How attractive are software companies doing $5-$10mn revenues for PE?

Coming from the software world, I wanted to get a view on what people in PE think about buying out companies in the software world that didn't become the next Salesforce.com or ServiceNow. Basically companies that got VC funding, did well in some niche but ended up being sub-scale, without any real possibility of an IPO

To put this in financial terms
1) Revenues = $5mn - $10mn recurring revenues, growing in the 10-15% y/y range
2) Net Retention rates = 105% -110%, Gross retention rates near 90%
3) Gross Margins= 80%+
4) Operating Margin (excluding SBC) = 0%
5) Enterprise focus = 80% of revenues coming from enterprise

I know that there are other software companies with a roll-up strategy (Constellation software, Micro Focus) that focus on stuff like this but look for larger deals that they can realize cost synergies with and milk for cash - but how would a pure financial buyer look at deals like this?

Appreciate any insights.

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Comments (11)

Nov 8, 2019 - 3:23pm

The value in the software side is the scalability, low variable costs and potential for meteoric growth of the topline in regional or global markets. If it's been several years since funding without a compelling growth profile, you have to look at the business based on earnings just like everything else. Chances are you're looking at an Axial/LMM value buyer auction at .7-1.5x revenue or 5-10x earnings. Financial buyers with existing platforms specific to the software (if there are any) could pay more. This is all based on those numbers - like every tech play, if the underlying tech is a game-changer to Accenture or Microsoft, they will pay a premium.

  • Prospect in HF - Event
Nov 8, 2019 - 6:17pm

Yeah, if its not anything strategic to a big Tech firm, then what is really your end game? Like I said 0% margins (so no EPS) - How will a financial buyer approach this? Will they look at some kind of a run off valuation, assuming that all R&D can be cut out, and you can potentially get to 40-50% EBITDA margins and just run off the cash flows from current customer base OR does it make more sense to come in and invest for revenue acceleration so then the business can be later sold to someone else willing to pay a higher multiple?

Nov 8, 2019 - 8:42pm

Typically with suspicion, since these companies are usually sub-scale for some sort of overarching issue - usually the market isn't big enough or maybe it's too crowded, so its future growth is cloudy. Otherwise current investors would just hold on, right? And if you're PE, you gotta flip it to someone else (hopefully strategic) anyway - why aren't those strategics stepping up to the plate for cheap today?

The best buyer for this type of business is a strategic for obvious reasons, and there are a lot of strategics only auctions that get run by a whole host of boutique tech banks in this exact scenario.

  • Prospect in HF - Event
Nov 8, 2019 - 9:24pm

But wouldn't the same logic apply to any software company (that isnt public) bought by a PE? Vista and Thoma Bravo have made a lot of money doing deals in software (some have been large public companies, but lots have been smaller private companies)

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