How Private Equity is Winning in Software

March 22, 2022

State of the Market

Private equity blew the doors off in 2021 as trillions in pandemic-related stimulus produced a historic surge in dealmaking and exits. Non-buyout private investing categories like growth equity and venture also saw huge increases in activity.  

Source:  Bain & Company’s Global Private Equity Report 2022

Growth Equity

Capital is flooding into growth equity and venture capital funds as investors seek exposure to technological change. A new breed of high-velocity competitor is responding by putting money to work at a frenzied pace. Buyout funds are getting in the game—but winning may require sharpened expertise and a new set of growth-related capabilities.The first thing to know about growth investing is that it has rapidly emerged as one of the most dynamic segments of the private equity industry. The second thing: It’s a high-velocity game with a different set of rules.

Source:  Bain & Company’s Global Private Equity Report 2022

While growth investing has always been a part of the private equity universe, it has largely stood off to one side. Buyout firms, limited by their mandates, have tended to leave growth companies and non-control deals to specialists or firms focused on Asia, where leveraged buyouts with majority stakes are far less common.But the disruptive power of digital technology has forced growth equity and late-stage venture capital to the fore over the past few years, and fast-moving investors with innovative new business models have joined the battle to control this burgeoning market. The numbers are striking. Growth and venture assets under management have expanded at about twice the rate of traditional buyout Assets Under Management (AUM) over the past 10 years and in 2021 comprised a full 82% of the traditional buyout total.

Software Investing

Software investors continue to ride the extraordinary wave of technological transformation that is sweeping the global economy. They are also paying extraordinary asset prices that reflect the widespread belief that growth is still in its early stages.  That’s a risk when the stakes are so high, but top-tier software specialists manage it with hyperfocus, flexible mandates, and the ability to create value through active ownership.

Source:  Bain & Company’s Global Private Equity Report 2022

The $284 billion in tech deals private equity investors closed in 2021 accounted for 25% of the total buyout value and 31% of the deal count during the year, comprising by far the largest share for any single sector. Software deals made up $256 billion, or 90% of the total tech value, with much of that activity involving public-to-private (P2P) transactions. Indeed, $105 billion, or 41% of the software total, involved buyouts of large, maturing public companies like Proofpoint and Cloudera that had lost some of their luster with retail investors despite continued growth prospects.

The valuation question

Unsurprisingly, the resulting competition for deals in the software sector has led to ever-higher multiples and regular speculation that valuations may be getting ahead of themselves (see Figure 4). Yet the performance of these investments has so far provided a firm rebuttal to the skeptics. While fast-growing technology companies are typically associated with higher risk, the mature or maturing enterprise software companies private equity has gravitated toward have actually turned out to be less risky and volatile than other investments.

Software buyout multiples have hit new heights as more capital floods the sector

A Bain & Company analysis of technology deals over the past decade shows that, while hurdle rates for software investments have been about the same as for other industries (a target internal rate of return of around 22% on average), software investments were more likely to outperform and by a wider margin. They were also less likely than buyouts in other sectors to lose money (see chart below).

Software and technology have outperformed other PE investments, with fewer write-offs and more than half of deals returning 2.5x or greater

Learn more about how PE firms are evolving their approach to investing in Software and SaaS and what that means to valuations here. It is worth a read.

The Global Private Equity Report is produced annually by Bain & Company.