Anxiety About The State of Tech Private Equity
From experience at my firm (MM tech PE) and speaking with others in the LMM and MM Tech PE market, there is a lot of anxiety on the state of PE given a potent cocktail of market dynamics - combo of higher rates, lenders taking less risk, tech disruption risk, and firms not willing to meet sellers at their valuation price/take risk.
The lack of deal flow is compounded by folks dwelling on the deals done in 2020 through 1H'22 at peak valuations and wondering what that means for future fundraising, particularly for the funds that raised and deployed a record fund size into those valuations. If you raised a peak fund in 2020/2021 and deployed into the top and struggling to transact at lower multiples today, there's a real sense of "what are we doing here" and what's the fundraising path forward if firm money-weighted returns are impaired (LPs probably wondering the same). A more software/services specific concern is that terminal valuations and exits for existing portfolio companies will be disrupted by AI.
Anyway, wanted to throw this out there and see if others are experiencing the same at their firms. This cocktail is throwing a wrench in how folks are thinking about future of certain firms and career trajectory at shops depending on how the above factors are hitting their firm/AUM-outlook.
Good ol mean reversion. Going to be a lot of VC / PE funds that have horrible returns and won't be able to raise another fund as a result.
Already seeing this. Tiger Global raised $2.7 billion for a $6 billion fund. Insight is hoping to raise $15 billion for what was supposed to be a $20 billion fund.
The exception is TA Associates who raised their entire $16 billion goal for a new fund. The difference is that TA invests in mature tech companies (read: boring but stable cash flow). There’s still LP interest in tech, especially at today’s lower valuations, just not in risky tech startups.
Source: https://www.valueaddpe.com/kkr-favorited-in-simon-schuster-buyout-brook…
TA has two things going for them that a lot of others do not that are experiencing the issue in the OP 1) long track record through multiple cycles, 2) your point - they are closer to traditional PE with more diversification across sector and outside of technology (biz services, consumer, financial, healthcare) than you might think. I suspect this shielded them somewhat from overpaying for a lot of software assets in 2020-1H22.
And to be honest, I think we'll see more diversified PE players take AUM share from the software PE shops. Not too dissimilar from dynamic in HF space with multi-manager hedge funds (Citadel, Balyasny) taking share from levered beta tech funds.
Unfortunately, this is spot-on. Confusing bull market for brains caused a lot of smaller software PE shops to think they are the next Thoma Bravo. The larger and more tenured firms with longer track records will survive (money-wtd return issue less of a factor for them), particularly those who can show they've come out the other side of a downturn successfully.
VC and late-stage growth is a whole other animal and this cocktail of issues is magnified by 2x-3x.
My associate perspective in MM PE right now is that the pendulum has/will swing from tech focused shops back to generalized shops that also do tech.
There’s inherent risk in being focused on one sector (we’ve seen this in the past with energy funds and seeing it now with tech). It’s an advantage in a bull market where MM tech funds cleaned up and raised huge funds, but now many will take a beating and likely not survive.
Being generalized protects risk (if the 20% of the fund in tech struggles, doesn’t bring down the whole fund) and allows you to deploy capital in other sectors if tech is slow or valuations are too high.
I’m at a fund that has all sectors and we definitely were a “loser” in tech in the last two years (couldn’t move as fast / bid as high / lacked pure specialization vs a 100% tech fund) but think we’re better positioned at this point vs a fund that deployed 100% into tech
Yup agree, this is in-line with my comment above with allocator $ in PE shifting to platforms like they've done with multi-managers in their HF allocations.
The whole "illiquidity is a feature, not a bug" meme is over and software LPs holding the bag of software assets with terminal risk from AI (a LOT of private software) are feeling this the most. Right now it's irresponsible to have as much concentration in software PE as they do. It made ppl very wealthy in the 2010s but trend will reverse to more diversified platforms. Probably bullish the public alts TBH long-term.
Might be a stupid question but gonna ask it anyways since I’m not in Tech PE. Totally understand that multiples are depressed but can’t funds just hold companies a little longer, grow EBITDA, maybe do a couple of tuck-ins and still make an OK return?
Not in PE so grain of salt but:
Others, thoughts?
Entry price is the biggest determinant of PE returns (on average). The multiples that 2020-1H22 LMM and MM software deals were done at will make it incredible difficult to come back from and even make a mediocre IRR. You had subscale software assets trading at 10x ARR....
Longer time horizons and lower IRRs but still market outperformance
TWT, but the math does not look promising. It's indisputable. It is hard to outrun paying 8x/10x/12x ARR for software assets that are only going to CAGR ARR 15-20% during a 5yr hold, and these are the types of deals that were done in 2020-1H22.
IMO the UPSIDE case for many underwritten investments has compressed to looking more like, 8-12% IRRs. Said differently, the winning investments of this fund vintage will have +/- public equity market returns and losers be hoping to simply get capital back. Overlay that math on fund-level economics and the % of winning investments you think the fund has, and the fund-level returns look awful in that scenario - all while having your $ locked up. If a sizable % of historical committed capital was invested in this fund vintage (hint - this is the case at a LOT of LMM and MM software funds), it will not be pretty.
Totally right with respect to the folks who already overpaid, all the guys who jumped in half cocked and bought low-to-mid tier assets at 10x+ over the last few years are going to get absolutely hosed. Already seeing it happen to a bunch of the big crossovers and I know at least 2-3 funds that beat my firm out of big bids in the last couple years who are probably looking at those assets with a healthy dose of remorse. All those permanent or long-term capital vehicles though are probably feeling pretty darn good right now.
Preach. I'm very bullish given the much better entry points right now than the past 3-4 years. Rates are coming up, leverage is going down, and the hayday of week-long DD to a double-digit closing multiple for your generic $10m+ ARR company are dead and gone. Now the true tech-natives have a more definitive edge over the tourists. The only people who need to feel anxious are the ones who were just here to ride the wave.
Talking past each other. If you are a scaled tech PE player with staying power and a quasi-permanent capital LP base, that's not the question and not in doubt. Thoma Bravo does not have a fundraising or money-weighted return issue. In fact, I agree the Thoma Bravo's of the world are likely salivating at the chance to scoop some deals on the cheap, and heck, they probably get the green-light to do more experimental stuff in AI and outside of core SaaS to diversify a bit - neat place to be.
However, the thread is about the myriad of 100% software-focused LMM and MM funds with a <20yr track record who deployed a sizable % cumulative LP capital at the top of the market. Ex - type of firm with 4 funds, with the fourth being raised in 2020 at 2-3x the size of the average of the first 3 funds and those dollars invested at 10x-15x ARR multiple. There are plenty of firms in this uncomfortable situation who would not consider themselves "tourists" - they just decided to monetize the GP at the market top and put future fundraising in doubt.
If you've put in the elbow grease at those funds through ~VP without participating in meaningful carry yet, you are absolutely thinking the partner track is a lot murkier and need to think about ejecting and starting over at another firm if things deteriorate - not a great place to be.
Username checks out
Molestiae sint repellendus odit ut dolore culpa quas. Nemo ab ipsa debitis voluptatem corporis eaque exercitationem. Expedita mollitia maxime atque quo. Doloremque rem quae harum ducimus eos.
Quo ducimus accusantium quia saepe sint est perferendis. Reprehenderit qui debitis quia. Accusamus repellendus quibusdam sapiente accusamus. Cum aut expedita laudantium vero praesentium asperiores fuga. Molestias voluptas sit consequuntur qui voluptatibus magni. Asperiores placeat optio dolores hic iusto cumque. Labore eum et molestiae deserunt quis quo.
Incidunt quia aut dolorem a. Totam quisquam ut repellat beatae nobis minima eos nihil. A mollitia asperiores magnam doloremque vitae voluptas. Eos at ut occaecati ut ut dolor. Ut error suscipit voluptatem.
See All Comments - 100% Free
WSO depends on everyone being able to pitch in when they know something. Unlock with your email and get bonus: 6 financial modeling lessons free ($199 value)
or Unlock with your social account...