How K1 navigates the high-priced enterprise-software market

Emerging managers need more than a concrete niche thesis to succeed in hypercompetitive markets like business-to-business software, the CEO of K1 Investment Management said Friday.

“In the late part of the cycle like we’re in right now, it’s increasingly frothy, increasingly expensive, and you’re likely having to take a lower return, and you’re often trying to find the businesses that are going up and to the right … and those businesses are priced to perfection,” K1’s Neil Malik told the audience at Buyouts Insider’s Emerging Manager Connect Outlook conference in New York.

An increasingly crowded market was enough to convince Malik that his firm needed to do more to differentiate after raising its first growth-equity fund in 2013.

“We came to the conclusion that buy-and-build, direct sourcing and sector specialty are necessary, but they’re not sufficient,” Malik said. “We have to have our own operations team.”

K1’s operations team, which today has 20 or so dedicated members, has played an important role in maintaining price discipline, he said. The firm since 2011 has consistently bought enterprise software companies for around 3.5x recurring revenue, Malik said.

“If you’re growing under 30 percent in software, you’re a dog. Nobody wants to talk to you. If you’re above that level, you might have an IPO opportunity and you’ll get a really nice growth multiple,” Malik said. “And so we’re focused on companies that generally aren’t growing quite as fast as the rest of the pack, can use some work, and that’s where our operations team can come in.”

In recent activity, K1 in December invested more than $200 million in SecureAuth Corp. in connection with the security technology firm’s merger with CoreSecurity.

Reflecting on his own experiences and observations, Malik said the single biggest mistake new managers make is targeting large limited partners when raising a first fund. Emerging managers have to be more realistic about how much time and capital they have, he emphasized.

“It’s important to get the wheels turning,” Malik said. “Too many folks wait for the big names to come in. Those are generally not the first movers in first funds, unless it’s a rare set of circumstances.”

Time is better spent building personal connections with folks in the high-net-worth and family-office communities, Malik said. Most of the time initial investors don’t care about the return, but are investing to “put you in business because they like you,” he said.

Action item: Learn more about K1 here: http://k1capital.com

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