Economics of a Software-Focused Private Equity Strategy

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?