The Growth in Add-on Acquisitions is Driving Mid-Market Software M&A
A prevalent strategy within private equity is add-on acquisitions – the practice of acquiring smaller companies via a larger existing portfolio company (referred to as the platform) in order to bolster the scale financial profile of the platform company. Add-on acquisitions are especially common for software-focused private equity investors due to it being a major avenue for portfolio companies to acquire new products, features, and customers in often fragmented verticals within software.
Capital Invested and Number of Software Add-ons
Despite add-on acquisitions being a common strategy for software-focused private equity, an insignificant amount of capital was invested into add-ons during the early to mid-2010s. This began to change in the late 2010s when the amount of capital invested annually started to far exceed the previous celling of ~US$2.0bn. A likely reason for this is that as tech valuations continued to climb through the latter half of the decade, competition for platform investments did so as well which caused mainly investors to start looking at smaller acquisition targets in add-ons to drive value creation for existing platform investments. An interesting observation is that dollars invested for add-on acquisitions this year so far have surpassed those for platform investments for the first time. Although quite surprising, this is consistent with what we have witnessed in the market with many private equity investors becoming hesitant to pursue new opportunities earlier in the year due to COVID and instead choosing to focus on existing portfolio companies as well as pursuing add-ons for those platform investments.
Software PE Capital Invested (US$bn)
Source: Pitchbook.
Although dollars invested in add-on acquisitions have not been very significant until recently, the number of add-on acquisitions have always been high relative to platform investments. The gap has only widened in recent years, with add-on acquisitions representing over 2x the number of platform investments in 2017 through 2020. This coincides with the fact that dollars invested in add-ons has risen over the same period, indicating that capital is being deployed across an increasing number of transactions.
Number of Software PE Deals
Source: Pitchbook.
Software Platform Investments vs. Add-on Acquisitions Median Revenue Multiples
One of the most interesting trends when comparing platform investments against add-on acquisitions are the valuation multiples paid in those transactions. As expected, the multiples paid for platform investments generally exceed those paid for add-on acquisitions. However, multiples for add-on acquisitions have been on the rise, narrowing the gap between them and platform investments over the past few years. This is consistent with the observation that as competition continues to pour over from platform investments to add-ons, the multiples for add-on acquisitions will be bid up. That being said, the multiples for both platform investments as well as add-on acquisitions have experienced a drop during this current year due to the impact of the pandemic on valuations overall.
Software PE Revenue Multiples
Source: Pitchbook.
Future Implications
It can be expected that add-on acquisitions will continue to be a predominant strategy for software-focused private equity going forward given the continued competition for attractive platform investments. Additionally, the fragmentation that exists in the many sub-verticals within the broader software sector presents an abundance of smaller companies that make good add-on targets for funds that are pursuing a roll-up strategy. Add-on acquisitions are also necessary for private equity investors to help “lower” the overall multiple paid for a platform investment by reducing the aggregate multiple of the combined entity as lofty valuations continue to be paid for those platform investments. However, competition and valuations for add-on acquisitions will likely continue to grow as well with the more dollars that are funneled into the strategy.
Written by Sampford’s Allen Fu.
About Sampford Advisors
Sampford Advisors is a boutique investment bank exclusively focused on mid-market mergers and acquisitions (M&A) for technology, media and telecom (TMT) companies. We have offices in Toronto, ON, Ottawa, ON, and Austin, TX and have done more Canadian mid-market tech M&A transactions than any other adviser.