The following excerpt is from Software Equity Group’s 2010 Software Industry Equity Report
In early January 2011, Software Equity Group conducted its third annual Software Company Buyer Survey to provide our readers a better understanding of 2011’s software M&A ecosystem and buyer thinking. We polled 176 of the largest software companies in the world, both public and private, and received an excellent response. Collectively, the respondents to our 2011 survey spent well over $13.9 billion on software acquisitions in 2010, and their plans and playbook will heavily influence the software M&A ecosystem in the year ahead.
Unsurprisingly, 83% of our respondents bought at least one software company in 2010 and stayed close to home. Buyers remained focused on strategic transactions that leveraged and enhanced their core businesses, acquiring tuck-ins and eschewing bargain shopping and unsought opportunities. Their M&A behavior in this regard was consistent with their responses to our 2010 survey, and reflected the economic uncertainty that persisted through much of 2010.
What lies ahead? The number of software M&A transactions will almost certainly grow this year, as 93% of respondents stated they plan to acquire at least one software company in 2011 and 51% stated they plan to acquire three or more software companies in 2011. Indeed, 17% of respondents stated they plan to acquire six companies in 2011, up from only 6% in 2010.
And what’s motivating these buyers? Buyers are laser focused on improving their products and broadening their current offering. Product enhancements – to plug holes, add incremental functionality, competitively differentiate and improve the user experience – was ranked by 40% of respondents as their most important M&A objective in 2011, and by an additional 27% as their second highest priority. Broadening their current offering – adding new product categories, entering new markets and expanding territories – was named the most important M&A objective by 30% of respondents, and as their second priority by an additional 40%. Financial benefits and market share as primary motives were seen as considerably less important. By contrast, in 2010, buyers were almost equally divided amongst financial objectives, product enhancement, market expansion and market share.
Software M&A spending will likely be robust in 2011, with 54% of respondents expecting to spend at least $100 million on software acquisitions this year. Valuations should also see an uptick. 60% of respondents expect to pay at least 10% more in 2011 for a company very similar to one acquired in 2010.
While SaaS providers have been on many large software company radar screens for the past three years, it hasn’t been an M&A spending priority for most. Until now. 30% of the buyers in our 2011 survey believe that it is “very important” that a target be all or sustainably SaaS/subscription based, a remarkable increase from just 13% in the 2010 survey. In fact, only 17% felt that SaaS was “unimportant” in 2011, a stunning decline from the 47% who expressed disinterest in 2010. It’s unclear whether big software company interest in acquiring SaaS providers has suddenly peaked because of the attraction of subscription based revenue, or because of market demand. Likely, it’s some of both.
What do buyers consider most important when selecting and valuing an acquisition target today? Since most buyers in 2011 are seeking to enhance and extend their own offerings, it’s of little surprise an overwhelming 63% of 2011’s Survey respondents deem the target’s products and technology platform the most important factors in deciding whether, and for how much, to extend an offer. The target’s profitability and growth, to the dismay of many private software company founders, is relatively unimportant to the overwhelming majority of our 2011 Survey respondents.
A notably greater number of buyers this year ranked the caliber of the target’s management team and operations to be the most important factor in deciding whether, and for how much, to extend an offer. It’s almost certainly because buyers today deem continuity, orderly transition and phased management withdrawal essential to the success of the transaction post-closing.
As our founder, Ken Bender, wrote in the editorial column of our 3Q10 Quarterly Report, the buyer mindset today has changed since the Great Recession. Our 2011 survey results back him up. M&A decision making has shifted from top down to consensus according to 60% of buyers responding to our survey; 72% say they’re doing much more analysis today of the market opportunity, go forward strategy and target synergies; and 84% of respondents indicated they conduct much more pre-LOI due diligence on a target’s financials, products and operations.
Despite this unprecedented degree of due diligence by buyers, we’ve observed a higher mortality rate in the past two years of software M&A transactions under LOIs that never closed, and decided to ask why.
Our 2011 Survey makes clear the exit valuation gulf between buyers and sellers is wide, and often gets wider during due diligence. A whopping 41% of our respondents told us that unrealistic valuation expectations were the single greatest reason why a deal under LOI failed to consummate. This response should be read in conjunction with responses to another of our questions regarding those post-LOI events that most imperiled the closing of a transaction.
According to the buyers we surveyed, the closing of a deal under LOI is most imperiled by the renegotiation of the proposed purchase price due to matters uncovered or clarified during due diligence. These can cover the gamut of missed revenue or EBITDA forecasts, uncollected sales taxes, missed product release dates, open source languages embedded without appropriate license, deceased third party developers who didn’t sign work made for hire agreements, customer attrition beyond what was indicated during pre-LOI discussions… it’s a long list, and buyers today do not react kindly. Often they see the value of the company as being less than originally bid, and reduce their offer. The targets, in turn, are often outraged for being “nickel and dimed”, especially when they’re so “strategic” to the buyer. More often than not, that’s the reason behind the “unrealistic exit valuation” response given by so many of the buyers we surveyed when asked, “What’s the most common reason an acquisition fails to consummate once you enter due diligence?”
It’s clear from the results of our 2011 Survey that buyers in 2011 will be more acquisitive; will pay modestly more; will be product and technology focused; will be process and consensus driven; and will closely scrutinize the target prior to closing to reduce risk and enhance the likelihood of realizing the expected return. Thus far, as we go to press, that certainly appears to be the case. We’ll detail that more in our 1Q11 Quarterly Report.