Charts reveal the software companies that rely most on stock-based compensation

As the software industry grapples with a slowdown in growth and the disruptive influence of artificial intelligence, stock-based compensation is coming under increasing scrutiny from investors. A recent discussion with the CEO of a prominent software company, who wished to remain anonymous due to the sensitive nature of the topic, revealed concerns about the industry's potential for a challenging financial adjustment. The executive highlighted that stock-based compensation, often referred to as SBC, has ballooned to unsustainable levels for many companies in the software-as-a-service sector, especially in light of their future growth projections. Recent analyses by Barclays and William Blair illustrate the extent of the issue, showing that for some firms, SBC constitutes a significant portion of their revenue. Notably, Snowflake leads the pack, with SBC making up around 35% of its revenue, followed closely by JFrog at approximately 28% and Atlassian at around 25%. Other companies like GitLab, MongoDB, and Datadog also report SBC figures exceeding 20% of their revenue. This trend of high stock-based compensation is becoming increasingly apparent as software stocks falter, prompting investors to demand greater profitability from these firms. According to Barclays analyst Raimo Lenschow, discussions surrounding SBC have intensified in investor meetings. For example, Atlassian reported generating $1.4 billion in free cash flow in its last fiscal year; however, had its stock compensation been in cash, its free cash flow would have been virtually zero. Barclays also analyzed how valuations shift when stock compensation is treated as an actual expense in free cash flow calculations, revealing significant fluctuations for several companies. For instance, MongoDB's enterprise value was approximately 53.5 times its projected free cash flow for the next 12 months. Yet, when accounting for stock-based compensation, its earnings plunged into negative territory. Similarly, Atlassian’s valuation multiple skyrocketed from about 12.8 times free cash flow to around 88 times when SBC was included—an adjustment some investors may view as excessive. These changing dynamics have compelled management teams to reconsider their approach to stock compensation. William Blair's analyst Arjun Bhatia noted that Atlassian's recent layoffs were partially aimed at accelerating its journey toward Generally Accepted Accounting Principles (GAAP) profitability while also attempting to curb one of the highest SBC levels in the industry. As growth slows and equity compensation remains high, other software companies could face tough decisions, including potential layoffs, as investors increasingly push for financial discipline across the sector.