Written by Patrick

Software is no longer a business model, but is instead a capital instrument.

In corporate finance, the cost of capital is the firm’s blended financing cost—how much it must pay to attract and retain the capital it needs. More broadly, it’s a way of asking, “How does supporting this project compare to other projects that carry similar risk?”

Yet this concept of a “cost of capital” does not have to be confined to equity and debt alone. Startups, nations, entire industries, specific teams, and even ideas also face a kind of “cost of capital”, because each one needs people or institutions to back its development.

In many cases, brand-new projects start with an extremely high “cost of capital” precisely because getting people to back something with a high uncertainty vs. risk tradeoff usually demands a premium return. Most investors, citizens, or potential stakeholders won’t jump on board unless they’re compensated for the extraordinary risk. Early on, the discount rate is high and the perceived uncertainty/risk is immense—so the cost of capital reflects that uncertainty.

We see a similar historical pattern in software. Originally, software development and deployment was risky, expensive, and weighed down by the high costs of maintaining on-premise racks, specialized hardware, and hefty upkeep. Investors and early backers often viewed it as something of a gamble because there was no strong track record of consistent returns. As a result, the implied cost of capital for software was high.

Over time, though, the story changed. Repeated successes in building, standardizing, and financing software brought the risk premium down. Developers could use commoditized hardware, reliable operating systems, and established tools rather than reinventing every layer of the stack. With each advance in processes and best practices, more institutions recognized that funding software was no longer as uncertain as it once seemed. This broader acceptance led to a lower discount rate for software ventures and steadily reduced software’s cost of capital.

You can observe this evolution in the public markets. The forward multiples for SaaS, such as those tracked in the BVP Cloud Index, have gradually shrunk from exuberant highs to a more normalized range. Simply put, what was once an exotic bet has become mainstream—leading to sustained investor interest at lower and lower discount rates.

Source: BVP Cloud Index