Flight to Quality: SaaS Valuations Are Splitting in Two. Which Side Are You On?
Two software companies sold last quarter. Similar ARR, similar growth rates, similar end markets. One closed at 11x revenue. The other closed at 3x. Same market. Completely different outcomes.
The SaaS valuation market isn't one market anymore. It's two, running simultaneously, and which one you're in is largely determined before a banker ever makes a call.
The Dynamic at Work: Flight to Quality
This pattern has a name. After every major market correction, and after every tectonic technology shift, capital stops spreading across the landscape and concentrates at the top. The broad market flattens. The premium assets pull away. The gap between the best companies and the average ones widens, sometimes dramatically. It's called flight to quality, and we're in one right now.
Two forces are driving it simultaneously. The first is the post-2022 rate correction, which reset valuation expectations across the board and pushed buyers toward assets that justify a premium on fundamentals, not narrative. The second, and the more structurally important one, is AI. The arrival of AI as a potential category-level threat to software business models has introduced a new question into every diligence process: does this company have a durable future in a world where AI keeps getting cheaper and more capable? Companies that answer that convincingly are in the premium market. Companies that don't are in the other one.
Industry transaction data tracking hundreds of SaaS deals annually shows the distribution pulling apart at both ends. Aggregate volumes held through the second half of 2025 and median multiples stayed roughly stable, which is why the headline looks fine. But the median is averaging two completely different markets into one number. Baker Tilly's H2 2025 Software and Technology M&A Update found "A" assets seeing intensifying buyer competition even as the broader market stayed uneven. That's bifurcation. That's flight to quality in action.
What the Premium Cohort Actually Looks Like
The three most influential factors currently influencing valuation, among several that matter, are doing the heaviest lifting in diligence right now.
Rule of 40. Rule of 40 is the sum of a company's revenue growth rate and EBITDA margin. A score above 40 signals that the business is balancing growth and profitability in a way that doesn't require sacrificing one for the other. In the post-correction environment, buyers have largely stopped paying premiums for growth-only stories with weak margins or margin-only stories with stalled growth. Rule of 40 is how they screen quickly for businesses that have figured out both. Companies above 40 get a different conversation than companies below it, and the valuation data reflects that gap.
Gross Dollar Retention above 85%. GDR measures how much revenue a company retains from its existing customer base before accounting for any expansion. It is arguably the single most scrutinized retention metric in software M&A diligence because it isolates the base: what stays without the sales team pushing. A GDR above 85% is the floor for a credible premium story. Above 90% is strong. Below 85%, buyers start discounting for churn risk regardless of how good the growth numbers look, because growth built on a leaky base is expensive and fragile. GDR tells a buyer whether the foundation of the business is solid before they assess anything built on top of it.
Proven AI moat and/or adoption. This is where the flight-to-quality dynamic becomes most acute in the current market. "We use AI" now describes the overwhelming majority of software companies and moves no needles in a buyer conversation. What buyers are learning to look for is proof: AI that has changed how customers work inside the product, AI capabilities that improve with usage and accumulate proprietary data, or AI features embedded deeply enough in customer workflows that removing them would cause real disruption. McKinsey's State of AI 2025 surveyed nearly 2,000 organizations and found that only 6% qualify as true AI high performers, defined as companies attributing 5% or more of EBIT impact to AI. The single strongest differentiator wasn't which tools were used. It was fundamental workflow redesign. That's the distinction buyers are internalizing: AI as a bolt-on feature versus AI as an operating advantage. The latter is a premium signal. The former is table stakes.
The Question Behind the Metrics: Defensibility Against AI Displacement
The three factors above tell buyers what a company looks like today. The defensibility question tells them whether it will hold.
AI is compressing development cycles. New entrants can build feature-competitive products faster and cheaper than at any prior point in software history. The question buyers are pressing in every diligence process, sometimes explicitly and sometimes embedded in how they weight their models, is: what does this company have that a well-capitalized AI-native competitor couldn't replicate in 24 months?
The answers that hold up come from one of four places. Proprietary data that accumulates with usage and trains models competitors can't access. Integration depth that creates genuine switching costs, not inconvenience-level friction, but switching costs that would require a customer to rebuild business processes from scratch. Vertical focus so specific the total addressable market isn't worth a generalist's time to attack (although a small TAM could have a negative effect on valuation). Or workflow architecture where the product compounds in value the longer it's used, creating a trajectory new entrants can't replicate from a standing start.
Companies with a credible answer in at least one of these categories are operating in the premium tier. In a flight-to-quality market, "we'll develop our AI strategy" is not an answer. Buyers are making bets on durability, and durability requires a real moat, not a roadmap.
Why the Average Multiple Is Misleading You
When a founder reads that SaaS M&A multiples are "around 5x to 7x," the natural instinct is to apply that range to their own company and feel reasonably positioned. The number exists. It's just concentrated at the top of the distribution, not spread evenly across it.
Using an average comparable to price your company in a bifurcated market is like using the average home sale price in a city to price a specific house. The data is real. It doesn't describe your house.
The market isn't asking whether your company is a software company. It's asking whether your company is a premium software company, with the metrics to prove it and the defensibility to sustain it. That's a different question with a very different answer for most companies.
What This Means for Process and Timing
Flight to quality changes the economics of how a process runs, not just the outcome. In a bifurcated market, valuation, certainty of close, and speed to close all move together for premium assets. The best buyers recognize a high-quality company quickly, get competitive fast, and move with urgency to win. For average assets, the same buyers slow down, increase diligence scrutiny, and use the process to extract terms rather than compete on price. Knowing which dynamic you'll face before you launch is essential, and it's determined almost entirely by preparation.
Three things matter most:
Audit your positioning against premium benchmarks before you go to market. Calculate your Rule of 40, pull your GDR by customer cohort, and understand your AI story with specificity. Know where you stand before buyers tell you in diligence. Gaps discovered before a process can be addressed. Gaps discovered during one cost you valuation.
Build and document your AI moat explicitly. Know the answer to the durability question before buyers ask it. If the honest answer is "not yet," there is usually time to address it before a process begins. If you have a real answer, make sure your narrative surfaces it early with specificity. Vague AI positioning is noise. Specific AI moat evidence is a premium signal.
Calibrate your timeline to the market dynamic. Flight to quality is active and accelerating. The premium cohort is drawing competitive processes right now. Waiting for conditions to improve misreads the environment. The right conditions for premium assets already exist. The question is whether your company is positioned to access them.
Where PEAK Fits
At PEAK, we spend the preparation period helping founders understand which market they're actually in and what it would take to access the premium tier. Flight to quality isn't a reason for pessimism. It's a reason for precision. The gap between the right process and the wrong one is wider in bifurcated markets, and so is the gap between outcomes. We help founders close the right one.
Bottom Line
The average SaaS multiple is a fiction right now. Not because the data is wrong, but because it's averaging two completely different markets into one number. Flight to quality is real, it's accelerating, and it's driven by two forces that aren't going away: a buyer base that has reset its standards after the correction, and an AI disruption that has made software durability the central question in every deal. The premium cohort is accessible. Getting there requires knowing what separates it from everything else, and working on that answer before a process begins.
Sources
Baker Tilly Capital, Software and Technology M&A Update: H2 2025 (March 2026). Named source.
McKinsey, "The State of AI in 2025: Agents, Innovation, and Transformation" (2025). Named source. 6% high performer finding and workflow redesign as primary differentiator cited directly.
