Software investments are currently surging in private markets. Technology pervades many PE deals because PE firms are in pursuit of deals that will drive sustainable value. Developments increasingly appealing to PE investors include artificial intelligence, data management, healthcare IT, industrial automation, and Software-as-a-Service. In 2016, the total number of PE deals in software increased from approximately 5,600 in 2007 to approximately 6,200. The number of software deals at entry increased from 228 to 481 during this period, with their share of total deals doubling from 4% in 2007 to 8% in 2016. Further, the number of these deals exited rose from 96 in 2007 to 186 in 2016. However, the success of an investment in software companies seems to depend on a few key factors; specifically expertise.
An analysis conducted by BCG found that a firm’s expertise in software deals makes an enormous difference in the size of the investment’s returns. In the sample they studied, “investors who had made at least 10 software deals out performed the median IRR of other industries (excluding high tech) by 15 percentage points.” Investors dubbed experienced, whose software deals made up at least 20% of their deals, not necessarily 10 or more, outperformed by 20 percentage points. All other investors only outperformed by 2 percentage points. As we can see, the experience investors held, specifically in software deals, is highly correlated to the magnitude of return on investment. This analysis proves expertise among a firm’s investors in software deals specifically contributes to the success of their investments.
With expertise comes the ability to apply unique value creation levers to generate these returns. Experienced investors apply any combination of industry-agnostic and software-specific value creation levers that can range in focus from strategic acquisitions to the optimization of operational processes. These levers are often categorized in terms of their impact on the valuation multiple, revenues, profit margins, and leverage. Software-specific value creation levers that affect the valuation multiple include sales and pricing initiatives that enhance the maintenance attach rate, Cloud/SaaS transformation that implements a subscription model, and productization. Industry-agnostic value creation levers that affect the top line include sales excellence, enhanced products and new products. Product innovation and product extension are the main ways to implement the enhanced and new product lever.
Recently, PE firm Thoma Bravo raised $12.6B in funding for a slew of Enterprise Software acquisitions. Thoma Bravo is a well experienced firm having invested in over 200 software and technology acquisitions valued at $57B since its inception. Per BCG’s analysis, Thoma Bravo is well positioned to make returns above 20% for each acquisition because of their strong expertise in Software investments. Thoma Bravo asserts that its new fund is the largest pool of capital raised to invest in enterprise software companies. In all, Thoma Bravo Fund XIII further demonstrates PE interest in, and growing influence across, traditional and cloud software.