VC-backed startups have tightened their belts and focused on profitability over the last couple of years due to the downturn. That shift has pleased VCs — but it’s also caught the eye of another type of investor: private equity.
PE firms upped their spending on venture-backed tech companies in the first half of 2024, data suggests, as startups have been looking more appetising for buyouts amid the dearth of IPO exits.
PE firms bought up VC-backed European tech companies worth a combined $2.3bn in the second quarter of this year, the highest quarter by deal value since Q2 2022, according to data provided to Sifted by PitchBook. It was also the second quarter in a row where deal value increased; back-to-back quarter growth hasn’t happened since 2021.
That said, deal count in the second quarter of 2024 was the lowest since late 2020 — indicating firms are spending more per deal on average, buying fewer but pricier assets.
Recent examples include London-based employee benefits platform Perkbox, which was acquired by Great Hill Partners for $164.4m in the first quarter of the year; LumApps, a French enterprise-software startup, was acquired by British PE firm BridgePoint for $650m in May this year.
What’s driving PE interest
Private equity investors have historically gone for a different type of company than VCs: more staid businesses focused on steady, rather than hyper, growth. VCs’ renewed interest in profitability and no longer focusing on growth at all costs has opened an avenue for private equity, thinks Raphael Grunschlag, managing director of technology at boutique investment bank William Blair (which advised on the recent LumApps deal).
“VCs are making sure their companies are maybe slowing growth a little bit and burning less. As they do that, the PE fund can look at that and say, ‘Oh, that company is starting to look like more my investment type’,” Grunschlag says.
Other exit options, like IPOs, are lacking. That makes selling to PE firms a more viable option for startups; more growth-focused PE firms are “finding more and more of those that are hitting our sweet spot coming out of VC firms,” Jonathan Wulkan, director at British PE firm Hg, tells Sifted.
It’s not a wholly new trend. Grunschlag argues PE firms have “always” been interested, but that companies have largely been too immature in terms of scale and organisation, with a growth-at-all-costs mentality, to be attractive; bankers and investors tell Sifted they’ve noticed more interest in the last year or two.
“I’ve talked to some of the big private equity firms, and they said there’s been a dramatic increase in inbound [from] scaled, venture-backed companies looking to talk to them,” Michael Brown, general partner at Battery Ventures, which sold its company AuditBoard to Hg earlier this year, tells Sifted. “This is anecdotal, but I heard it more than once.”
Companies need to be at break-even or profitable to intrigue PEs. Some firms are looking “right around that sort of 25% to 50% [growth] range — that’s usually a range that we found can be compounded sustainably while also driving cash flow,” says Wulkan.
Grunschlag says the Rule of 40 — a metric which says a software business’s revenue growth rate and profit margin combined should equal or exceed 40% — still holds true in the buyout space. Generally, he says private equity firms are looking at companies with higher than 15% revenue growth year over year.
Valuation-wise, companies ripe for a buyout are still commanding strong multiples. Grunschlag says that for companies evaluated on an ARR multiple, he’s seeing 6x to 8x, or occasionally 10x. That would mean a company making $5m in ARR would be valued at $50m. And deals are competitive, he says.
VCs desperate for liquidity
It’s no secret that venture firms’ LPs (their investors) are impatiently tapping their feet, waiting for VCs to return some money to them. Sifted reported late last year that 56% of European VCs hadn’t returned capital to their LPs in the 12 months to November. That’s made VCs a more eager counterparty in PE acquisitions, bankers and investors say.
If VCs can get instant liquidity with a PE buyer — at competitive prices along the lines of an IPO or strategic sale — that’s made it a more attractive option, says Brown.
Private equity firms have long had relationships with VCs, but recently “there’s just been more of an overlap on the Venn diagram between the companies that we like — so, profitable, growing really fast, but not hyper growth, clear leaders — and the willingness to transact,” Wulkan says. That’s “probably the biggest thing that’s changed,” he adds.
Hg’s Wulkan says that his firm is evaluating a couple of deals right now, one of which is in France, and predicts we’ll “see more of this in Europe.”
Diversified interests
Mike Turner, a lawyer at Latham and Watkins, says he doesn’t think the number of VC-backed companies acquired by PE firms has gone up, but that the range of tech companies they’re willing to consider is widening.
“Recurring revenue enterprise software businesses have long been favoured by the PE world,” says Turner. “But more recently we have seen interest in many direct to consumer businesses as well: in brands, travel, wellness/healthcare and video games for example.”
It’s driven by PE firms looking to diversify their portfolios, Turner says, and coincides with the growth of the tech sector in Europe. Plus, “the visibility that the PE sponsors now have on successful exits (IPOs and M&A) coming from across the range of technology businesses.”
Bankers like Grunschlag say he’s seeing the most interest in vertical integration software and AI.
Take-privates
As well as buying up private startups, there have been several recent “take-privates” — where PE firms buy listed companies, taking them off the stock exchange.
Darktrace, a British cybersecurity company and part of a cohort of startups that popped up in the mid-2010s, was acquired by US PE firm Thoma Bravo for $5.3bn in April. Earlier this month, a consortium of investors led by EQT agreed to take private Irish video games company Keywords Studios for £2.2bn.
“This is probably more about opportunistic behaviour, where PE sponsors believe there to be assets which are undervalued on the public markets,” says Turner. The European market has been particularly active for this, Turner says, because valuations of the continent’s exchanges tend to be “markedly lower” than places like the NASDAQ.
Read the orginal article: https://sifted.eu/articles/private-equity-acquisitions-vc-startups/
