43 | Who's Buying Your Software Company? Strategic vs. Private Equity

When founders picture selling their company, they often focus on one thing: the price. But who sits on the other side of the table shapes far more than valuation. It changes how the deal gets structured, how fast it moves, what buyers dig into during diligence, and what life looks like after closing. In this episode, managing directors Mike Lyon and Jeff Bean discuss the different buyer types software founders are most likely to meet, how they think about value, and what founders should weigh before deciding who fits.

Vista Point Advisors is a boutique sell-side investment bank providing unconflicted M&A and capital raising advice to founder-led software, AI, and internet businesses. We partner with entrepreneurs of growing businesses to help them understand their options in the marketplace so they can maximize business value, leverage their options, and realize their ideal outcomes. 

Securities offered through Vista Point Advisors, member FINRA/SIPC. This has been provided for informational purposes only and should not be considered as investment advice or a recommendation. It is not intended to address all circumstances that might arise. The views expressed herein may change at any time subsequent to the date of issue. Opinions contained herein should not be interpreted as a guarantee of future results. Outcomes will vary depending on individual circumstances. Any examples used in this material are generic, hypothetical and for illustration purposes only. Testimonials from past clients may not be representative of the experience of other clients and there is no guarantee of future performance or success. Clients are not compensated for their comments. 

Transcript

The Path to Exit, Episode 43 

[00:00:19] Mike Lyon: Hello and welcome, everyone. I'm Mike Lyon, Founder and Managing Director at Vista Point Advisors, and this is The Path to Exit. This show is dedicated to helping founders of software, AI, and internet businesses understand what it takes to raise capital or sell their business and how to do it well. My guest today is Jeff Bean, Managing Director at Vista Point Advisors.

In this episode, we'll discuss the different likely buyer types in your transaction, from public strategic to standalone private equity firm and everything in between. Please enjoy my discussion with Jeff.

Jeff, sometimes founders think about a transaction they're doing, and they just think about it as a price and a transaction. They don't realize there's actually a lot of different elements to the buyer types they'll interact with, on everything from valuation to what life is like post-transaction. To get us started, can you just talk about the three main buyer types we see with private software company transactions?

[00:01:08] Jeff Bean: So the three types of buyers that we see are, on one spectrum, public strategic acquirers. Those are publicly listed companies trading on an index, largely here in the US, but maybe internationally as well.

On the other end of the spectrum would be a private equity or growth equity buyer, and they would be looking at a software company as a new platform investment.

And then the in-between land is the PE-backed strategic. Think of those as large private companies that could span from almost like-size up to billions of dollars in enterprise value. So there's a pretty big range of outcomes in terms of what that buyer looks like, but that's a private company that is funded by one of the larger PE funds out there.

[00:01:47] Mike Lyon: Yeah. Great way to bucket them. And I think, as Jeff said, to some degree the public strategics act somewhat similar to each other. There's obviously a range there, and the private equity firms kind of act similarly.

On the private equity-backed strategic, we almost think of it as a spectrum that touches both of those endpoints. So some of those private equity-backed strategics will act like a big public company, and some of them will act more like a standalone private equity firm, and you'll see all varieties in the middle. And so they're, in some ways, the trickiest one to analyze, because sometimes there's not a lot of information about them.

But the way we're going to structure this discussion is just to talk through a lot of the things you'll run up against in a transaction and how to think about these three different buckets of buyers.

So Jeff, the big question everyone has when they're looking at buyer types is valuation. Who's going to pay the most in a transaction? How does that work between these different buyer types?

[00:02:37] Jeff Bean: So it really depends. I would say in any one instance, whether it's a public strategic or a PE-backed strategic or a PE platform standalone deal, there are scenarios where they all would see valuation pretty similarly.

There are scenarios where a public strategic, or maybe a PE-backed strategic, would likely see synergy values in other aspects of the product and be able to price that in much more, and thus be more competitive on valuation. And then there are also scenarios where it's a high-growth business and, for whatever reason, the strategic acquirers within that category aren't really seeing the value as much, but you have these standalone growth equity funds or PE shops that do see that value and can price that in, and thus maybe a standalone transaction ends up being the highest valuation.

I'd say one of the most important aspects to valuation, particularly for whether it's a public strategic or a PE-backed strategic, is how is that business valued? So if that business is valued highly in the public markets, say a 10X multiple trading on the Nasdaq, they have a fair amount of flexibility in what they can pay. If that same business is trading at 3X in the public markets, they're not likely buying any asset for north of five, seven, or 10 times, because it's going to be diluted to their valuation. And the same holds true in the private markets. Where that private company got priced at by their PE funder really impacts what they can pay for businesses, and also where they expect the exit.

So those are the aspects of transactions that we're always evaluating in terms of the buyers list and who we're talking to. It shows up a lot more and is more obvious on the strategic side in terms of valuation. On the PE side, I'd say the biggest inputs to valuation are really the quality of the funds you're speaking with, and then all the inherent KPIs and dynamics that go into what makes a quality business and what prices accordingly.

[00:04:27] Mike Lyon: Yeah, great points. And I think one of the ways to think about it is, in any transaction, who could pay the most? It would likely be a public company strategic. So imagine a scenario where Google or Microsoft both had to have this asset. That would clearly get bid up a lot, and in theory they could pay the most.

In practice, it doesn't always happen that way. In fact, we see a lot of times a standalone private equity deal for a business that's somewhat disruptive and has really good KPIs trade actually higher, because they feel like there's ability to go disrupt the market. So there are different situations where each of these buyers can win. The public company strategic always has the ability to pay the most, but if you look at what's happened the last five years, that hasn't been the case, because they don't really have to have a lot of these assets, right? It's more opportunistic. So I think it's important to just think about what's likely versus, in theory, what could happen.

One thing that's closely related to valuation is what we would call quality of buyer. So Jeff, for each of these different buyer types, how do we evaluate the quality of that specific buyer in any given situation? What are you looking for?

[00:05:36] Jeff Bean: Let's maybe take the public bucket first. I'd say the quality-of-buyer analysis on a public company comes down to how that business is valued in the markets, and thus what can they pay? And then also, how acquisitive are they? Have they done a lot of transactions? Do they have a history of getting deals done? If it's a new public company that trades at a decent multiple but has never done a deal, that public company is going to behave a lot more like a private company in terms of their ability to get transactions done, just because they don't have the infrastructure to do that.

On a PE-backed strategic, so a big private company that's backed and private, the quality is really going to be more subjective. It's going to come down to, one, do we like that equity? Maybe some reverse diligence that we get done on that equity, understanding what that looks like. How many deals have they done? Who their PE backers are? How acquisitive have they been? All those aspects will impact the quality as well in terms of our assessment of them.

On the PE standalone or growth equity funds, the quality is much more defined by the size of the fund, how many deals have they done, what's their history in that sector or category, how are they as a partner. All those aspects would really factor in. And then, do they have a history of paying multiples that end up getting deals done? Different funds are active in different areas of the market in terms of what multiples they pay and what quality businesses they're looking for. So making sure that those kind of jive with the business and client that we're working with is really important.

[00:06:57] Mike Lyon: The two things I would highlight that Jeff said that I think are really important: for a strategic buyer, if we could only have one data point to evaluate how good of a buyer they are, it would be their multiple. So if they're valued at four times revenue, it's going to be really hard for them to pay 15 times revenue. It's possible if there are lots of synergies or they just have to have it, but if you look at their DNA and how they think about valuing businesses, if they got valued at four, it's going to be really hard for them to pay that.

And then on the private equity side, just making sure you're talking to the right investors. So for example, if you're a really high-growth software business, you want to be talking to the high-multiple PE firms. You don't want to waste time with some of the lower-multiple guys, because they're just not going to be competitive. However, if you're more of a slower-growth business but you have a lot of cash flow, you'll be wasting your time with the high-multiple guys. They probably won't be that interested, because they have a different profile, and some of those other investors who wouldn't be competitive in a high-growth situation suddenly become really competitive, because they're used to paying EBITDA multiples or valuing businesses in different ways.

But I think we've seen a lot of founders waste time. They're really excited about a public company strategic and then just get low-balled, and there was never really a chance for it to happen. The other thing I would say is, in terms of sophistication of buyers, Jeff made the point of how much M&A have they done. You'd be surprised how many brand-name companies out there that are public really don't do any M&A, and they are horrible to deal with because they have no muscle memory. They literally don't know how to do it, and the people who are in charge of doing M&A don't really know how to do it. So some of our worst situations in terms of dealing with buyers who just don't know how to close the deal have been some of the bigger brand-name public strategics who just don't have that muscle memory.

Jeff, so let's maybe transition and talk a little bit about the different types of deal structures you likely see with these buyer types, and how to think about that ahead of time so you know what you're getting yourself into.

[00:08:56] Jeff Bean: So the typical deal structures that we see are: cash, obviously, is a critical one and always a component of the transaction. Equity or rollover stock could be a consideration as well, depending on who the buyer is.

Let's maybe take the public company strategics. Those transactions are generally all cash. If we wanted to take equity, we could always buy the equity in the public markets. And so typically a transaction with a public strategic should be all cash. There could be a scenario where a public strategic tries to put something in earn-out, or some type of deferred but guaranteed consideration, and that could be up for consideration. An earn-out is consideration that's tied to some type of performance based on the company post-close. In general, we heavily discount earn-outs. We are not proponents or fans of those at all. It's very rare to have those in our transactions. But if there is a big gap in valuation between seller and buyer, a strategic might try to place an earn-out in there, or if they feel like there's not a lot of competitive tension in the process, or if it's a one-off discussion, they might try that as well.

With a PE-backed strategic buyer, that consideration would also likely be a big chunk of cash. There could be some equity rollover as well, and that equity rollover, just to be clear, would be in the acquirer. And so that's where, around reverse diligence, we'd have different opinions on that equity based on the diligence that we do on it. Not all private equity is treated equally, and so there could be different views on if we like that equity or not, which could impact the type of consideration you would see in a transaction, whether it's all cash or some type of rollover.

On a standalone PE platform transaction, it's usually pretty straightforward. That's going to be cash up front, and then the rollover equity is our equity, right? And so that's very clear how that works. You're selling a portion of the business as opposed to the whole business. You don't really typically see earn-outs or other types of consideration in those cases.

[00:10:48] Mike Lyon: And I think one way to think about this is the risk, or the bet you're making, going forward. If you do a public company deal, you're likely going to get fully cashed out. And if you did take some equity, so let's say you rolled 20% of the business, likely you're selling to a really large strategic, so you're really betting on the performance of that big strategic to determine your equity value, because you're such a small percentage of it.

On the opposite end of that is the private equity deal, where you're going to own some equity but it's in your business, so you're kind of betting on your business solely. And then if it's a private equity-backed strategic, it's somewhere in the middle. If it were a really large strategic, it would look like the public company point we made. If it were a like-sized business, you might really be able to move the needle on the combined entity, so you're betting a little bit more on yourself.

So Jeff, maybe let's just hit some of the big ones here in terms of how we think about transactions. We tend to think about it from liquidity, upside, and control. So let's maybe run through where the differences are in those three concepts for those three buyers. Let's start with the public company.

[00:11:56] Jeff Bean: So with a public company acquirer, I would say liquidity is probably maximized, right? That's generally going to be an all-cash transaction. And the upside in that scenario is kind of gone, because you've sold the whole business and you've sold it all for cash. That's maximum liquidity.

In terms of control, you've lost all control of the business. You sold it to a public company acquirer, and your upside is just the upside in that company's stock if you have it. But like we said, those are generally going to be all-cash transactions.

[00:12:24] Mike Lyon: In general, that deal is max liquidity, at least on a percentage basis. Basically no upside and no control, unless there's a different accommodation there.

Maybe let's go to the other end of the spectrum, which would be the PE standalone deal. What do those three factors look like there?

[00:12:38] Jeff Bean: Yeah. So the PE standalone is like maximum upside. Depending on how much of the business you sell, generally we see 30 to 80% as kind of the guardrails for typical transactions. So it could be a minority transaction or majority. And then obviously, if you sell less of the company versus more, you're going to have more upside versus less in the go-forward business.

And the control piece is also important. So you have maximum control in a platform transaction relative to any other transaction. And then the type of platform transaction that you do, if it's a minority versus majority, also has really big ramifications for that control piece. And so that's a constant dialogue that we're having with our clients around, okay, what are they trying to optimize for if we end up doing a platform transaction, and then what are the trade-offs around control and upside and valuation in those deals?

[00:13:23] Mike Lyon: One of the reasons why we've seen a lot of these types of deals over the past five or 10 years is, when you compare the liquidity, sometimes on an 80% private equity deal the liquidity might be a little bit less, or in some cases the same as a full strategic deal. So you're getting roughly the same amount of cash after the transaction, but you still have this upside in your business. You still own 20 or 30% of the business, and on average, Jeff said, it could be as much as 70%. So that's one reason why you're seeing people do those deals. They're getting comparable amounts of cash, maybe a little less, but they still maintain some upside.

And Jeff, maybe address just the last buyer type there, the private equity-backed strategic.

[00:14:01] Jeff Bean: Yeah. So the PE-backed strategic is kind of the hybrid. You have given up control of the business, right? You sold the whole company. You may have gotten all cash, you may have gotten cash and some equity. And that's where the buyer profile really matters a lot in terms of who that buyer is.

So if that buyer ends up being a private company that's not much larger than your business when you sold it, then you don't have control, but you do have influence on the outcome. Your business will influence the outcome of the overall equity performance. If the private entity that you sell to is a really large, think a billion-dollar private company, you're not going to really have that large of an influence on that outcome. So you've definitely given up control, but you might have upside, and that upside would be in the form of the buyer's stock.

Typically our clients go into these transactions thinking largely cash, and then depending on what that might look like in terms of who the buyer personas are, it could differ. Depending on who the buyer is, we might have different perspectives on if we actually want that equity or we don't.

[00:15:00] Mike Lyon: Yeah, absolutely.

Let's maybe transition a little bit and talk about how the transaction plays out differently, and specifically when we say speed of transaction. I would put speed and almost like buyer competence in the same bucket. Maybe talk to us a little bit about the differences you see there between these three buyer types.

[00:15:18] Jeff Bean: So I would say, in general, the spectrum on speed starts with the private equity funds. They're going to generally move faster than strategics, and truly faster than a public strategic. And then the hybrid, the PE-backed strategics, it kind of just depends on who the sponsor is and what the transaction looks like. But I'd think they're probably somewhere in the middle.

Now, having said that, there are exceptions to that rule. We have seen some public company strategics, for whatever reason, whether they had some kind of arbitrary aspect going on in the business, or they wanted to get a deal done before a quarterly earnings, move lightning quick. But I would say, if you're making generalities about buyer personas, the PE funds are used to moving fast, doing diligence outside of exclusivity, getting purchase agreements done quickly. They just generally have fewer hoops to jump through sometimes than some of the public strategics do on M&A committees, et cetera. And so they usually move faster. But that's not the only aspect that we're evaluating in the transaction, though it definitely is an important one.

[00:16:18] Mike Lyon: I would just say the way to think about this is, the PE guys are deal guys fundamentally, and they move fast, and part of their sales pitch to companies is, "Hey, we can make this fast. We'll get through the transaction really quickly." In general, that's true. However, if you give them exclusivity too early, they will definitely take as much time as they can to diligence the business.

But in general, they move fast. I'd say well-oiled public company strategics move somewhat fast, they just all have a day job, and most importantly, their key stakeholders have a day job. The only slight difference there is, pay attention to some of these younger public tech companies who have a very powerful CEO, so maybe founder and CEO. Sometimes they act a little bit differently than a big public company who has a big board would act.

But I think in general, we see the more PE-like it is, the faster it moves, just because they're used to doing that. I would also say they're a little bit more sharky. PE firms are known for trying to play games in a process in a way that strategics don't always do. And I would say strategics change their mind less about deals, because there's a strategic imperative to do a deal, versus sometimes on a standalone private equity deal, they're just looking for the right deal. It doesn't have to be in a particular sector.

[00:17:29] Jeff Bean: I think that's a great point, because while we generally have a perception that speed kind of goes hand in hand with certainty of a close, it's not always the case. And so sometimes there's just inherent aspects of how these strategics work that impact their ability to do things quickly, but it doesn't necessarily impact their interest, or the overall fact that they want to close the transaction.

[00:17:48] Mike Lyon: Exactly.

Jeff, one of the biggest surprises founders have, I think, during the process is just how different the diligence process is, and how different buyer types focus on different things. Can you maybe address how that's different amongst these three buyer types?

[00:18:02] Jeff Bean: Yeah, it's a great point. So the strategic buyers, they are looking through the lens more of product, and thus the diligence that they do on a transaction is much more product and tech. And they're going to do that in-house. They're not going to bring on market consultants or third-party product folks. They're roping in maybe a CTO or other folks internally, and they're going to want to be doing demos and doing technology diligence all pretty upfront in the process. And it's really the most important diligence that they would do as a buyer. Strategic acquirers are also going to do their accounting diligence and their legal diligence, but the product and tech diligence really matters to their interest level in the transaction and informs their ability to pay.

On the PE side, the other end of that spectrum, they also do product and tech diligence, but I wouldn't put it as paramount relative to the strategic acquirers. The PE funds are much more financial driven, and so they are evaluating retention models, customer cubes, pipeline coverage, bridges to year-end projections. Their diligence is really more financial KPI driven, focused on the last six months and the forward six months as the most critical period.

They will also do tech, product, and legal diligence, but they're going to be hiring third parties for that. The diligence they do themselves will be much more financial driven. They'll be hiring third parties for tech, market, and legal, which will be important, but not nearly as important as the commercial diligence they do on the KPIs and metrics.

[00:19:42] Mike Lyon: And I think it literally will almost feel like night and day for you as a founder, depending on who you're dealing with, what they're focused on, and when they're focused on it. And if you think about it from each of their perspectives, it really makes sense. Strategic buyers are buying you because they want your product. They want your revenue too, but if they're a really large strategic, it's more about, can we cross-sell this product or upsell this product?

With PE firms, generally the types of deals we see is they're trying to evaluate, if we inject more capital into the business, can we grow faster? And usually that's on the sales and marketing side. If you don't have a good product or good retention rates, they're just not going to care anyway. So they tend to be more focused on those financial metrics.

Last point I wanted to touch on here is life after the transaction. Life can be really different if you stick around. And Jeff, maybe talk about how that looks different across these buyer types.

[00:20:32] Jeff Bean: So for a public strategic buyer, life after the deal for the founder might not be that exciting, frankly. It might be a great home for the company and the employees, but given that you sold the business, you gave up all control, and you got all cash likely in the transaction, there's not the same upside and usually excitement that we see from our founders. And so it's pretty typical that founders probably transition out over some period of time. There are scenarios where we do see our clients get excited about staying on, and maybe there's some really exciting way they can grow the business. But I would say, across the board, it's probably the most likely outcome for a founder to transition out, just because it's such a different beast to be within a large public strategic as opposed to how you've been operating independently.

The life with a PE-backed strategic looks pretty similar to a public strategic, although there could be big differences depending on who that party is. You have given up control of the business, and you don't have a lot of say in some of the real strategic avenues of how you grow the business going forward, because obviously you sold the whole company. But depending on what the persona of that buyer could look like, if it's a smaller private company, it might look and feel not too differently than how it was previously when you were standalone.

And then the last type of buyer profile was a PE platform transaction. Life after the transaction probably depends mostly on what type of deal you did. If it's a minority transaction and you sold 30 or 40%, that would look and feel a lot different than if you sold 70 or 80% of the business. The biggest change in that scenario is you have a board now, right? You have a partner that you're working with. You probably have quarterly board meetings where you have some materials you're walking through. And that's probably one of the biggest reasons why partner fit becomes really important on a PE platform transaction, because you now have a partner that you're working in conjunction with. Making sure the cultural fit works will impact the life after the deal a lot, and that's why that becomes such an important criterion for evaluating buyers at that stage.

[00:22:37] Mike Lyon: Yeah, great points. And I think at the extremes, let's say you sell to a public company strategic and you have no upside left in the transaction. You're likely going to feel not as motivated. You don't have as much upside, and frankly, you might feel a little bored. These are big companies that move really slow. You're not the lead product. You're the smaller company that they acquired. And sometimes we hear founders just get bored, particularly younger, aggressive founders.

On the opposite end of that, imagine a PE standalone deal where we really maximize the multiple. So it was a really competitive process, the PE firm really paid up. The folks who did that deal at the PE firm are going to be judged on that transaction. So that's much more likely to feel more stressful. You're certainly going to have more upside, because now you own a decent chunk of the equity. But that's a scenario where it could feel really stressful, particularly if the first couple of quarters don't go well and the PE firm feels like they're behind on their return profile.

So not any one situation is right for all founders. Every founder is different, but those are the extremes. Then obviously you can find all the flavors of that in the middle.

But today we talked a lot about the three different buyer types you'll likely see in an exit, and we analyzed them across multiple dimensions: valuation, deal structure, speed of transaction, diligence, and what life will be after the transaction. Jeff, thanks for your time. Great to have you back.

[00:23:59] Jeff Bean: Yep. It's fun talking through it.