Andy Burnham, heir presumptive to the Labour Party and Number 10 (wherever that might be in the future) has openly expressed support for the equalisation of Capital Gains Tax with income tax rates. Whether he will actually implement this change is anyone’s guess. However, as a long term Corporate Finance (not tax!) adviser, uncertainty around the CGT regime has been a source of periodic upheaval and client anxiety.
For those business owners who have already decided that they want to exit, it might accelerate their timescales and create some urgency. For others, it might push the timing for an exit up the agenda; albeit a good business exit process usually takes months not weeks and increasingly tax changes are implemented on the day of the budget concerned, so time to plan can be a luxury and big decisions made in haste to accommodate expected tax changes are sometimes be repented at leisure.
Prior to 1998 CGT was, in broad terms, paid at an individual’s income tax rate, with indexation and retirement relief (in many cases materially) softening the impact. In 1998, however, the new Labour Government introduced Taper Relief, including Business AssetTaper Relief (BATR), which was designed to incentivise the holding of assets and penalise “flipping”.
For business assets, BATR (in simple terms) reduced the percentage of the gain that was taxable, with the maximum relief reached after two years of qualifying ownership. At that point, only 25% of the gain was chargeable, so a higher‑rate taxpayer on 40% would pay an effective rate of 10%. For non‑business assets, taper relief was slower and the maximum 40% reduction applied only after ten years. The calculation for assets acquired before April 1998 also involved indexation relief on the base cost, which compensated for the effect of inflation up to that date.
This arrangement was complex and drove a great deal of tax planning in the attempt to arrive at the lowest level of gain. For example, the use of loan notes to defer the crystallisation of a gain could secure an additional year or two of relief and was a standard tax planning device.
This complexity ultimately led the government to abolish Taper Relief, which was not only hard for taxpayers to understand, but also hard for HMRC to administer. The arrangements also incentivised the holding of assets for as long as possible, even when this was economically inefficient, and saw investors delaying business sales (and therefore tax realisations) to reduce the amounts payable.
In 2008 the Government introduced a flat rate of Capital Gains Tax for most forms of asset at 18%. The goal was to make the tax more straightforward and transparent. However, for those shareholders who had held their business shares for a long time, 18% was a considerably higher effective rate than they had been used to paying. Take for example the sale of the shares in a business by a long‑term shareholder generating a gain of £5m. Under BATR the tax on the gain (unindexed) would have been £500,000, whereas the new Capital Gains Tax rate would lead to tax payable on the same gain of £900,000.
The shareholding community were understandably vocally unhappy with this outcome and so the Government of the time introduced Entrepreneurs’ Relief (ER), which allowed shareholders who had held their shares for at least 1 year (later extended to two years), were employees or officers of the business and owned at least 5% of the company (including voting rights) to tax their gains at only 10% on a lifetime limit that was steadily increased to reach £10m by 2011. In the above example and assuming the conditions were met and the lifetime limit not already used, the tax due on the £5m gain would be back at the £500,000 payable under BATR.
The Entrepreneurs’ Relief regime lasted for twelve years, during which time most business vendors were comfortable with the generous allowance and there was a material reduction in the level of tax planning and structuring that had previously been rife. It was in place long enough to encourage the establishment of incentive schemes designed to bring management teams into the ER regime to take advantage of the gap between the ER rate of 10% and the standard CGT rate (which for higher‑rate taxpayers on most non‑residential assets later rose to 20%), let alone the highest income tax rate which peaked between 2010 and 2013 at 50%, reducing thereafter to the current 45%.
In 2020 the level of gain that benefited from the 10% rate was reduced hugely from £10m to £1m and the name of the relief was changed from Entrepreneurs’ Relief to Business Asset Disposal Relief (BADR). Despite the reduced generosity of the allowance attributed to business vendors, the general (higher) CGT rate of 20% was still materially lower than Income Tax rates and the advantage of creating a capital disposal therefore remained very tangible. The focus of tax advisers shifted to ensuring that capital treatment was assured on business disposals, and most vendors accepted the level of CGT due without undertaking planning to manage it. On our example £5m gain, the CGT for a qualifying vendor would be £900,000 (10% on the first £1m and 20% on the remaining £4m).
In 2024, changes were announced to increase the general higher CGT rate from 20% to 24% and to increase the rate applicable to the first £1m of qualifying gains for business vendors from 10% to 14% from April 2025 and then to 18% from April 2026. On the same illustrative £5m gain, a qualifying business vendor would, under those rates, now pay £1.14m of tax (18% on £1m and 24% on £4m), the highest tax burden on such a transaction since pre 1998.
If a future government were to enact an equalisation of CGT and Income Tax then, assuming that a business owner was paying Income Tax at the additional rate, the tax payable (without any new allowances or reliefs being introduced for entrepreneurs) on the £5m gain would be £2.25m, almost twice the amount due under the post‑2024 regime and four and a half times the amount due under the Entrepreneurs’ Relief regime until 2020.
So, what would be the potential impact of such a change?
It has been a long time since we had an economy which didn’t in some way reward business ownership with lower effective tax rates on capital gains. During that time the market economy in the UK has evolved to take advantage of the benefits of value creation and capital growth.
In the short term, I have no doubt that the impact of such a change would be to halt M&A in the UK in its tracks to give time to think and in the hope that a subsequent change of regime would reverse the policy to continue to reward risk‑taking shareholders. For most business vendors there is no imperative about the timing of a business sale and previous threatened changes have demonstrably resulted in accelerated selling followed by a pause.
In any case entrepreneurs and their investors would no longer need to focus on capital growth in the way that they historically have. If a capital event were to be taxed in precisely the same way as income, then business owners might as well just draw all the cash in their business as they go along. Without the capital tax advantage of creating business value there is no benefit in deferred gratification and the reward for investing now to build future value is a riskier equation for sure.
The potential for incentivising management to remain with the business through a transaction would be inherently limited compared to the equity‑based incentive schemes available today which would likely damage earlier‑stage/high‑growth‑potential businesses that would have to pay competitive salaries without the capacity for capital value creation.
Many other countries have capital gains tax rates that are similar or equal to income tax rates and investment and growth are demonstrably achievable in these regimes. However, they all have considerably lower income tax rates than the UK and in some (Germany and the Nordics) there is a much greater tradition of long‑term family or employee share ownership. It is also usually the case that the prices paid for businesses in these jurisdictions are less aggressive than in the UK or US.
If the equalisation of rates were to be accompanied by strong support for entrepreneurs, effective arrangements and incentives to support internal share markets, an overall reduced rate of income tax and a plan to replace equity‑based incentives with income‑based ones that didn’t prejudice the current generation of management teams, then conceivably the strategy could result eventually in a more stable economy where the culture was about retention and growth and not about valuable exits. It is undeniably the case, for example, that Private Equity still thrives in Germany, France and the Nordics where alignment of tax rates is much closer than in the UK.
I see little prospect of this headline policy being accompanied by the kind of support and planning it would require, however. A more likely scenario is paralysis in M&A, a return to aggressive tax planning including offshoring, and a shift to less entrepreneurial investment in UK businesses as strategies turn to cash extraction. I am not sure that it would deter the establishment of new businesses, which is rarely a tax‑driven decision, but it would certainly make it harder for new businesses to attract high‑quality senior staff without the carrot of future capital gains.
Whatever one’s politics, seismic tax changes are destabilising and potentially have unintended consequences. Observing how the tax reliefs available to entrepreneurs have already more than halved since 2020, it is guesswork where their tolerance for being taxed ends.
Andy Burnham, heir presumptive to the Labour Party and Number 10 (wherever that might be in the future) has openly expressed support for the equalisation of Capital Gains Tax with income tax rates. Whether he will actually implement this change is anyone’s guess. However, as a long term Corporate Finance (not tax!) adviser, uncertainty around the CGT regime has been a source of periodic upheaval and client anxiety.
For those business owners who have already decided that they want to exit, it might accelerate their timescales and create some urgency. For others, it might push the timing for an exit up the agenda; albeit a good business exit process usually takes months not weeks and increasingly tax changes are implemented on the day of the budget concerned, so time to plan can be a luxury and big decisions made in haste to accommodate expected tax changes are sometimes be repented at leisure.
Prior to 1998 CGT was, in broad terms, paid at an individual’s income tax rate, with indexation and retirement relief (in many cases materially) softening the impact. In 1998, however, the new Labour Government introduced Taper Relief, including Business AssetTaper Relief (BATR), which was designed to incentivise the holding of assets and penalise “flipping”.
For business assets, BATR (in simple terms) reduced the percentage of the gain that was taxable, with the maximum relief reached after two years of qualifying ownership. At that point, only 25% of the gain was chargeable, so a higher‑rate taxpayer on 40% would pay an effective rate of 10%. For non‑business assets, taper relief was slower and the maximum 40% reduction applied only after ten years. The calculation for assets acquired before April 1998 also involved indexation relief on the base cost, which compensated for the effect of inflation up to that date.
This arrangement was complex and drove a great deal of tax planning in the attempt to arrive at the lowest level of gain. For example, the use of loan notes to defer the crystallisation of a gain could secure an additional year or two of relief and was a standard tax planning device.
This complexity ultimately led the government to abolish Taper Relief, which was not only hard for taxpayers to understand, but also hard for HMRC to administer. The arrangements also incentivised the holding of assets for as long as possible, even when this was economically inefficient, and saw investors delaying business sales (and therefore tax realisations) to reduce the amounts payable.
In 2008 the Government introduced a flat rate of Capital Gains Tax for most forms of asset at 18%. The goal was to make the tax more straightforward and transparent. However, for those shareholders who had held their business shares for a long time, 18% was a considerably higher effective rate than they had been used to paying. Take for example the sale of the shares in a business by a long‑term shareholder generating a gain of £5m. Under BATR the tax on the gain (unindexed) would have been £500,000, whereas the new Capital Gains Tax rate would lead to tax payable on the same gain of £900,000.
The shareholding community were understandably vocally unhappy with this outcome and so the Government of the time introduced Entrepreneurs’ Relief (ER), which allowed shareholders who had held their shares for at least 1 year (later extended to two years), were employees or officers of the business and owned at least 5% of the company (including voting rights) to tax their gains at only 10% on a lifetime limit that was steadily increased to reach £10m by 2011. In the above example and assuming the conditions were met and the lifetime limit not already used, the tax due on the £5m gain would be back at the £500,000 payable under BATR.
The Entrepreneurs’ Relief regime lasted for twelve years, during which time most business vendors were comfortable with the generous allowance and there was a material reduction in the level of tax planning and structuring that had previously been rife. It was in place long enough to encourage the establishment of incentive schemes designed to bring management teams into the ER regime to take advantage of the gap between the ER rate of 10% and the standard CGT rate (which for higher‑rate taxpayers on most non‑residential assets later rose to 20%), let alone the highest income tax rate which peaked between 2010 and 2013 at 50%, reducing thereafter to the current 45%.
In 2020 the level of gain that benefited from the 10% rate was reduced hugely from £10m to £1m and the name of the relief was changed from Entrepreneurs’ Relief to Business Asset Disposal Relief (BADR). Despite the reduced generosity of the allowance attributed to business vendors, the general (higher) CGT rate of 20% was still materially lower than Income Tax rates and the advantage of creating a capital disposal therefore remained very tangible. The focus of tax advisers shifted to ensuring that capital treatment was assured on business disposals, and most vendors accepted the level of CGT due without undertaking planning to manage it. On our example £5m gain, the CGT for a qualifying vendor would be £900,000 (10% on the first £1m and 20% on the remaining £4m).
In 2024, changes were announced to increase the general higher CGT rate from 20% to 24% and to increase the rate applicable to the first £1m of qualifying gains for business vendors from 10% to 14% from April 2025 and then to 18% from April 2026. On the same illustrative £5m gain, a qualifying business vendor would, under those rates, now pay £1.14m of tax (18% on £1m and 24% on £4m), the highest tax burden on such a transaction since pre 1998.
If a future government were to enact an equalisation of CGT and Income Tax then, assuming that a business owner was paying Income Tax at the additional rate, the tax payable (without any new allowances or reliefs being introduced for entrepreneurs) on the £5m gain would be £2.25m, almost twice the amount due under the post‑2024 regime and four and a half times the amount due under the Entrepreneurs’ Relief regime until 2020.
So, what would be the potential impact of such a change?
It has been a long time since we had an economy which didn’t in some way reward business ownership with lower effective tax rates on capital gains. During that time the market economy in the UK has evolved to take advantage of the benefits of value creation and capital growth.
In the short term, I have no doubt that the impact of such a change would be to halt M&A in the UK in its tracks to give time to think and in the hope that a subsequent change of regime would reverse the policy to continue to reward risk‑taking shareholders. For most business vendors there is no imperative about the timing of a business sale and previous threatened changes have demonstrably resulted in accelerated selling followed by a pause.
In any case entrepreneurs and their investors would no longer need to focus on capital growth in the way that they historically have. If a capital event were to be taxed in precisely the same way as income, then business owners might as well just draw all the cash in their business as they go along. Without the capital tax advantage of creating business value there is no benefit in deferred gratification and the reward for investing now to build future value is a riskier equation for sure.
The potential for incentivising management to remain with the business through a transaction would be inherently limited compared to the equity‑based incentive schemes available today which would likely damage earlier‑stage/high‑growth‑potential businesses that would have to pay competitive salaries without the capacity for capital value creation.
Many other countries have capital gains tax rates that are similar or equal to income tax rates and investment and growth are demonstrably achievable in these regimes. However, they all have considerably lower income tax rates than the UK and in some (Germany and the Nordics) there is a much greater tradition of long‑term family or employee share ownership. It is also usually the case that the prices paid for businesses in these jurisdictions are less aggressive than in the UK or US.
If the equalisation of rates were to be accompanied by strong support for entrepreneurs, effective arrangements and incentives to support internal share markets, an overall reduced rate of income tax and a plan to replace equity‑based incentives with income‑based ones that didn’t prejudice the current generation of management teams, then conceivably the strategy could result eventually in a more stable economy where the culture was about retention and growth and not about valuable exits. It is undeniably the case, for example, that Private Equity still thrives in Germany, France and the Nordics where alignment of tax rates is much closer than in the UK.
I see little prospect of this headline policy being accompanied by the kind of support and planning it would require, however. A more likely scenario is paralysis in M&A, a return to aggressive tax planning including offshoring, and a shift to less entrepreneurial investment in UK businesses as strategies turn to cash extraction. I am not sure that it would deter the establishment of new businesses, which is rarely a tax‑driven decision, but it would certainly make it harder for new businesses to attract high‑quality senior staff without the carrot of future capital gains.
Whatever one’s politics, seismic tax changes are destabilising and potentially have unintended consequences. Observing how the tax reliefs available to entrepreneurs have already more than halved since 2020, it is guesswork where their tolerance for being taxed ends.
Investors loved it, private equity firms chased it and public markets rewarded it with valuation multiples that often seemed to defy financial logic. Over the last few decades SaaS businesses have become the most prized possession in the digital economy.
The Rise of SaaS and the Golden Era of Valuations
SaaS’ combination of recurring revenues, high gross margins, predictability and opportunity for scalability, has made it an consistently attractive target for investors. Consequently, since the late 2010s trade buyers and private equity firms have competed fiercely for these quality software assets. The investment thesis was elegantly simple. Build software once, sell it on a recurring basis, deploy anywhere thanks to the cloud, retain customers year-on-year and increase revenue rapidly. Unlike traditional industries, SaaS companies could grow without opening new factories, hiring large numbers of employees or carrying significant inventory. In comparison their revenue was predictable, margins were attractive and scalability was almost limitless. An apparently enormous multiple was quickly franked by rapid growth.
Then came the pandemic.
As offices were forced to close and workforces dispersed, software moved from being an enabler and improver of business, to becoming business critical. The result was a surge in demand for cloud-based software unlike anything the sector had experienced before. At this point SaaS appeared to be an unstoppable force, as valuations continued to climb. This period represented something of a ‘golden age’ for SaaS. The widespread adoption of cloud computing transformed how businesses purchased and consumed software. The COVID-19 pandemic accelerated these trends dramatically, as almost overnight cloud software became critical infrastructure for organisations as they adapted to remote and hybrid working environments. As a result, demand surged across workflow automation tools, collaboration platforms, cybersecurity solutions and digital transformation technologies. As capital continued to flow into the software sector, public market valuations soared and private market transactions followed suit. By the end of 2021, software companies were consistently trading at eye-watering revenue multiples.
However, beneath the surface a new technological shift was beginning to emerge…
The Dawn of AI
While investors were still focussed on cloud adoption, another innovation was quietly entering the market. Artificial intelligence (AI). The rapid progress of AI has forced investors, operators and acquirers to reassess many of the assumptions that have underpinned software valuations for the last decade.
Compared to other technology cycles, the adoption of AI has been extremely fast. Government research found that there were 3,170 active AI companies in the UK in 2022 and 5,862 active AI companies by the end of 2024 – an 84.9% increase in 2 years. Unsurprisingly, enterprise spending on generative AI has reached meaningful levels in a fraction of the time it took cloud software to gain widespread acceptance. Organisations are no longer experimenting with AI solely through innovation teams or isolated pilot schemes. Instead, AI is increasingly being embedded directly into core business processes, customer interactions and operational work flows as headlines predict the technology will swiftly revolutionize working practices and replace human jobs.
The Impact on SaaS
It is clear that AI isn’t going anywhere, which is threatening profound implications for SaaS businesses, particularly those in the mid-market and currently considering disposal or fund-raising.
Historically, the value of a software company was largely determined by the company’s ability to build and distribute software quickly and efficiently. Strong growth rates, recurring revenue and customer retention were often sufficient to justify premium valuations. The “Rule of Thirty” rewarded rapid revenue growth in valuation terms even if that growth was at the expense of profits. This was because an underlying assumption of the market was that software in use represented a significant barrier to entry. A whole barrage of (now conventional) KPIs have been used by investors or acquirers to evaluate this “stickiness” and growth trajectory such as net churn, cost of customer acquisition and, of course, growth in Annual Recurring Revenue (ARR).
AI is beginning to change that assumption. It enables the cost and complexity of developing software to fall rapidly; tools powered by AI are allowing smaller teams to build products faster, as well as to write code more efficiently and launch new services at unprecedented speed. Potentially it permits businesses to solve their own problems using AI rather than to deploy third party software to solve them. The result is that software development threatens to become increasingly commoditised.
For years, software companies were able to create value by helping clients perform tasks more efficiently. AI is allowing software to perform those tasks on behalf of people. The distinction may sound subtle, but from an investment perspective it’s profound.
For example, a Customer Relationship Management (CRM) platform once helped sales professionals manage opportunities. Today, AI can identify prospects, draft emails, prepare notes and recommend actions to take. Similarly, where accounting software once organised financial information, AI can now interpret that information, identify anomalies and suggest decisions. At the hands of AI, software is evolving from a tool into a worker.
For many SaaS businesses, this is an uncomfortable situation, for if software can be built more easily and at a lower cost, the software itself becomes less valuable. In an environment where many of those businesses have historically been valued very highly this threatens “down rounds” or even the risk that the next round will not be forthcoming. The question facing investors is no longer whether a SaaS company is growing quickly, it’s whether that company remains relevant in a world where AI is becoming embedded into every application and over what period its relevance will be sustained.
The UK’s SaaS Mid-Market
Many of the UK’s most successful software businesses were built during the ‘race’ to use cloud software. At the time they developed loyal customer bases, strong recurring revenues and valuable market positions. In 2026, many of these businesses now find themselves caught between two competing situations;
On one hand, AI presents a huge opportunity. Businesses that are able to successfully integrate AI into development and thence into customer workflows may become more valuable than their competition.
On the other hand, AI is lowering barriers to entry at a pace few were able to predict.
Put simply, products that once took years to build can increasingly be replicated in the space of a few months and features that once differentiated software platforms can be reproduced through easily accessible AI models.
In other words, AI is both creating and destroying value at the same time.
For most of the last decade, success was measured by growth rates, customer acquisition and annual recurring revenue. Although these metrics remain important, they are no longer sufficient on their own. In 2026 investors want to understand who owns the data, who controls the workflow and who can create advantages AI can’t easily replicate. This is being translated into an appetite for the following key characteristics;
Software which embeds specialist domain knowledge such as deep vertical expertise.
Software which is integrated into customers’ workflows and systems and not just sitting over or alongside them
Software which has already demonstrably secured a trusted status within a regulated or compliance oriented environment where untested/untrusted solutions are unlikely to be a threat
Software which fulfils mission-critical functions within client businesses rather than being a “nice to have”
Software where there is a demonstrable development road map which incorporates AI within the back end of the business and moving to customer front end offerings over a realistic time horizon.
Software which enjoys direct access to customer data and the capacity to deploy that data (even if anonymously) to develop insights/provides a meaningful feedback loop.
Software which can demonstrate a genuine customer return on investment.
However successful they have been to date, there is scepticism about the long term value of software which is horizontal, relatively undifferentiated and which doesn’t embed specialist understanding of a niche environment or vertical.
Conclusion
The decline in average SaaS valuations in the last couple of years reflects more than rising interest rates and changing market conditions. Instead, it signals a broader reassessment of what makes a software business valuable. For most of the last decade investors rewarded growth, recurring revenue and scalability. While these fundamentals remain important, the rapid adoption of AI is shifting the focus towards defensibility.
As software only becomes easier and cheaper to build, investors will increasingly ask what cannot be replicated. Proprietary data, ownership of critical workflows, industry expertise and customer trust are becoming more important than software functionality alone.
This is creating a growing divide across the SaaS market. Businesses that use AI to strengthen their competitive advantage are likely to command premium valuations and attract investor interest. While those whose products risk becoming commoditised may continue to face pressure on growth rates and valuation multiples. SaaS multiples still remain second only to AI in terms of sector multiples, after all their fundamentals remain attractive over a three to five year horizon, but we are likely to see those multiples increase for some and reduce for others, depending on their defensibility and the likely impact of AI on their long term performance.
The “cloud race” era rewarded companies for delivering software. The AI era is rewarding companies that deliver outcomes. For mid-market SaaS businesses in the UK, that distinction is likely to define valuation performance for years to come.
Investors loved it, private equity firms chased it and public markets rewarded it with valuation multiples that often seemed to defy financial logic. Over the last few decades SaaS businesses have become the most prized possession in the digital economy.
The Rise of SaaS and the Golden Era of Valuations
SaaS’ combination of recurring revenues, high gross margins, predictability and opportunity for scalability, has made it an consistently attractive target for investors. Consequently, since the late 2010s trade buyers and private equity firms have competed fiercely for these quality software assets. The investment thesis was elegantly simple. Build software once, sell it on a recurring basis, deploy anywhere thanks to the cloud, retain customers year-on-year and increase revenue rapidly. Unlike traditional industries, SaaS companies could grow without opening new factories, hiring large numbers of employees or carrying significant inventory. In comparison their revenue was predictable, margins were attractive and scalability was almost limitless. An apparently enormous multiple was quickly franked by rapid growth.
Then came the pandemic.
As offices were forced to close and workforces dispersed, software moved from being an enabler and improver of business, to becoming business critical. The result was a surge in demand for cloud-based software unlike anything the sector had experienced before. At this point SaaS appeared to be an unstoppable force, as valuations continued to climb. This period represented something of a ‘golden age’ for SaaS. The widespread adoption of cloud computing transformed how businesses purchased and consumed software. The COVID-19 pandemic accelerated these trends dramatically, as almost overnight cloud software became critical infrastructure for organisations as they adapted to remote and hybrid working environments. As a result, demand surged across workflow automation tools, collaboration platforms, cybersecurity solutions and digital transformation technologies. As capital continued to flow into the software sector, public market valuations soared and private market transactions followed suit. By the end of 2021, software companies were consistently trading at eye-watering revenue multiples.
However, beneath the surface a new technological shift was beginning to emerge…
The Dawn of AI
While investors were still focussed on cloud adoption, another innovation was quietly entering the market. Artificial intelligence (AI). The rapid progress of AI has forced investors, operators and acquirers to reassess many of the assumptions that have underpinned software valuations for the last decade.
Compared to other technology cycles, the adoption of AI has been extremely fast. Government research found that there were 3,170 active AI companies in the UK in 2022 and 5,862 active AI companies by the end of 2024 – an 84.9% increase in 2 years. Unsurprisingly, enterprise spending on generative AI has reached meaningful levels in a fraction of the time it took cloud software to gain widespread acceptance. Organisations are no longer experimenting with AI solely through innovation teams or isolated pilot schemes. Instead, AI is increasingly being embedded directly into core business processes, customer interactions and operational work flows as headlines predict the technology will swiftly revolutionize working practices and replace human jobs.
The Impact on SaaS
It is clear that AI isn’t going anywhere, which is threatening profound implications for SaaS businesses, particularly those in the mid-market and currently considering disposal or fund-raising.
Historically, the value of a software company was largely determined by the company’s ability to build and distribute software quickly and efficiently. Strong growth rates, recurring revenue and customer retention were often sufficient to justify premium valuations. The “Rule of Thirty” rewarded rapid revenue growth in valuation terms even if that growth was at the expense of profits. This was because an underlying assumption of the market was that software in use represented a significant barrier to entry. A whole barrage of (now conventional) KPIs have been used by investors or acquirers to evaluate this “stickiness” and growth trajectory such as net churn, cost of customer acquisition and, of course, growth in Annual Recurring Revenue (ARR).
AI is beginning to change that assumption. It enables the cost and complexity of developing software to fall rapidly; tools powered by AI are allowing smaller teams to build products faster, as well as to write code more efficiently and launch new services at unprecedented speed. Potentially it permits businesses to solve their own problems using AI rather than to deploy third party software to solve them. The result is that software development threatens to become increasingly commoditised.
For years, software companies were able to create value by helping clients perform tasks more efficiently. AI is allowing software to perform those tasks on behalf of people. The distinction may sound subtle, but from an investment perspective it’s profound.
For example, a Customer Relationship Management (CRM) platform once helped sales professionals manage opportunities. Today, AI can identify prospects, draft emails, prepare notes and recommend actions to take. Similarly, where accounting software once organised financial information, AI can now interpret that information, identify anomalies and suggest decisions. At the hands of AI, software is evolving from a tool into a worker.
For many SaaS businesses, this is an uncomfortable situation, for if software can be built more easily and at a lower cost, the software itself becomes less valuable. In an environment where many of those businesses have historically been valued very highly this threatens “down rounds” or even the risk that the next round will not be forthcoming. The question facing investors is no longer whether a SaaS company is growing quickly, it’s whether that company remains relevant in a world where AI is becoming embedded into every application and over what period its relevance will be sustained.
The UK’s SaaS Mid-Market
Many of the UK’s most successful software businesses were built during the ‘race’ to use cloud software. At the time they developed loyal customer bases, strong recurring revenues and valuable market positions. In 2026, many of these businesses now find themselves caught between two competing situations;
On one hand, AI presents a huge opportunity. Businesses that are able to successfully integrate AI into development and thence into customer workflows may become more valuable than their competition.
On the other hand, AI is lowering barriers to entry at a pace few were able to predict.
Put simply, products that once took years to build can increasingly be replicated in the space of a few months and features that once differentiated software platforms can be reproduced through easily accessible AI models.
In other words, AI is both creating and destroying value at the same time.
For most of the last decade, success was measured by growth rates, customer acquisition and annual recurring revenue. Although these metrics remain important, they are no longer sufficient on their own. In 2026 investors want to understand who owns the data, who controls the workflow and who can create advantages AI can’t easily replicate. This is being translated into an appetite for the following key characteristics;
Software which embeds specialist domain knowledge such as deep vertical expertise.
Software which is integrated into customers’ workflows and systems and not just sitting over or alongside them
Software which has already demonstrably secured a trusted status within a regulated or compliance oriented environment where untested/untrusted solutions are unlikely to be a threat
Software which fulfils mission-critical functions within client businesses rather than being a “nice to have”
Software where there is a demonstrable development road map which incorporates AI within the back end of the business and moving to customer front end offerings over a realistic time horizon.
Software which enjoys direct access to customer data and the capacity to deploy that data (even if anonymously) to develop insights/provides a meaningful feedback loop.
Software which can demonstrate a genuine customer return on investment.
However successful they have been to date, there is scepticism about the long term value of software which is horizontal, relatively undifferentiated and which doesn’t embed specialist understanding of a niche environment or vertical.
Conclusion
The decline in average SaaS valuations in the last couple of years reflects more than rising interest rates and changing market conditions. Instead, it signals a broader reassessment of what makes a software business valuable. For most of the last decade investors rewarded growth, recurring revenue and scalability. While these fundamentals remain important, the rapid adoption of AI is shifting the focus towards defensibility.
As software only becomes easier and cheaper to build, investors will increasingly ask what cannot be replicated. Proprietary data, ownership of critical workflows, industry expertise and customer trust are becoming more important than software functionality alone.
This is creating a growing divide across the SaaS market. Businesses that use AI to strengthen their competitive advantage are likely to command premium valuations and attract investor interest. While those whose products risk becoming commoditised may continue to face pressure on growth rates and valuation multiples. SaaS multiples still remain second only to AI in terms of sector multiples, after all their fundamentals remain attractive over a three to five year horizon, but we are likely to see those multiples increase for some and reduce for others, depending on their defensibility and the likely impact of AI on their long term performance.
The “cloud race” era rewarded companies for delivering software. The AI era is rewarding companies that deliver outcomes. For mid-market SaaS businesses in the UK, that distinction is likely to define valuation performance for years to come.
