Outside of highly targeted or opportunistic investment interests, the technology and solution areas for procurement and finance have only garnered significant attention within the private equity community in recent years. But in less than half a decade, these firms have become a staple in M&A in the sector. And not only has private equity driven the acquisition and buyouts of many of the largest companies in the sector, but it has also been a source of growth capital investments as well (albeit not as frequently). In recent years, just about every process above a certain size — including numerous providers eventually picked up by strategic buyers — involved one or more private equity firms at some stage.
I spend a good portion of my time leading Spend Matters’ effort to provide strategy and due diligence support to these firms, and in recent weeks, I have been in touch with over a dozen colleagues in the industry. Today, in Part 2, we turn our attention to this segment of the market, examining the COVID-19 situation on the private equity markets, in particular, as it pertains to M&A and buyouts.
This Spend Matters Nexus series, including today’s column, is open to everyone during the coronavirus crisis. It provides insight and analysis about what is happening with procurement and finance technology investing — as well as what we can expect in the months to come, as we emerge from the coronavirus disruption.
If you’re looking for a baseline of information on M&A in these markets at the moment, read Part 1 of this series: The Impact of COVID-19 on M&A and Procurement Technology Investing (Part 1: Introduction).
Current State: The ‘We Are Here Dot’
There are a wide variety of firms which, prior to COVID-19, had become interested in the procurement and finance technology sector. This includes:
- Buyout-centric firms that have always specialized in acquiring technology companies (sometimes with a history of owning assets in these areas). Most of these firms bring a history of applying leverage to deals.
- Firms that have more recently built funds, teams and practices to invest in technology (including procurement and finance buyouts). As above, most of these firms bring a history of applying leverage to deals.
- Other private equity investing styles that have emerged in the sector in recent years within the sector, including growth capital and minority investing models (providing competition/overlap with traditional venture funds as well as strategic investors in these asset classes).
Regardless of the orientation of a particular firm or even a fund within it, many share commonalities:
- Nearly all are sitting on hundreds of millions (or even billions) of “dry powder” to invest in firms (even if their near-term appetite is not as strong as it was just a few months ago)
- The debt markets — often a primary source of deal funding — remain a stubborn challenge well into April 2020 (they began to get frosty in late February).
- Day-to-day activities have been turned upside down by the coronavirus crisis.
To this last point, on the surface, a familiar scene is being painted inside many funds. “Triage” is perhaps the operative word, as priorities shifted during March. This included many deal teams shifting their efforts from preparing for and analyzing new opportunities to understanding exposure and minimizing downside risk in existing portfolio companies.
But this is not true across the board, and there are even exceptions in certain firms. A number of firms we have spoken to are still preparing for processes, albeit at a slower rate, than usual. Still, some are taking the time to do significant research to get out in front of planned efforts (as well as to take advantage of proactive or opportunistic situations).
Fortunately, the tech overall, and procurement and finance solutions generally, has been spared some of the challenges of other sectors, based on typically multi-year deals and recurring, SaaS-based revenue models. Even high debt loads in certain deals may be offset by recurring revenues. However, credit risk and delayed payments (and/or new terms) that could impact working capital/cash flow can still have an impact on private-equity-backed companies, especially in highly leveraged investments.
This is less of a near-term factor in growth equity investments, however.
Deal Flow and Leverage — The Lifeblood of Most Funds is Taking a Pause
Perhaps the most common challenge we’ve heard, echoed from many colleagues in the industry, is that sellers are putting processes on ice, at least temporarily. Deal flow and managing the funnel of activity really is the lifeblood of deal teams under normal operating conditions. Most frequently, the majority of private equity transactions in the procurement and finance technology sectors are based on deals initiated by sellers (even in cases where a well-positioned firm has maneuvered its way to exclusivity early in a process). Hence, if seller-driven interest is pushed out, there’s simply not as much to be done.
The other challenge, which I’ve hinted at previously in this analysis, is the challenge of putting leverage on deals. Most deals have over 50% leverage applied in this sector (e.g., in this case, a firm only must put up 50 cents on the dollar to fund the transaction, and that’s just a starting point) and often significantly more. Leverage is provided by speciality lenders, including specialized funds. This funding has become scarce in the past month.
Despite the current challenges, opportunity beckons in the procurement and finance technology sectors. There are numerous types of transactions we see strong potential for happening in 2020.
These include growth capital deals (likely at terms more favorable to investors than before), as well as PIPE and take-private opportunities. In addition, the number of tuck-in opportunities, likely at more favorable terms than the past, should also be a contributor to deal flow in the next 12 months. More traditional-type deals are likely to make a comeback as well, perhaps sooner than many think (especially by firms that are more proactive vs. reactive in their investment approach).
But what will it take for the markets to really reopen again?
Reopening the Floodgates … a Checklist
Here’s my checklist for the private equity markets to reopen in earnest in our sector.
These are roughly in order of importance:
- Resumption of processes that have been delayed (owing to uncertainty or valuations)
- Debt providers/lenders getting off the sidelines
- Situational opportunities presenting themselves on a more frequent basis
- The “new normal” amid COVID-19 (and during the recovery from it) leading to new investment themes and hypotheses (e.g., risk mitigation, payments/financing, etc.)
- “Signaling deals” generate momentum that in turn create a flywheel effect. As an example, I’m keeping my eyes on one “solutions-type deal” to push its process ahead (it’s not exactly tech). Given the material EBITDA associated with this provider (at least prior to COVID-19), it’s a solid bellwether to see if the sector can get back on track (based on maximizing the potential pool of buyers interested in the asset).
Of course, in terms of getting things back to normal, we also can’t ignore the importance of London, New York and the West Coast at least partially reopening for business in terms of face-to-face meetings.
Lastly, inside some firms, there could also be an “enough is enough” moment, as strategic buyers, which are at an advantage for the time being, take advantage of opportunities consistently at the expense of financial buyers.
It’s All About Timing
Our conversations and research would suggest that in the next few weeks it is more likely than not that we will see a gradual resumption of activity and transactions, rather than a finger-snap return to the market of Q4 2019 and early Q1 2020.
What’s our gut on timing? We reckon that as Q2 2020 progresses, that we’ll see a gradual resumption of more and more activities, especially toward the end of the quarter. Based on where we sit, some of it is starting already, albeit not enough to call a trend just yet.
Jason Busch is Managing Partner of Azul Partners’ Investor Advisory Group. He works with sponsors, CEOs and boards on data-driven due diligence, M&A and strategy. Jason is also the lead author of Spend Matters Nexus, a private newsletter and subscription service.