“Private equity will always love software,” explained Pete Dalrymple, managing director and co-head of technology investment banking at William Blair. “Maybe the valuations are different, but the fundamentals are not. Software is embedded in our daily lives and is ubiquitous across numerous industries and use cases. In good markets and bad, investors appreciate the recurring and predictable nature of these businesses, their capital efficiency, and the additional M&A opportunities that oftentimes come along with owning a platform of scale.”
Although tech M&A was “muted” in Q1, as technology-focused investment bank Union Square Advisors characterized it in a recent report, significant enterprise software deals closed, and others were announced.
In February, Thoma Bravo closed its take-private deal of Coupa Software for $8 billion. Coupa, based in San Mateo, California, is a cloud-based business spend management (BSM) platform that unifies processes across supply chain, procurement and finance functions. The transaction includes a significant minority investment from a subsidiary of the Abu Dhabi Investment Authority.
In March, when the collapse of Silicon Valley Bank dominated headlines, Silver Lake and Canada Pension Plan Investment Board announced they will buy customer experience management software developer Qualtrics for $12.5 billion. Co-headquartered in Provo, Utah, and Seattle, Qualtrics is a cloud-native software provider that helps organizations identify and resolve points of friction across all digital and human touch points.
Also in March, Blackstone said it would buy events tech provider Cvent from Vista Equity Partners, for $4.6 billion.
The same month, Vista completed its take-private buyout of Duck Creek, a Boston-based insurance software provider, for $2.6 billion.
And the deal announcements have continued in April, with London-based Cinven agreeing to acquire Archer, an Overland Park, Kansas-based provider of integrated risk management software, from Clearlake Capital Group, a Santa Monica, California-based PE firm and Symphony Technology Group, a Palo Alto, California-based firm. STG initially acquired Archer in 2020 as part of its acquisition of RSA Security from Dell Technologies and subsequently partnered with Clearlake in 2021 to establish Archer as an independent business.
Unique asset class
Why are enterprise software deals flourishing when transactions in other sectors are not?
In a tight macroeconomic environment, businesses tend to prioritize efficiency in ways that significantly cut operational costs. One way to achieve that is to deploy enterprise software, a form of technology that will streamline different departments and operations to increase the overall efficiency of the whole organization.
“Enterprise software is a unique asset class because we believe it is incessantly primed for continued growth at scale,” said Monti Saroya, senior managing director and co-head of flagship fund at Vista.
Enterprise software cuts across many sectors, such as the supply chain, human resources, industrial manufacturing, energy, healthcare, transportation, hospitality and many more.
Historically, enterprise software has been better insulated from economic downturns and is faster to recover when compared with other technology platforms that may be more consumer-facing and reliant on discretionary and transitory spending decisions, said Saroya.
Software is the most powerful tool available to the modern enterprise, he added. “It is often one of the last services businesses look to ‘turn off’ during uncertain periods, which creates sticky and predictable reoccurring revenues at attractive margins.”
Enterprise software deals generate a lot of cash flow, and they have a high degree of predictability over time because they have “good go-to-market models,” said Mike Hoffmann, a partner at Thoma Bravo.
The sector produces high recurring revenue and high gross margins, and the investments don’t require material capital expenditures, Hoffmann added. Enterprise software developers “have very low capital intensity, so you don’t have to build manufacturing plants like what some other industries require.”
Enterprise software businesses also lend themselves nicely to consolidation, added Hoffmann, noting that investors who own such businesses can acquire another software company that sells to the same end buyer, creating a “complementarity” that can be utilized through the same distribution channel in a very efficient manner.
In the lower mid-market, the idea of creating high gross margins appeals to Sumeru Equity Partners, a San Mateo, California-based PE firm that recently invested $110 million into Consensus, a Lehi, Utah-based intelligent demo automation platform that serves large enterprise B2B customers.
“We are not manufacturing a physical good and so we don’t have high cost,” said Jason Babcoke, a co-founder and managing director of Sumeru. “We get to keep and reinvest most of the money that we get from revenue back into R&D.”
The longevity of enterprise software products is another appealing attribute for Sumeru. “Typically, if you develop one module, it can have a shelf life of at least 10 years, and the revenue that you get from that will allow you to build the second, third, fourth and fifth module, so your IP has a very long shelf life.”
The quality of clients that enterprise software companies attract is also an appealing attribute, noted Babcoke. Once you win those customers, you can keep them for many years, in part creating some stability in the business, he said. “You are selling into big important customers that are stable and growing.”
The current state of the market is one reason why PE investors are keen to write checks. “We are definitely in a more ‘buyer-friendly’ market for software companies today than we have seen in recent years, and the IPO option is much less attractive and less viable,” said Chris Lane, managing director and co-head of technology investment banking at William Blair.
In an era in which some strategic acquirers are out of the market because their own businesses and share prices have underperformed, others are emboldened by lower prices, less competition, and the desire to scale their platforms, added Lane.
“Net-net, yes we believe this market favors the bold and experienced software-focused private equity investors that have recently closed larger funds,” said Lane, adding that there are only a few funds in the world that can pull off an acquisition such as the Qualtrics deal, for example.
Take-private deals are growing.
Lower valuations are tempting PE firms that previously viewed the market as too cost prohibitive to participate, Thoma Bravo’s Hoffmann explained.
Some of the companies that are being bought in take-private transactions are generally those that haven’t yet gotten to a level of profitability that they otherwise likely would have if they were operating in the private markets, Hoffmann added.
The burden of operating on the public market is huge for young companies, most of whom had a venture capital background, especially those that went public through an IPO or SPAC just before or during the pandemic, said Aly Simons, co-chair of the technology M&A practice at Goodwin Procter.
For some enterprise software companies, it can take longer for them to secure contracts, a situation that could be challenging for some companies that are used to operating in a venture capital model of early wins. The advantage of private equity is that it “has a lot of patience,” Simons pointed out.
But given the higher cost of debt, and the changes in the leveraged finance markets, the amount of debt being used in software LBOs today is less than it was in the past, said William Blair’s Lane. “Currently, financing approximately 30 percent of the purchase price is quite common; in 2021, that number might have been 50 percent or more,” he said.
And what’s changed in the current market is that the paradigm of “growth at all costs” chasing sky-high multiples that are fueled by a seemingly limitless supply of cheap capital has shifted back towards a more realistic focus on sustaining efficient, profitable growth.
“This is now an environment where founders and business leaders are prioritizing patient, long-term capital and working with a strong operational partner,” Vista’s Saroya said.
The pace of dealmaking in software is unlikely to slow down, especially when you consider that many technologies are still being developed.
AI can up the stakes in the future, Simons said, adding that with artificial intelligence still developing and many companies still figuring out how to implement it, we will likely see a sea of activity going forward with enterprise software.
“A lot of these companies don’t have AI integrated into their solutions the way that they could in the next 12 to 24 months,” she said. This could also widen the door for M&A. Some companies “will turn around and build it themselves, but a lot of them will acquire existing AI companies in order to build out that functionality.”
As Vista’s Saroya explained: “Software is projected to remain the fastest growing sector of the global economy for the foreseeable future, with recent advances in areas such as cloud computing and AI still in their early stages of demonstrating what could amount to the creation of exponential value for organizations and investors. This rare mix of resiliency and long-term relevance can result in meaningful opportunities to drive consistent, risk-adjusted returns.”