By: Allen Cinzori, Managing Partner
Originally Published May 11, 2017
As is often the case, most of us take for granted what we know, and minimize the complexity of what we do not understand. I am routinely reminded of this as nearly every client will tell us during their process they “had no idea” how difficult it is to sell a software company. For nearly 20 years, I’ve searched for the proverbial silver bullet that will educate prospective sellers on what lay ahead. No luck. The good news is that as I peruse my competition’s websites and marketing collateral, they seem to fare no better – and in many cases worse. Perhaps, however, I too am simply taking for granted what is right in front of me… hundreds of former and current clients that have walked in the same shoes as a prospective seller. As they sit on the other side of their transaction, they have the benefit of experience, and their unabated willingness to share these experiences with SEG’s prospects is likely worth far more than a single silver bullet.
If I were smart, I would write a series of blogs on all the various topics that prospective sellers take for granted. After all, 20 years translates into a fair amount of material. We shall see.
For the time being, however, I am quite amazed at the state of the current software M&A market and the perception among many would be sellers. The simple perception is that these good times will continue, or possibly they believe they control their destiny and can define the right time to exit their business. As SEG has proven with data, and written about for years, the market and most importantly buyers dictate timing, not sellers. Simply stated, wait too long and the buyers will have built or bought what they need, and the seller’s value will be relegated to its customer base and P&L. The issue? A seller’s products, technology and IP are what drive attractive valuations. A seller worth 5x revenue could easily see its valuation decline 50% or more if the buyers placed their bets on another software provider or built a solution internally.
I often believe the perception is that when a seller decides it’s time to sell their company, they will put out the “for sale” sign and they will be awash with buyers. Maybe this is due to the fact software owners are constantly inundated with inbound inquiries from private equity and search funds in pursuit of their next deal. Of course, the reality is the vast majority of these inbound inquires yield little value as the software company lacks the proper investment profile for the investor that is likely blindly canvassing the market with its outbound BD campaign.
The truth is, finding buyers that offer a seller the best fit (i.e, valuation, culture, customer, employees, etc.) is hard. The good news, the private equity community has made it a whole lot easier in 2017.
Why, you ask? Private equity continues to be very hungry for software companies. They have the benefit of record levels of assets under management as their investors eschew the public markets in favor of this investment class. Further, lenders, who co-invest with private equity on platform deals, continue to show an incredible willingness to lend considerable sums depending on a software company’s recurring revenue, retention rates, cash flow, etc.. Simply put, private equity is sitting on a lot of cash, looking to put their cash to work and willing to stretch for the right deals. Obviously, this will not last.
SEG’s recent SaaS M&A Snapshot reveals private equity and private equity backed strategic buyers account for 44% of 1Q17 SaaS M&A deals (1Q17 SaaS M&A Snapshot). In contrast, public strategic acquirers accounted for 33% in 1Q17. In the mid to late 2000’s, we would have seen private equity accounting for less than 25% of all software deals and likely less than five to 10% of SaaS M&A deals.
At the same time, the number of public software company buyers has continued to decline significantly as public companies have consolidated (e.g., Saba/Halogen (TSX:HGN), Oracle (NYSE:ORCL)/NetSuite (NYSE:N), Salesforce (NYSE:CRM)/Demandware (NYSE:DWRE), etc.), and been taken private. Exacerbating this is the fact few software companies have been eager to enter the public markets. While we are currently tracking a dozen B2B software IPOs in 2017, at this stage we remain well below the consistent B2B software IPO waterline of yesteryear. Today, SEG tracks 185 public software companies that comprise our SEG SaaS and SEG On-Premise index. In contrast, there were more than 300 public software companies just over a decade ago.
Private equity firms, including Thoma Bravo, Francisco Partners and Golden Gate Capital, are blazing the trail at the start of 2Q17. Thoma Bravo acquired Lexmark’s enterprise software business; Kofax, ReadSoft and Perceptive Software. Perceptive Software will be sold to Thoma Bravo’s existing portfolio company, Hyland Software, while Kofax and ReadSoft will serve as a new portfolio company under the Kofax brand. Francisco Partners acquired SmartBear Software, provider of software quality tools for teams. According to the press release, SmartBear has been growing at double digit rates for the past five years. Additionally, Golden Gate Capital recently acquired 20-20 Technologies Inc, a global provider of computer-aided design, business and manufacturing software for the interior design and furniture industries.
For SEG’s clients, these large acquisitions mean very little on the surface. However, the downstream effect is massive for our clients and also for most software sellers. Private equity buyers are in the business of investing and growing software companies. One of their most powerful tools for growth is inorganic growth via M&A. A perfect example of this is Accruent, a software real estate and facilities management provider. Since being owned by private equity (i.e., Vista, TA, Genstar) in 2010, Accruent completed nine acquisitions in seven years, including two by Software Equity Group (i.e., 360 Facility & Evoco). Prior to 2010, Accruent had done one acquisition in 15 years. As mentioned above, private equity accounted for 44% of 1Q17 SaaS deals. However, only 8% were platform investments, the remaining 36% were bolt-on and tuck-in acquisitions used to fuel growth. More importantly, many of these bolt-on and tuck-in acquisitions were done by acquirers who never would have had the wherewithal to acquire without the deep pockets of their private equity sponsor. SEG’s most recent transaction is a perfect example. While the strategic fit between our client HomeTrak and their strategic buyer, ClearCare is terrific, I am extremely confident this deal would have never happened between these two software companies had Battery Ventures not backed ClearClare in 2016.
In the past couple years, a whopping number of SEG’s clients have been sold to private equity backed strategic buyers. Select examples include: ClearCare (Battery Ventures), MRI (GI Partners), HighJump (Accel-KKR), and SunGard (Silverlake et al.).
I hesitate to think what happens when the private equity markets slow. I am certain many of the deals SEG closed in the past few years would have closed at lower valuations or not at all. Obviously, a slowing private equity market would drive valuations down as result of reduced competition and fewer dollars available from lenders. But more importantly, the supply of buyers will likely have the biggest impact on would be sellers. The math is not that complex. There were nearly 2,000 software transactions in 2016, and a significant portion were tied to private equity.
Selling a software company is complex for hundreds of reasons. Perhaps the easiest part of the sale is finding a group of buyers. Unfortunately, I fear many take for granted the supply of buyers that exist today. Windows of opportunity open and close. Today, the windows are wide open. Those that over-engineer an exit may just find themselves on the outside looking in.
For more information about private equity insights, see our 1Q17 SaaS M&A Snapshot.