Middle Market Software Private Equity Opportunities and Trends

The middle market software private equity space is a rapidly growing segment, with deal volume increasing by 15% in 2020 alone. This growth is driven by the increasing demand for software solutions in various industries.

Middle market software companies are typically valued between $100 million and $1 billion, offering a sweet spot for private equity investors looking to make a meaningful investment. These companies often have a strong track record of growth and profitability.

Private equity firms are increasingly targeting middle market software companies with a strong presence in the cloud, artificial intelligence, and cybersecurity spaces. This is because these areas are expected to experience significant growth in the coming years.

Investors are also looking for companies with a strong customer base and a proven ability to scale, which is why companies with a strong sales and marketing strategy are in high demand.

Middle market software private equity firms typically invest in companies with enterprise values between $10 million and $1 billion. They often target software companies with strong growth potential and a proven track record of success.

These firms usually acquire a majority stake in the company, taking control of its operations and strategy.

Middle market software private equity firms typically have a hands-off approach, allowing the existing management team to continue running the company.

They focus on providing strategic guidance and resources to help the company scale and achieve its growth objectives.

Middle market software private equity firms often have a strong network of industry experts and advisors who help identify and acquire new investment opportunities.

They typically hold onto their investments for 5-7 years, with the goal of exiting through a sale or IPO.

Accel-KKR is a top 10 private equity investment firm based in Menlo Park, California, targeting mid-market software and tech-enabled companies.

Accel-KKR has made 420 total investments over time and currently has $19.11B in AUM across an active portfolio of 66 firms with a median valuation of $73.47M.

Other notable middle market private equity firms include Audax, Genstar, American Securities, Madison Dearborn Partners, Court Square, and HIG, among others.

These firms often invest in software and technology-enabled businesses, focusing on adding value through expansion initiatives and collaborative efforts.

Accel-KKR invests in software companies, including those in tax compliance, enterprise labeling and artwork management, and ERP solutions.

Here are some key characteristics of middle market software private equity firms:

Note that some firms, like Main Capital Partners, focus on specific software verticals, while others, like Accel-KKR, have a broader focus.

Middle market software private equity offers a unique set of benefits and opportunities for investors. One of the main advantages is the potential for higher returns, with median net IRRs for US mid-market funds coming in at 13.5% since 2000, compared to 12.7% for large buyouts.

Private equity firms can also benefit from the agility and innovation of mid-market companies, which tend to perform well even in market downturns. In fact, middle market deals only dropped by 19% in 2022 compared to large cap deals, which dropped as low as 40% by volume.

The mid-market segment offers more room for growth, both operationally and in scale, making it an attractive investment opportunity. This is because smaller, mid-market companies are typically less mature than large cap targets, providing more scope for incoming private equity investors to strengthen and supplement management teams.

Working in middle market private equity can be a great career choice for those looking for a balance between autonomy and advancement opportunities. You'll have more responsibility on deals and with portfolio companies, and you'll get to think about each deal in more depth.

You can expect to work fewer hours than at an investment bank or a large private equity firm, with an average week of 60-70 hours. This can be a welcome change for those who value a better work-life balance.

Advancement opportunities are also more accessible in middle market private equity, especially to mid-level positions. There are fewer people aiming for the top, making it easier to move up the career ladder.

Here are some key benefits of working in middle market private equity:

Investing in the middle market offers several advantages, including high potential for returns. Mid-market companies are agile and innovative, creating vast opportunities for growth and expansion.

Most mid-market companies perform well even in market downturns, making it more likely for investors to achieve higher returns than expected. In 2022, middle market deals only dropped by 19%, compared to large cap deals which dropped as low as 40% by volume.

Private equity firms can compound their long-term returns by investing in several high-performing companies within a fast-growing segment of the middle market. This strategy allows them to spread their capital across multiple ventures and scale them for fast growth and expansion.

Diversifying a private equity portfolio is easier with smaller mid-market deals, which require lower capital requirements. This enables funds to distribute their capital across multiple promising ventures, spreading the risk and protecting the investor's capital from significant losses.

Investments in the middle market typically have more room to grow both operationally and in scale. Smaller mid-market companies are less mature than large cap targets, providing more scope for private equity investors to strengthen and supplement management teams, improve financial controls, and add new product lines.

The cost of professionalizing a mid-market business is lower, as the costs are applied against a smaller base of operations. This makes it easier for private equity firms to drive up earnings growth through operational improvement.

Mid-market companies present inorganic growth potential, with private equity firms able to provide capital and M&A execution expertise to support market consolidation and buy-and-build strategies. This greater room for manoeuvre has led to mid-market buyout funds outperforming larger institutions since 2000, with median net IRRs of 13.5% compared to 12.7% for large buyouts.

The investment process in middle market software private equity involves fast decision-making, often with competing investors vying for the same opportunity.

Companies need the right data to make quick decisions, and technology tools can help private equity firms make decisions much faster. Fund managers can keep track of potential investors and maintain open communication to prevent deals from falling through.

In this competitive landscape, technology-driven solutions are crucial for driving success in middle market software private equity, whether it's buyouts, growth equity, private credit, or distressed debt investing.

The private equity investment process is a complex and multi-step journey that involves several key stages. Broadly speaking, it involves deal sourcing, due diligence, deal structuring, and active management.

Deal sourcing is a crucial part of the process, as it involves finding the right opportunities to invest in. This can take a significant time investment for private equity investors to find lucrative companies whose assets are likely to grow quickly and multiply in value.

Private equity investors compete with several other investors who are also interested in the same opportunity, making fast decisions a necessity. Technology-driven solutions such as business intelligence, investment research, and pipeline management can help these firms make decisions much faster.

The entire private equity deal lifecycle requires fast decisions on the investor side, meaning companies need the right data to make these decisions quickly. Fund managers can keep track of all potential investors and keep the lines of communication open to prevent deals from falling through mid-cycle.

Upon determining that a private equity investment makes sense, fund managers can then structure the deal to include terms such as the purchase price of the asset or company, how many shares are being sold to the firm, the closing date of the deal, and asset ownership and transfers.

Here are some key deal structuring terms to consider:

Active management is also a critical part of the private equity investment process, especially for companies acquired in the lower and core middle-market segments. Companies in these segments are easier to actively manage following a private equity deal, opening possibilities for firms to add value to their assets.

Valuation is a crucial step in the investment process, and it's not as straightforward as it seems.

Private companies don't publicly report their financials, so investors have to dig deeper to get the information they need.

Using comparable company analysis (CCA), investors can research companies in similar industries to get a sense of the private company's valuation.

Private equity firms can analyze the comparable market share across several companies to determine a private company's valuation.

Public companies are a breeze to value, as you can simply multiply the stock price by the existing shares.

They often work with software companies that have annual revenues between $25 million and $500 million.

These firms typically have a team of experienced professionals who work together to identify and acquire promising software companies.

Their days are filled with researching potential investments, analyzing financial data, and meeting with entrepreneurs and executives.

Middle market software private equity firms often focus on companies with strong growth potential and a clear path to profitability.

They may also work with companies that have a unique value proposition or a competitive advantage in their market.

Their goal is to help these companies scale and achieve their full potential.

In some cases, they may also provide strategic guidance and operational support to portfolio companies.

This can include helping companies improve their sales and marketing efforts, or implementing new technologies to increase efficiency.

Middle market software private equity has seen significant growth in recent years, with deal values increasing by 15% annually from 2015 to 2020.

The majority of these deals are strategic, with 75% of buyers being existing software companies looking to expand their portfolios.

A key trend in middle market software private equity is the increasing focus on software as a service (SaaS) companies, which now account for 60% of all deals in the space.

These companies are attractive to investors due to their predictable and recurring revenue streams.

The digital revolution is transforming various sectors, including the Education Software sector, which has seen significant changes over the last two decades.

Many industries are undergoing transformations, with Field Service Management (FSM) being essential for sectors like Utilities, Telecommunications, and Healthcare.

The most active buyers in the software industry are often seeking strategic partnerships to support further growth, which is crucial for software company founders considering an exit.

The Education Software sector is aggressively pursuing digital solutions, with America's school systems driving this transformation over the last two decades.

FSM is also vital for industries like Construction, Manufacturing & Equipment, Oil & Gas, and Facility Management, among others.

The exit outlook for private equity is looking incredibly bright. For more than two years, investors have been waiting patiently for a rebound in portfolio distributions.

Everything is lining up for a reality check, and it's finally happening. This is a major turning point for private equity investors who have been holding on to their investments, waiting for the right moment to cash out.

The wait is almost over, and investors are about to see a significant return on their investments. The exit outlook is the brightest it's been in years, and it's a great time to be a private equity investor.

Cultivating Relationships with Top Firms is Key to a Successful Sale.

Many middle market private equity firms, such as Audax, Genstar, and American Securities, are known for their expertise in the middle market, particularly in software.

Building relationships with these firms can be beneficial for SaaS founders and executives looking for a majority investment or strategic sale.

It's essential to exercise caution when disclosing details about your company, as oversharing can potentially hinder your chances of a successful sale.

Some top private equity firms, like Madison Dearborn Partners and HIG, are known for their astuteness in uncovering information.

Seeking guidance from an experienced sell-side advisor is prudent if you have received an inbound offer or are already in discussions with a top private equity firm.

Middle market private equity firms like Stone Point Capital and New Mountain Capital often participate in the middle market, which can be a good starting point for building relationships.

Middle market private equity firms are a crucial part of the software industry's growth and development.

In the US, some notable middle market private equity firms include Audax, Genstar, American Securities, and Madison Dearborn Partners.

These firms have a significant presence in the market, with a large number of deals and portfolio companies under their belt.

Some of these firms, like Audax and Genstar, have a strong track record of investing in software companies.

However, it's worth noting that the definition of "top" middle market private equity firms can be subjective, depending on how one measures success.

AUM, average annualized returns, and number of deals or portfolio companies are all valid metrics for evaluating these firms.

But, as the article points out, some firms like Summit, General Atlantic, and TA Associates might be too large to qualify as "middle market" private equity firms.

They are often categorized as growth equity firms instead.

In any case, cultivating relationships with top private equity firms is key to a successful sale, especially for SaaS founders and executives.