May 3, 2017
Interviewed by: Privcap
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Inside The Surge in Software Deals

As software has permeated every business sector, private equity firms have clamored to invest in deals that include a software opportunity, driving up valuations and shortening hold periods. Three experts discuss the deal dynamics at play. 

As software has permeated every business sector, private equity firms have clamored to invest in deals that include a software opportunity, driving up valuations and shortening hold periods. Three experts discuss the deal dynamics at play. 

The Surge in Software Deals

David Snow Privcap:
Today, we’re joined by Leo Peavy of Preqin, Mike Fanelli of RSM, and Jeff Bistrong of Harris Williams. Gentlemen, welcome to Privcap today. Thanks for being here.

Unison: Thank you, David.

Snow: Let’s talk about a certain kind of deal in a certain sector that’s becoming incredibly important now in the deal market: that’s software. Jeff, you run the tech media and telecom practice at Harris Williams. Talk about the influence that the demand for software companies has had across sectors.

Jeff Bistrong, Harris Williams & Co.:
Right. When we think about technology, one could say everything is software because it’s effectively driven by it. And we’ve seen tremendous capital going to the software-focused private equity groups. But the more traditional private equity groups, given the maturation of the sector, have all really started to come and compete for those deals, as have large family offices, which we’ve talked about. And sovereign wealth funds have come and started to go direct and do these software deals. So, in terms of the demand side, it’s increased significantly. And you can’t fabricate a lot of supply, so there is some acceleration and shorting of hold periods for software companies. But the demand is driving up valuations.

Michael Fanelli, RSM:
Do you see the non-software technology-focused private equity firms able to compete with the software technology-focused PE firms, not knowing the industry as well?

Bistrong: Often.

Fanelli: Really?

Bistrong: Often, they’re able to—for good or for bad, maybe they don’t know the sector as well, but they like an asset and they will outcompete some of the traditional software-focused guys.

Fanelli: Interesting.

Bistrong: And who will often be scratching their heads and saying, “How did they get to that valuation?”

Fanelli: Right.

Bistrong: Now, in really high-growth SaaS companies where the software players have focused for a long period of time, they tend to prevail.

Snow: It sounds like some of these private equity firms go out and buy a software company and realize they can get their targeted return in 11 months, right?

Bistrong: In the past 24 months, we’ve had three transactions where a private equity group invested and we helped them exit in less than 12 months at their target returns for their hold period or better.

Snow: These are firms that—while they traditionally hold on to companies for three to five to even seven years—if there’s a bidder for your asset where you’re getting an attractive rate of return for your investment, you’re selling it. That’s your fiduciary responsibility.

Bistrong: You’d think that would traditionally would be a strategic and it has been. There have been a lot of deals that have traded private equity to private equity in that kind of time period.

Snow: The private equity firms that have not traditionally been in software that are now investing in it—what kinds of people are leading these deals? Do they have software backgrounds? Is there a scramble for talent to find people who actually understand this industry?

Bistrong: First of all, one could argue that software is not a thing unto itself, but an enabling tool for all these other sectors where these firms traditionally focus. So, they either have cross-pollinated with a knowledge about software through their other investments or they will bring in a software or technology-centric partner to help them make that transition.

Snow:  Even if you’re focused on—you’re an expert in agriculture. If you really are an expert, you should understand the impact that the internet of things and software is having—

Bistrong: Right. You look at ag data owned by Vista or some other ag-tech deal because you understand the end market and what the software is doing to drive value.

Snow: There’s a finite supply of software companies out there. Some of them are getting quite mature. With the increasing amounts of capital and the flat supply of software companies out there, what’s going to happen in the M&A market?

Bistrong:  What I’ve maintained over the past several years is that we’re on this plateau. But now, I’d say we’re on a high plateau, so I don’t think valuations can go up much from here.

Snow: Is there a plateau above the high plateau that we can—

Bistrong: Yeah.

Fanelli: Could be. We’ll let you know next year.

Bistrong: Well, no. You have debt availability. You have strategic capital. You’ve got tons of dry powder on the private equity side. I suspect we’ll more or less stay here. We don’t foresee where the edge of that plateau is, but we may hit it hard at some point.

Fanelli: All businesses have some type of tech-enabled service along with it, whether it’s within the company itself or various suppliers and vendors otherwise that support it. We just see it getting bigger and bigger and our software technology team continues to grow itself. The key is, though, for these non-software technology private equity firms we’ve seen at least, they do bring in a team or a person because the valuation model is totally different from a regular business, especially in a SaaS or recurring-revenue model world. That’s how, a lot of times, you can get that 12-month return on an investment because you made your most recent month recurring-revenue number much higher than when you acquired it and you’re able to do more annualized-type analysis on that as opposed to just a regular non-software business.

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