Is the buyout the new exit strategy for venture-backed software?


Golub Capital, Peter Fair, private equity, venture capital, software, technology

By Peter Fair, Golub Capital

With the exit hurdle moving higher for tech unicorns, it’s harder for venture-backed software companies to access public equity markets. But there’s good news: Private equity has the tech sector in its sights. The multiples just might make founders and their venture backers think twice about the IPO as their choice of exit strategy.

IPO activity in 2017 has fallen short of expectations given stock-market records. Among companies that managed to list shares in Q2 2017, growth rates of nearly 100 percent, or better, were not uncommon. That caliber of growth is becoming increasingly harder to achieve in the face of competition from established tech leaders such as Amazon, Google and Apple.

Coupled with the haircuts some tech companies have taken on valuations, it becomes clear why “grow fast or die slow” has become a mantra in Silicon Valley. It’s no surprise then that companies with IPO ambitions need to clear a high bar.

Venture-backed software companies achieving growth between 30 and 40 percent — more moderate, albeit still attractive — should consider PE as an alternative liquidity source. The number of PE buyouts of venture-backed technology companies is growing. In the first half of 2017, 43 VC-backed technology companies exited to PE, according to Pitchbook data, which is more than those that IPO’d in H1 2016. This year’s total exits to PE are expected to surpass the 71 deals in 2016, with firms like Vista Equity Partners and Thoma Bravo raising sizable funds to focus on this space. (Thoma Bravo closed a $7.6 billion fund in September 2016 to pursue tech deals.)

Recognizing the opportunity to acquire software companies with solid recurring revenues, private equity firms are offering multiples to rival the public markets and strategic buyers. Thoma Bravo’s $3 billion acquisition of Qlik Technologies in 2016 is one example, with the deal fetching a payout about 20 percent higher than where the software company’s shares had been trading.

Beyond the competitive acquisition multiples, other attributes of a PE exit may be attractive to tech companies and their investors. First, in some cases, current shareholders may be able to roll a portion of their equity into the new entity, providing a so-called second bite of the apple. Second, unlike an IPO, there are no six-month lockup periods that could put the ultimate exit valuation for shareholders at risk.

So how can venture-backed software companies looking to move to the next level of growth benefit?

To prepare for a potential exit to PE, current equity holders should focus on optimizing their cost structure as evidence of a company’s graduation from rapid, cash-fueled growth to solid, repeatable and predictable earnings. Here, the stability of software’s subscription-based revenue model provides an advantage in seeking a PE buyout.

One need not look far for examples of successful transactions in this space: The recent acquisition of Applause by Vista Equity Partners and the purchase of Workforce Software by Insight Venture Partners are two. Both had previously raised capital through venture syndicates. As technology continues to drive disruption in every industry from retail to security, more opportunities are likely to surface.

PE firms are attuned to the software sector’s growth potential and have raised considerable funds to acquire compelling tech assets. For venture-backed firms, exiting to the public markets has long been the proof of having made it, yet today the less-obvious choice of buyout is one that shouldn’t be dismissed.

Peter Fair is a managing director on the Late Stage Lending team at Golub Capital, where he is responsible for originating, underwriting, executing and monitoring investments. Golub Capital Late Stage Lending offers venture debt opportunities to venture-backed, late-stage SaaS companies. Golub Capital is a nationally recognized credit asset manager with over $20 billion of capital under management. For over 20 years, Golub Capital has provided credit to help medium-sized U.S. businesses grow. For more information, please visit golubcapital.com.

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