PE investments into software startups benefit from tech experience

13 June 2017 Consultancy.uk

The rise of software startups is creating considerable opportunities for the Private Equity (PE) industry, finds a new report. PE firms are well positioned in terms of experience to take advantage of the bonanza, with an expected boom of more than 900 software startups between 2017 and 2021 presenting investors with experience in technology the opportunity to improve internal rates of return by up to 20%.

The venture capital market has, over the past decade, increasingly focused on supporting startups in the software and technology segment. Total venture capital investments hit $127 billion last year, at around 50% of money in play being relating to software development. In the same period the private equity market has exploded, with buyouts last year hitting $257 billion and exits generating $328 billion for the market as a whole.

In a new report from The Boston Consulting Group (BCG), titled ‘Cracking the Code in Private Equity Software Deal’, the consulting firm considers the current activity of PE firms in the software segment, as well as the wider context in which deal activity is taking place. The research from the firm, which was performed by BCG and the HHL Leipzig Graduate School of Management, included data from more than 1,800 deals entered into between 1997 and 2010, as well as the exit results related to 27 of the exists from software companies between 1998 and 2012.

PE firms are doing more software deals

The number of PE deals in the software segment has increased over the past two decades. The industry saw around 1% of deals in the segment in 1997, grow to 4% ten years later. Since 2012, deal activity hovered at around 6% before, in the most recent analysis hitting 8% of total deals.

The growth in total deal volume, up from around 5,600 in 2007 to 6,200 last year, and the increase in software as a share of total deals, has seen the total number of software deals increase from 228 to 441.

The study also included a breakdown of data from the past two decades. This aspect of the research shows that corporate divesture has decreased considerably, from 33% in 1997 to 13% in 2016, while the number of private companies snapped up too has decreased in the years since 2007, from 66% of total to 46% last year. Venture capitalists as a source of investment for software companies have more than doubled meanwhile, climbing from 11% in 2007 to 23% last year.

Serial and experienced investors do nearly 50% of software deals

The firm also explored how the companies in its sample performed over the most PE holding period, finding growth averaged 7% while EV/EBITDA multiples were found to increase from 10 to 13, indicating that the portfolio companies tended to perform better.

While the average growth and performance increases were relatively stable overall, the firm notes that considerable differences between investor types was noted. The firm found that around 35% of PE investors in the total sample had performed one deal, of which, 52% were considered opportunistic investors, 6% serial investors in the segment, 14% serial experience investors in the segment and 28% experienced investors in the segment.

Serial and experience software investors outperform

Experience counts

The research found that the different investor classes were able to considerably improve their respective return on outcomes, while serial investors were able to outperform the industry median by 15%, and experienced investors were able to outperform the medial by 20%. Opportunistic investors by contrast only managed to outperform the median by 2%.

Exit through late-stage

VC buyout opportunities

PE firms that are well positioned in terms of experience in the market for software company buyouts are, according to BCG, able to benefit from the large number of venture capital backed software companies that are expected to hit the market over the coming years.

Late stage companies, while decreasing in number of the past two years, are expected to see increased buyout activity between 2017 and 2021, with, around 200 of the 900 startups going to market likely to be bought up by PE firms.

According to Nicolas Hunke, a BCG partner and a co-author of the report, “Serial and experienced investors typically apply a rigorous proprietary playbook to create value at software companies, addressing a distinct set of industry-agnostic and software-specific levers. Four software-specific value creation levers typically applied are sales and pricing initiatives, changing to a cloud-based software-as-a-service offering, productization, and state-of-the-art software engineering.”

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Private equity firms ramp up sustainability focus

19 April 2019 Consultancy.uk

In line with business leaders across the industrial gamut, private equity firms are increasingly on board with sustainability projects. According to a new study, the investment arms for major funds are implementing a number of strategies aimed at supporting sustainable economic development in line with global goals.

While the business world has finally begun to acknowledge the danger of climate change, effective action plans remain difficult to achieve. The Paris Agreement has stipulated a clear target for the decades leading up to 2100, although massively reducing emissions while not crashing the economy could be a tall order.

Businesses that are able to acquire capital can use it to boost productivity and output, thereby creating a virtuous cycle of development. However, some businesses are better able to utilise resources than others, both in terms of their relative productivity, as well as the value of the respective outcomes relative to costs (including environmental harms). Financing can therefore provide an avenue to select businesses that are aligned with various global sustainability goals, while shunning those that drive little or unsustainable social value creation.

Top moves made by investment arms towards responsible investment

Profit has for the longest time been the central criterion for investment decisions. Yet profit at any cost is increasingly seen as creating considerable social harms, while often delivering only marginal value. As a result, the private equity sector, which was initially sluggish to change its ways with regards to sustainability, has started to see the topic as an opportunity as much as a challenge.

A new study from PwC has explored how far sustainability goals have become part of the wider investment strategy for private equity (PE) firms. The report is based on analysis of a survey of 162 firms and includes responses from 145 general partners and 38 limited partners.

Maturing sustainability

Top-line results show that responsible investment has become an issue for 91% of respondents. For 81% of respondents, ESG (environmental, social, and corporate governance) was a board matter at least once a year, while 60% said that they already have implemented measures to address human rights issues. Two-thirds have identified and prioritised Sustainable Development goals that are relevant to their investment segments.

Change in concern and action on climate-related topics over time

While there is increasing concern around key issues, from human rights protections to environmental and biodiversity protection, the study finds there are mismatches between concern and action. For instance, concern among investment vehicles around climate change has increased since 2016.

In terms of risks to the PE firm itself, concern has increased from 46% of respondents in 2016 to 58% in the latest survey. However, the number who have taken action remains far below those concerned, at 9% in 2016 and 20% in 2019. Given the relatively broader scope of investment opportunities, portfolio companies face higher risks – and more concern – from PE professionals, at 83% in the latest survey. However, action is less than half of those concerned, at 31%.

Changing climate

In terms of the climate footprint of the portfolio companies, 77% of respondents state concern in the latest survey. 28% of respondents are taking action through the implementation of measures to mitigate their concerns.

Concern and action taken on ESG issues

In terms of the more pressing issues for emerging responsible investment or ESG issues, governance concern of portfolio companies comes in at number one (92% of respondents), while 60% have taken action on it. Firms have focused on improving awareness – setting up policies and a range of training modules for their professionals around responsible investment decision making. Cybersecurity takes the number two spot, with 89% concerned and 41% implementing strategies to mitigate risks.

Climate risks take the number three spot in terms of concern for portfolio companies (83%), but falls behind in terms of action (31%). Health and safety track records are a key concern at 80% of businesses, with 49% implementing action. Gender imbalance within PE firms themselves ranks at 78%, which is being dealt with by 31%. A recent survey from Oliver Wyman showed that there is gender balance at 13% of GP teams in developed countries.

Biodiversity is also an increasingly pertinent topic, with risks from pollution and chemical use increasingly driving wider systematic risks around environmental outcomes. It featured at number eight on the ranking of most likely global risks for the coming decade, with its impact at number six. As it stands, biodiversity is noted as an issue at 57% of firms, with 15% implementing action.