A few weeks ago I had the chance to spend time with a general partner from a large private equity firm. This particular partner was focused on software companies in the middle market. Naturally, I wanted to learn how the model works, so I drilled in.
Here’s the general idea:
- Buy the majority of a “platform” software company with modest growth for 10x EBITDA (e.g. find a software company with $40 million in revenue generating $10 million/year in EBITDA and purchase 70% of it for $70 million)
- Spend 3-4 years helping the platform company acquire 5-10 smaller, complementary software companies for 5x EBITDA (sub-scale companies sell for a much lower multiple e.g. a $5 million software company doing $1 million in EBITDA might sell for $5 million)
- Build up the company to $30 – $40 million/year in EBITDA and sell it for 10x EBITDA (likely to another private equity firm)
Pretty interesting. This makes sense and is a standard roll up strategy, only applied to software companies. The next time you read about a private equity firm buying a software company with modest growth, there’s a good chance this is the strategy.
What else? What are some more thoughts on the economics of a software-focused private equity strategy?
David Cummings on Startups 
We represent small software companies looking to be acquired. On occasion we take on a client that has a compelling technology but little to speak of in terms of market penetration or revenue. We often are able to get interest from strategics who recognize the company fit, the buy versus build advantage, and the time to market advantage. We have generally gotten stiff armed by PEG’s that have a platform company that could be comparable to a strategic buyer. Any thoughts on how to get the PEG to abandon their minimum EBITDA gate and view the technology strategically?