Improving small biz could be good news for software but bugs lurk

The condition of small businesses and their future prospects have been frequently debated by investors. Over the last few years, these businesses have been buffeted by negatives including rising costs, higher interest rates, difficulty in hiring and, two years ago, tighter bank lending as several smaller banks entered FDIC receivership. But throughout, there have also been reasons for hope — from peaking inflation and rates to easier bank lending to the new Presidential administration — which could help to usher in better profitability through regulatory change and a stronger domestic economy. Of course, that change also comes with the risk of higher tariffs.

 

We offer an edited discussion on the topic with Taylor Bowley of the Bank of America Institute and Brad Sills, Enterprise Software analyst at BofA Global Research. The Institute analyzes the bank’s proprietary data to develop a deep understanding of consumer behavior and the economy. Several of Brad’s companies get the majority of their revenues from small businesses, and Brad will help us to understand what it would mean for software if we saw improvement for small business.

 

Question: How does the Institute define small business and what data are we looking at to get the insights that you’re sharing on the Institute website?

 

Taylor Bowley: Bank of America Institute leverages the bank’s 69 million consumer and small business accounts. It’s a pretty powerful dataset, and it allows us to have real-time insights into the economy. And when it comes to small businesses, it’s a bit of a nuanced term. The SBA (Small Business Administration) has a fairly broad definition that’s based on employee headcount, but within Bank of America proprietary data, small businesses are defined as those with less than $5 million in revenue. This includes small businesses across different industries, geographies and even revenue tiers, so long as they fall under that $5 million threshold. And at the Bank of America Institute, we analyze everything from small business profitability to major outlays like rent — and even which small businesses might be benefiting from certain fiscal stimulus or consumer spending patterns and which ones might be feeling more pressure from the higher-for-longer interest-rate environment.

 

Question: Revenues for small businesses will be impacted by tariffs over the next few months and quarters, but some of the other trends we’ve seen in the data may be longer lasting and less impacted by policy. Could you discuss some of the more sticky trends post-COVID?

 

Taylor Bowley: One positive for small businesses is wage inflation has fallen from its peak. Back in 2022, 2023, these small firms were having to deal with really high wage inflation. And if you think about, for instance, there are so many restaurant options in New York City. So, for workers, it was easy to just find the place that was paying them the most, and this inevitably was putting a lot of pressure on the payroll front for small businesses. In our data, hiring remains in an okay spot for small businesses as of 2025. Though, given what we’re seeing recently from public data, the strength of the labor market will be something that we’ll be watching going forward. And prior to tariff announcements at least, survey data on small business sentiment was in a much better place than it was a year ago or even six months ago. And despite the general trepidation on what could happen in the market, small businesses were overall feeling cautiously optimistic going into the tariff announcements.

 

Question: A few of Brad’s companies get the bulk of their revenues from small businesses. Brad, what kind of services are small businesses getting from your software companies, and what are the software companies saying about the small business macro?

 

Brad Sills: Yes, we do have some software companies that have exposure to SMB (small to medium businesses). In fact, some companies just serve SMB exclusively. When you think about what they provide, it’s really two categories. There are front-office applications to help automate sales and marketing functions, and there are back-office operations that are automated through accounting systems, for example. And in both categories, we have seen consistent results. We’ve seen pressure in the SMB over the last two years as a result of rising rates. SMBs tend to be more sensitive to the higher cost of capital. And what we have seen is that companies are not in growth mode. They are focusing on the defensive type projects, the ones that keep the lights on, like accounting. And so we’ve seen accounting software has been pretty stable through this, but front-office applications where you’re helping your sales and marketing personnel get more leads, convert those leads to customer, manage the customer — that’s a more discretionary category, and we’ve seen some movement in that. We’ve seen some high-growth companies that serve the SMB in the front office see a deceleration from call it high thirties down to mid-teens in some cases, and that’s a result of really three things. One: you’ve seen a little bit of an increased churn in the business, probably a point or two on the retention rate. We’ve seen customers look for ways to save money on their software spend via downgrades to cheaper-priced solutions. And we’ve seen pressure on the upsells. We haven’t seen firms willing to make that leap to a higher-priced offering for more feature functionality. That’s where we’ve seen the impact in these businesses from the higher-rate environment, generally a tougher spending environment for SMBs.

 

Question: I suppose the point is that it’s hard to call the turn. The forward path will depend a lot on policy, but fair to say that there is a lot of room for improvement?

 

Brad Sills: That’s correct. Those businesses that were growing in that mid-thirties percent range, we don’t think we’re going to get back to mid-to-high thirties type growth. I think that that was post-pandemic-fueled spending as a result of rates at zero and some demand pull forward as a result. But we do think we can get back to mid-to-high twenties from this current mid-to-high teens level. And that’s really a function of churn coming back down. We’ve seen stabilization in churn and in fact it’s improved a bit with less pressure on those downgrades. We’ve already seen that impact as well. What we haven’t seen is the upgrades and the firm’s back-to-growth mode, if you will, getting back to taking on that new project for automating the sales functions or even upgrading their existing system to get premium features at a premium price. And so the upgrade activity, the growth initiatives we have not seen come back yet. We are hopeful that we will see that going forward.

 

Question: AI tools for small businesses: it seems daunting if you’re a small business trying to harness the power of AI. Are your companies a way for small businesses to get access to some of these AI analytics?

 

Brad Sills: Absolutely. There’s a debate in software right now as to whether or not big enterprises will take on the AI initiatives themselves and bypass a lot of the packaged application vendors. And in the SMB, you don’t have that debate because small businesses don’t have the know-how, the technical expertise, the budget to really harness their own data through expensive data management tools, data repositories, and to run LLMs (large language models) on their data. They’re going to rely entirely on these packaged application vendors, and so we think it’s a great place to be for some of these software companies that are already installed in the SMB that have the dataset that’s robust. You tend to have these category killers in SMB software that have a significant share and a flywheel effect. And there are a number of companies that are in that position, where the opportunity is for them to embed AI features into their existing applications. That’s a natural place to run AI for SMBs. It’s the convenient place to run AI and there are a lot of these new features in development that are already generating meaningful value for small business, things like agents to help support a customer through automated support desk or a business development rep to generate leads through an agent, generating anywhere from 20% to 40% uplift in their ability to generate leads. Case deflection rates (the rate at which customers are able to find answers through self-service or other non-agent channels) have gone up on the service desk for some of these early-adopter customers that have taken on some of these new agents. On the support side, we think the opportunity is significant for these companies and you can see on the back office an opportunity for the companies that provide accounting software to take on more and more functions of the CPA. You can run payables and receivables and close the books. You can run analytics through agents that opens up the TAM (total addressable market) for the accounting software business materially to CPA services. We are bullish on that opportunity for AI and the SMB for some of these platform companies.

 

Question: We’ve discussed some positives: AI, obviously the potential for a macro improvement even though there’s a lot of uncertainty and there are some negatives too, especially around tariffs and uncertainty. But as you think about valuations for your companies, especially those software companies that do cater to small businesses, do you think they’re getting credit for (A) an improvement in the small business macro? And then (B) is the market giving them more AI credit than they deserve? Maybe some of these larger software companies that have AI offerings?

 

Brad Sills: We don’t think that AI is priced into SMB software. I think this is really an opportunity for upside for growth and for margin expansion in the group. Right now, the software group in general is trading in line with historical levels on an EV (enterprise value) to sales or free cash flow basis on an adjusted growth basis. We’re not arguing that valuations are cheap, but we’re not arguing that valuations are stretched either. That’s also true for SMB software. We haven’t seen revenue contribution yet from AI, and so it’s really a “show me” story in the SMB. And we think that as you see contribution and companies start disclosing contribution from AI, given the strategic nature of that revenue and the addressable market that it’s addressing, we do think that’ll be a catalyst for valuations and for multiple expansion in the group.

 

Question: We’ve talked about a lot of positives, but certainly there’s a lot of uncertainty out there as well, one of the biggest pieces of uncertainty being tariffs, where there’s seemingly a new piece of news every few hours. How much of a risk are tariffs when it comes to small businesses, and what are you doing with the data to understand what’s going on?

 

Taylor Bowley: Brad made a really important point earlier around how small businesses may not have the wherewithal or the resources or the operating expense to handle certain situations like large corporations. Imagine a boutique jeweler in Nashville. They can’t necessarily easily negotiate supply chain pipelines or have the capability to suddenly front-load their inventories because they operate on really thin profit margins and, frankly, they just don’t have the bandwidth or operating expense to do that. The cost of goods sold is a key element to small businesses’ balance sheets when assessing what price hikes are or are not passed along to consumers. So, while inflation has come down from its 2022 peak, the PPI (Producer Price Index) has been outpacing the CPI (Consumer Price Index) since around November of 2024. This is already saying that there are challenges for businesses producing goods and services.

If small businesses wind up on better footing as trade stabilizes and there’s regulatory and tax relief, that would be welcome news for certain software companies, as there are a few which get almost all of their revenues from small business. And what’s interesting about AI offerings from companies that cater to SMBs is that these small customers can’t build their own AI tools, so unlike with large companies, there’s low risk that software companies are disintermediated.