Who Will Buy your Emerging Software Company?

As entrepreneurs who have been through the fund raising process know, this question is one they should be prepared for when speaking with potential venture investors.  Giving some real thought and analysis as to who will be a potential acquirer and why is important as it the mostly likely way that investors will eventually get a return on investment.  But over the last decade, there is an important distinction that has developed into a serious trend regarding who might want to buy your growing software company one day.

First, let’s share some basic data.  Ascent works with B2B Tech/SaaS software companies in the U.S., so that is what we will focus on.  According to Pitchbook, over the last five years the average number of IPOs has been around 30 per year (2018 is showing a modest increase) and the average number of strategic acquisitions (think IBM, Oracle, SalesForce, Cisco etc.) has been around 1,200.  You can see why M&A is the more likely path to an investment outcome. This is probably not news to anyone.  What is more interesting is that the activity level of financial buyers for technology companies, or Private Equity (“PE”) tech, has grown significantly.  Ten years ago there were under 100 PE acquisitions in our area of focus (B2B Tech).  Last year there were 438! (data from Pitchbook).  That is a major increase, growing from about 16% of the strategic driven M&A volume to over a third, or 36%.

Outcomes for Information Tech Companies

You might ask what is driving this trend, and we see a number of factors at work:

1)    We believe that as SaaS businesses have matured and been rewarded by the public markets with premium valuations, the private equity world has taken notice.  The Nasdaq Tech 100, or NXDT, has outperformed the Dow Jones Industrial Average by 183% to 65% over the past 5 years. This also means that PE buyers see a path to liquidity for their tech bets down the road.

Nasdaq Tech 100 vs. Dow Jones Industrial Average

2)    When net customer churn is low, or even negative, and profitability has been achieved through some scale, SaaS provides a highly predictable and attractive revenue stream as well as high margins, making it an ideal business model for paying off debt or leverage often used for private equity acquisitions.

3)    The substantial increase in capital flows into PE funds.  Institutional investors have been directing larger and larger amounts of capital to tech-focused PE Funds.  According to Preqin data in the Wall Street Journal, annual capital raised has grown from the $50B per year range in 2010, to over $200B recently.  Firms such as Silverlake, Vista Equity Partners and Thoma Bravo have all raised funds north of $10B, and there are a growing number of other competitors, not to mention the enormous Softbank funds, and sovereign wealth funds starting to make more direct investments or acquisitions in our world.

There are certainly some in the PE world who argue that software and tech are not a great match for the investment model, claiming that tech markets can change very rapidly, pricing is often very expensive and it is more of a momentum/growth bet versus a true value or turn/around type opportunity more typical of buyouts.  But these objections are drowned out, at least for the time being, by those PE firms who are making aggressive moves to acquire emerging SaaS and tech businesses.

So, as you prepare for your next set of fund raising meetings, in addition to studying the universe of relevant potential strategic acquirers, you probably want to look at which tech oriented PE firms have been active in your segment of the tech world.  If the current trend persists, and you are able to scale your business to the proper level, there is better than a 1/4 chance that your software company could be acquired by a financial buyer.