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Investment in Tech Startups: Diversion for Private Equity Firms?

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Dec. 28 2016, Published 4:56 p.m. ET

Private equity firms sought revenue growth in 2016

Earlier in this series, we discussed why PE (private equity) firms are interested in the technology space and how these firms have not shied from resorting to unconventional lending resources to fuel their M&A (mergers and acquisitions).

Marketo, despite a 40% rise in revenue, posted a $69 million loss in 2015. It was acquired by Vista Equity Partners, a PE firm, in 2016. This is surprising as PE firms are usually keen on a company’s operating cash flow and prospects.

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As the above chart by Bloomberg shows, the technology companies acquired by PE firms had decent revenue growth with minimal-to-negative profits. Cvent, a SaaS (software-as-a-service) company, and Marketo, a marketing automation software company, were acquired by Vista Equity Partners. Epiq, a legal technology provider, was acquired by OMERS Private Equity in July 2016.

Tech buyout strategy to generate a substantial return

It is apparent that PE firms are keen on software companies that have revenue dominated by subscription revenue, as it leads to more predictable recurring revenue. If these companies continue to grow ~20% annually, they are likely to double in size in a little over four years. PE firms are acquiring them with the vision that if they can achieve or maintain those levels, multiples will improve along with investors’ willingness to pay.

PE firms are also keen to latch onto opportunities with technology companies facing issues, find synergy among to, and generate a considerable return. Elliott Management applied the same strategy with Symantec and LifeLock.

In February 2016, Elliott Management took on a substantial stake in Symantec (SYMC). It then pushed Symantec to “explore its options” and made it acquire Blue Coat Systems and LifeLock. Elliott Management had a stake in both Blue Coat Systems and LifeLock. To learn more, read Was LifeLock’s Sale Profitable for Elliott Management?

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