It’s well known that software is one of the hottest sectors for M&A. The middle market, where West Monroe primarily advises, makes up the highest proportion of deal flow this decade, and we don’t expect that to slow down anytime soon. We’ll likely continue to see high valuations and multiples for software businesses in 2019 and expect competition to remain high among private equity and strategic buyers.
As deal activity continues in 2019, we expect four trends to remain prevalent for software buyers and sellers.
We continue to see services businesses across industry segments acquiring software businesses with a recurring revenue model, especially in the middle market. Where companies can acquire digital and SaaS-oriented capabilities that serve a similar customer base or enable cross-sell opportunities, they can quickly boost EBITDA margins and uncover opportunities to expand market share much faster than they can through organic growth.
As many software companies are working through or planning a next-gen product, buyers should understand the transformational changes to a company’s product (and the associated costs/benefits) prior to an acquisition. Next-gen solutions are not always the right path; more build vs. buy analyses need to be completed than are happening right now. (Here’s our recent viewpoint on next-gen platforms.) Even if a next-gen platform isn’t necessary, add-on acquisitions require a capable product management function to be able to build new strategies and adjust to new product offerings.
Buyers are placing an increasing emphasis on the quality of a company’s technology leadership and their associated vision and roadmap to seek increased assurance about the future of the platform. Poor leaders result in underperforming teams; if the right leaders aren’t in place, the company will be hamstrung until they can be replaced. This goes hand-in-hand with finding leaders who can drive operational efficiency as products and platforms are being consolidated and integrated as a result of acquisitions and new product launches.
Operationally, we’re seeing more deliberate attention being paid to sell-side readiness to help sellers tell a more compelling story about customer stickiness, growth opportunities, and capabilities to scale. Given the continued maturation of the software space, sellers are now becoming savvier in how they present their business to potential buyers; this preparation can help speed up the deal making process and help sellers better position the risks that underpin their platforms. For example, if a seller can proactively identify security deficiencies or technical debt and create a roadmap that demonstrates a plan to address those issues, buyers are usually more comfortable and can more quickly validate the associated risks and required remediation steps.
Is software a growing part of your portfolio? Are you satisfied with the diligence of your software acquisitions? How are you retaining or attracting new tech leadership to drive value from software acquisitions? West Monroe’s software experts are here to discuss strategy with you.