With the credit markets seemingly in a state of turmoil, some say the “boom” days of buyouts will be replaced by “gloom and doom.” Multi-billion dollar deals like HCA, First Data, Sungard and Affiliated Computer Systems may be a thing of the past - or at least until "Summer of 2007" is well in the rear view mirror of aggressive lenders - as debt financing terms, if available at all, are anchored with higher interest payments and potentially onerous restrictive covenants (remember those?!). Simply put, those IRR models being run by the junior staff at large PE firms aren't showing eye popping returns like the ones that have been prevalent for a few years. But, opportunities are still very rich for the middle market. There is still a ton of equity capital that needs to be invested, with or without the "juice" that comes from the layers of debt above it on the balance sheet. Even in those cases where leverage is prudent and available on attractive terms, it doesn't necessarily imply a huge valuation anymore. According to a senior Partner at Insight Venture Partners, one of the most active IT/Software focused PE firms, "There is no doubt that deals will continue to get done for growing, profitable businesses, but the valuation spread should narrow between leveraged majority and traditional minority growth equity deals." According to a recent article in The Economist, Private Equity Intelligence estimates that private equity funds raised $240 billion in the first half of this year. Many of the more active players in mid-market technology buyouts are, in fact, traditional VCs or "growth equity" shops that simply were intelligent, nimble and aggressive enough to adjust their investment approach to take advantage of frothy credit markets, the likes of which were never available to them in the past. After all, in the past, "lending to a software company (was) like lending to air" as one senior credit committee office at a very large commercial bank put it. Firms such as Insight Venture Partners, Battery Ventures, JMI Equity, HIG Ventures, Bessemer Venture Partners, Polaris Venture Partners - note the term "V-E-N-T-U-R-E" in many of their names - and dozens of others have very large funds that need to be invested on behalf of L.P.s. The financial engineering strategies that have driven recent investments in more mature companies with stable cash flow will give way to renewed focus on equity investments in growth stage companies with attractively accelerating top line revenues. Because so much equity capital needs to be put to work, we predict that larger equity checks will continue to be written and therefore larger, often majority, ownership positions will be held. If the right combination of management team/product/market opportunity is found, why not invest twice as much capital and own twice as much of the company and sit on one fewer board? With the size of the funds we are talking about, there is still ample opportunity for portfolio diversification. This is very good news for many technology companies that may be seeking growth and/or founder liquidity capital that have differentiated products and services in large and growing markets, but not necessarily a ton of cash flow from longstanding maintenance streams and services engagements. Note that many of the tech buyouts were done with companies growing 5% to 10% annually in more mature markets but with predictable, recurring cash flow used to service and pay down debt. Don't get me wrong, profitability and cash flow are in demand, but not necessarily so that a pile of debt can be raised. In the absence of overly aggressive lenders, these VC/PE-cum-buyout firms will look to "juice" their returns "the old fashioned way"….by rolling up their sleeves and helping innovative companies and strong management teams establish and execute on aggressive top line growth strategies. This, after all, is what they do best. |
