio. He hunts exclusively for massive reinvestment runways. He wants a business that plows profits directly back into high return internal projects. When a company compounds its own capital internally at massive rates, the classic capital allocation conundrum is completely moot. You let the business do the heavy lifting. Here is why that matters to you. The playbook is shifting fast. You need a structural plan to force down your effective multiple post close. Or you need an asset with a huge internal runway. Those are the levers to win the bid. The math requires it. Every single week. The firms executing this playbook will consistently outpace the pack.

The Institutional Abort Button

The second major theme this week is the institutional power to walk away. Deal heat makes people do stupid things. Top performing firms are formalizing the abort button. A stalled integration destroys deal IRR. Jeremy Segal brought this up again on M&A Science. Progress codified what they call an Orange Flags system. They built this specifically because targets consistently withhold crucial information after signing the LOI. Sellers drag their feet on basic requests. The Orange Flag system forces an immediate CEO level discussion the second that happens. The mandate is clear. Force transparency immediately, or pull the plug. Process replaces human emotion. The system dictates the outcome. We heard the exact same philosophy over on How I Invest. Scott Abu Khair from Pinkus Capital argued that declining deals is a massive competitive advantage. Capital allocators face intense deployment pressure right now. Pinkus protects their discipline by setting absolute dollar drawdown thresholds. Those thresholds provide the governance cover required to resist short term pressures. It gives the team permission to pass on mediocre opportunities. They recently abandoned a multi million dollar transaction just to protect a decade long relationship. They prioritized the long game over the quick deployment. That is true discipline. Institutionalizing your walk away criteria saves you from yourself. You need a system that forces the hard choice before deal fever takes over. Protect the fund at all costs. The best investors know their boundaries intimately.

Lucas Swisser

Over on How I Invest, Lucas Swisser delivered a massive reality check on artificial intelligence. Everyone is hunting for venture scale returns in the pre revenue startup space. Swisser analyzed the actual numbers and found a completely different reality. He said what we found in the data is you are actually much more likely to get a tenfold return in the pool on a percentage basis if you are above 10 billion dollars in market cap. Think about that. The dominance of foundational models means scale is everything. Raw generative features offer zero defensibility. You have to look for massive data network effects, or you will get crushed by the incumbents.

David Weisburd

David Weisburd also dropped some serious heat on How I Invest regarding the structural nature of venture capital. He completely shattered the illusion that venture is a traditional asset class. He said Einstein famously said compound interest was the eighth wonder of the world, but the real eighth wonder of the world is the compounding of other things, specifically brand and access to information. Here is why that matters to you. Raw capital accumulation rarely outpaces structural network advantages. Second quartile funds are functionally dead money. Venture is strictly an access class. You either have the brand to see the best deals, or you are holding the bag.

Pat Dorsey

Finally, Pat Dorsey had an incredible moment on Capital Allocators while breaking down modern moats. He thinks traditional metrics are failing us in the software era. He argued that Return on Invested Capital is largely useless for spotting moats in capital light businesses. He warned investors that the denominator is nothing. That is exactly right. When a business requires almost zero tangible capital to grow, traditional return metrics produce absurdly inflated numbers. You have to look past the spreadsheet. You need to focus on qualitative evolution and internal reinvestment runways. Relying on old school industrial metrics to value modern software companies will lead to catastrophic mispricing in your portfolio.

The bottom line

The overarching message this week is crystal clear. The smartest buyers are engineering their own pricing relief through aggressive post close synergies and strict kill deal governance. They mandate early transparency and pull the plug fast when diligence gets muddy. You must manufacture your own margins and trust your institutional process. The current market demands proactive value creation from day one. That is The Carry. See you next Sunday.