The New 14-Year Cycle: Today’s Cloud Slowdown Is the Opportunity Startups Need to Build Tomorrow’s Winning Companies

The cloud industry is currently experiencing a retrenchment period after the pandemic-induced boom times of 2020–2021, but this is not a sign of trouble. Rather, it’s the start of the next 14-year cycle in tech, known as the Patterson cycle. This cycle, coined by legendary investor Arthur Patterson, presents unique opportunities for growth and innovation in the cloud industry, and many experienced cloud professionals are migrating from public and late-stage SaaS companies to healthy early and mid-stage startups to take advantage of the opportunity. Entrepreneurs are ready to solve mission-critical problems and pull together their trusted colleagues who are feeling relieved of their golden handcuffs. This is why many of the next great cloud companies — the next Salesforce.com and ServiceMax — will be born during this period.

Yes, nearly every cloud company has been facing headwinds lately, with considerable layoffs and a sense of uncertainty plaguing the industry. However, amidst these challenges, it’s crucial to recognize that cloud fundamentals remain strong. Cloud companies are still growing and their business models remain strong. In fact, the top 25 public cloud companies are currently growing at scale by 15% annually.

What’s more, cloud software is expanding to job titles it previously never reached, such as general counsel and VP of field operations. Previously, cloud software was limited to a few job titles, such as Salesforce for VP of Sales or NetSuite for VP of Finance. Now, new cloud companies can emerge by offering compelling solutions for specific job titles.

Today, what we’re seeing is a pattern that’s common in the venture industry. Growth typically occurs for approximately eight years and this is followed by a period of retrenchment that lasts around six years. This so-called “Patterson cycle” was first identified by Arthur Patterson while a Professor at Stanford Business School (GSB). As Patterson observed, the beginning of a cycle is often characterized by a closed IPO window, limited exits and M&A activity, and depressed valuations, and this leads to challenges in the late-stage private market. Indeed, there hasn’t been a single public cloud exit in the past year or so.

It’s still a good time to be a cloud leader

There are those who hold out hope that this will be a quick V-shaped recovery and by next year the party will start again. But it seems clear that this is looking more like an L-shaped recovery. We believe 2023 will continue to be challenging, but in ’24 and ’25, the market will settle and we’ll start to come off the bottom. Then, over the next 3–4 years, there will be slow and steady growth with normal valuation multiples. This period is then likely to be followed by much faster growth and higher valuation multiples.

Today’s Patterson cycle presents a unique opportunity in the cloud industry, not only for entrepreneurs but also for managers, directors, and VPs. During this period, as the cloud industry rebounds, they can expect to slowly rebuild their stock option value and ultimately enjoy great exits five to ten years from now. Furthermore, with depressed valuations, 2024/2025 will be great years to buy a house or condo before real estate prices soar again.

In fact, this is a remarkable opportunity for early-stage companies to attract top talent. Experienced professionals who were previously tied to late-stage companies suddenly have the freedom to explore new opportunities and, with their stock options underwater and their golden handcuffs removed, many are looking to move to companies with brighter prospects.

For seed and Series A cloud companies, the reset in the market also presents favorable conditions in terms of office space and rent. As remote work tapers off, many young companies are taking advantage of the availability of affordable office space to establish a presence, create a strong company culture and build highly collaborative teams.

The stage is set for innovation

History has shown that challenging times are good times for innovation. In previous market cycles, we’ve seen the emergence of industry leaders like Salesforce, ServiceMax, and Okta, and the current cycle is an ideal moment for forward-thinking entrepreneurs to identify gaps in the market, challenge traditional approaches and create novel solutions that address the evolving needs of enterprises and consumers.

There are several reasons why this is the perfect time to build the next great cloud company. One is that startups can now concentrate on quality over quantity. Instead of scrambling to sign on hundreds or thousands of customers, they can instead focus on finding a few valuable early customers to help shape and build their product, and achieve product-market fit.

Another reason is that, although budgets may be tight, executives have leeway to work on new solutions that will prepare their companies for the next cycle of growth. Downturns provide time and space to experiment with and pilot new apps. A third reason is that, as mentioned earlier, talent acquisition is easier now.

The right investors are required

While this is a great time to launch a new cloud company, entrepreneurs should be careful about who they raise money from. During market slowdowns, the headless syndicate — seed rounds composed of dozens of different angel investors — can prove to be problematic. These investors can sometimes become less involved or supportive just when their portfolio companies need their help the most.

The problem is compounded by the fact that the later-stage firms that would normally provide the next rounds of funding are instead focused on helping their portfolio companies survive. On the plus side, however, established seed firm and value-added angels remain as committed as ever to seeing their fledgling portfolio companies succeed.

The upshot is that startups need to be more strategic and proactive and seek out the right investors, those who can provide not only capital but also the expertise and support required to sustain them while we wait the year or two or three it will take for the B and C markets to come back.

Who are those right investors? They’re Classic Series A investors — those firms that specialize in early-stage investing and are headed by experienced operating partners who have been entrepreneurs themselves. These firms tend to give startups exactly what they need — a syndicate leader and board member with right-sized financing who welcomes notable value added angels and seed firms to the Classic Series A syndicate.

In the cloud world, these investors usually have connections to the leading players in the industry, which enables them to provide the guidance and advice needed by startups to build themselves into successful global companies that dominate their categories.

Final takeaway

Today’s cloud landscape is challenging. But challenging landscapes have always been the launchpad for tomorrow’s stellar companies. The advantages are there for the entrepreneurs with the vision and courage to take them. With guidance and support from Classic Series A investors, cloud startups can unlock their full potential and achieve long-term growth.

~Matt Holleran, General Partner of Cloud Apps Capital Partners