The Perfect Formula for a Recession Resistant Software Company Today
While many of the elements that define attractive investment opportunities remain consistent, buyers and investors do tend to place more emphasis on certain criteria depending on the broader economic conditions. With most economists anticipating an economic downturn in the near future, we wanted to gain deeper insight into what matters most to buyers or investors considering new investments today.
We surveyed the top private equity investors at leading software-focused firms and found a common theme throughout their responses: More than ever, investors are focused on acquiring mission-critical and recession-resistant businesses.
You can read the full report with insights on investors’ observations, priorities, and outlook for future M&A deals.
Here’s a quick summary of how investors define recession-resistant businesses.
What do recession-resistant businesses have in common?
While there are many factors investors consider when evaluating opportunities, gross margin and gross retention are among the most important to them today, according to our survey.
Gross profit margin is a good indicator of a company’s scalability as it shows the amount of money left to reinvest in future growth. While gross margin alone shows a company can quickly onboard and serve new clients, it doesn’t mean it can keep them. The combination of high gross margins and high gross retention is especially attractive to investors because it means a company is growing efficiently while minimizing customer churn, so any future success will only add to its profitability, rather than compensating for loss, SEG Managing Director Allen Cinzori said. And if a recession hits, they may feel less of an impact.
“Many companies with lower gross margins require a lot of implementation and labor that is time consuming,” he said. “Customers may stay simply not to go through the pain of leaving. But if you can get high retention paired with high gross margin, that’s the secret sauce.”
A mission-critical industry or function
When we asked investors an open-ended question about what qualitative metrics were most attractive to them in today’s market, more than 20% indicated they care most about companies that are “mission-critical” or “recession-resistant.”
There are several ways to define this. It could mean supporting an industry considered to be essential, such as agriculture, healthcare, government, food and beverage, manufacturing, or life sciences. Think of the industries whose employees were considered “essential workers” throughout the COVID-19 pandemic. They may have cut costs and experienced labor shortages, but they continued day-to-day operations. Many actually saw a significant increase in sales.
Another way to look at this is how critical your technology is to business operations. Software that supports ERP systems, supply chains or security, for instance, can have widespread implications for many industries. They are essential for the day-to-day business of their end customers from an operations, regulatory, or compliance perspective. This makes it painful and challenging for end users to switch providers and nearly impossible to be without a solution.
The data in our latest SaaS Public Market Update shows these mission-critical companies maintained the highest EV/Revenue multiples compared to other categories, primarily due to their mission-critical nature and crucial customer reliance on the product offerings.
Their categories included ERP, Supply Chain Management, and Security.
A scalable delivery model
At a time when digital transformation is a high priority for most organizations, cloud-based SaaS businesses are much more attractive to the market compared to on-premise solutions. These solutions are easier to implement and don’t require a large upfront investment or significant costs to update and maintain. They also allow for greater flexibility.
A strong product
Whether or not an organization is able to withstand challenging economic times comes down to two things: their product and its value to customers. Is the product truly different from other solutions on the market? Is it integral to operations? How difficult would it be for customers to switch to an alternative? These are all important questions CEOs should continue to reassess as the market changes, budget priorities shift, and new competitors enter the scene.
Recession-resistant businesses focus on the fundamentals
While the public SaaS market has seen a decline in valuations, our Q3 SaaS M&A update and investor survey show there’s still strong demand and investor appetite for mission-critical, recession-resistant businesses. Even if your company doesn’t have a mission-critical function, you can focus on other fundamentals — including enhancing your product offering, ensuring you have an efficient and cost-effective delivery model, and staying committed to customer success.
Our team of experienced M&A advisors can offer guidance on how to maximize your company’s valuation and position your company as an attractive opportunity for investors when the time is right.
For more insights on the M&A market outlook for 2022 and how you can take advantage of the opportunities ahead, download our full report.