- Drives earnings growth through complementary acquisitions
- Increased focus on recurring/repeating revenue models
- Using more leverage to keep equity values down
Brian Conway is chairman of TA Associates’ executive committee and a managing partner in the Boston office. He joined TA in 1984 and has co-led the firm’s technology group.
TA is known for technology investing. What is the firm’s current approach to the sector?
Technology is still the largest industry area for TA, which somewhat reflects our focus on growth private equity and our history. For the last five years, 49 percent of dollars invested have been in technology. Software is the largest piece. If we split tech into fintech, software, etc., software is 35 out of the 49 percentage points. Software alone is bigger than our other industries, consumer, healthcare, business services or financial services, and we’ve been investing in software since 1979. That was my area of focus when I was a card-carrying, deal-doing partner.
We’ve done a lot in vertical market software, whether it’s an investment in a company that develops applications for real estate management, or a company that provides ERP software for convenience stores, principally those that are coupled with petroleum operations. We invest in organic growth, plus we build companies with acquisitions. We’ve done that to a lesser extent with horizontal software as well.
One thing that’s interesting, because it grew up out of an interaction of financial services and technology, is payments, particularly where the payment is integrated into the software that’s sold. We have one investment in an integrated payments company in the healthcare vertical. We also have an investment in a company that sells software that runs daycare centers: every time you drop off your child, there’s a revenue stream that comes out of it. Or at a doctor’s office, when you swipe your card for copayment.
How has TA dealt with increasing prices for technology companies?
Growth private equity is all about driving your return from the growth of earnings. One of the ways we’ve driven growth in our portfolio companies is through complementary and strategic acquisitions. They’re financially attractive because you typically can purchase at a lower multiple, using all debt financing, based on the target’s pro forma earnings. As the acquirer, you’re really only interested in the product and the technical people, so you can sell these additional products to your existing customer base and new customers. General and administrative cost and most of the sales and marketing costs are often redundant. In a software business with 90 percent gross margins, there’s typically a lot of synergies.
Not only are these financially attractive, but for these niche vertical-market software companies you can expand the addressed market, in some cases doubling, tripling or quintupling it through identifying adjacent markets. These transactions also make strategic sense: you reduce product or customer concentration, and you’re able to accelerate product development to the next generation.
Last year, we did 49 acquisitions. Tech has worked particularly well for us. Over the last five years we’ve done 76 add-on acquisitions in software alone.
How else has the firm navigated the high-multiple environment?
It’s sort of a simplistic idea, but the No. 1 determinant of our returns is sustained earnings growth. We’ve tended to do better when there was a recurring or repeating revenue model. That’s now about 80 percent of what we do, up from about a third six or seven years ago. If you were to look at public markets, the public will pay a much higher multiple for a recurring revenue model, because it’s more predictable in terms of growth and earnings. Because of the predictability, you can leverage that cash flow, use it for acquisitions or investing in R&D and bringing out new products.
Any other noteworthy adjustments?
We’re known for our industry-based origination. We have five industry groups — business services, consumer, financial services, healthcare and technology — and we’ve doubled down on that while increasing our focus on quality business models. We’ve basically doubled our company visits since 2008, to 3,300 last year. A big chunk of those acquisitions we talked about originated out of our industry groups. We also have a strategic resource group that drives growth: merger integration, performance improvement and overall value creation. This team, which is comprised of professionals with deep consulting and operating experience, is very much a part of the investment process during the early stages and will help develop detailed 180-day plans prior to the deal closing. We are firm believers in aligning with our management teams from the very beginning of the partnership to ensure that we share the same goals and vision for the company’s growth trajectory.
What’s the exit environment like?
We have been net sellers for at least the last four years. The biggest source of liquidity last year was 10 sales and four partial recaps — the idea is if you’ve reached in two to three years what you thought you would do in four to five, this is the best way to go. We have also done minority, 50-50 or majority recaps, where we roll equity and take some off the table. This way, we are taking capital loss completely off the table, early cash flows are good for IRR, and from a risk/reward point of view it gives you more confidence to hold onto the remaining equity that you have for longer. Ultimately we are trying to triple or better that equity value.
How has easier credit affected your business?
We’ve been using more leverage — not as much as the buyout business, but more than traditionally for TA. So five years ago, in 2012, it was 2.5x Ebitda, and last year across investments we made it was 4.7x. What’s happened is that the equity values have stayed relatively constant, but the enterprise values have gone up by the amount of the debt, so effectively all of the benefit of the leverage has gone to the seller. But you take some comfort that your equity value has not gone up as much as purchase prices.
Edited for clarity by Eamon Murphy.