LOOKING BACK ON 10 YEARS OF FRENCH TECH BUYOUT
Back in 2005, when the French Buyout (or LBO[1]) market itself was already pretty mature, several members of the ISAI team invested in one of the very first Tech Buyout deals in France: seloger.com.
7 years later, although the segment was only in its early stages, we announced the launch of our Tech Buyout investment activity under the name “ISAI Expansion” and completed, on February 14th, 2013, our very first transaction with Hospimedia. The value proposition was simple: to provide Tech entrepreneurs who have chosen to move forward as a profitable business with financing and liquidity solutions that were, until then, inaccessible on the French market.
Tech Buyout vs "traditional" Buyout: lower financial leverage, and more operational growth!
One of the key differentiators for Tech Buyouts vs Buyouts in traditional sectors lies in the key role that Growth plays in a Tech company’s valuation. Given the youth of the sector and its continuous need for innovation, Tech companies eligible for LBOs have often generated significantly higher growth rates than companies operating in traditional sectors. To illustrate this, the average annual organic growth rate of ISAI Expansion’s portfolio companies is higher than 25%[2]! When we analyse the value created in many of our exited portfolio companies, we see that the performance achieved is largely driven by this Growth effect. And, despite the recent setbacks of listed Tech stock markets, which have put an even stronger emphasis on the importance of profitability, a recent study showed that, in the software sub-segment, Growth is still valued twice as much as profitability in the famous “rule of 40”. This particular focus on Growth partially explains the specificity of Tech Buyouts. The entire financial operation must enable this Growth, and never constrain it. This implies paying a particular attention to the financial leverage, which must remain reasonable; arbitrating for an “in fine” rather than amortized leverage; or remaining cautious on bank covenants.
How has the French Tech Buyout segment evolved over the past few years?
Over the past ten years, we have studied more than 75% of the Tech Buyout transactions in France (on the small, lower-mid cap segment), and we will continue to deploy ISAI Expansion funds with the rigor that we have always cultivated. This segment has undergone spectacular developments in recent years.
According to Lincoln International, the number of Buyout transactions in Software (a Tech sub-segment) has, for instance, increased by +130% between 2015 and 2022 globally, with many new players among both
Generalist and Tech Buyout funds. This evolution was especially driven by:
An almost uninterrupted increase in multiples between 2009 and 2021;
Attractive economic fundamentals such as growth, low capital intensity, limited working capital requirements, etc.;
The acceleration of the digitalization of companies and individuals during the Covid crisis; and,
As a result, a proven outperformance compared to traditional Buyouts. According to Bain & Company[3], Software Buyouts generated, on average, a multiple of 2.8x between 2010 and 2018, vs. 2.2x for LBOs in other industries!
This development is excellent news, and we are glad because this is an essential building milestone for the Tech ecosystem in France.
But for how long will the industry still be able to take advantage of this easily accessible “eldorado”?
With the surge of acquisition multiples, especially in 2020 and 2021, we can only wonder whether these transactions concluded at very high prices over this period, especially in the software sector, will generate similar performances to the ones we have observed in the past.
Three considerations fuel our thoughts:
First, the decrease of Software Buyout valuations remains limited (around -20% versus their peak level) compared to their listed equivalents (-50%), but it is clear that this gap will probably be filled in the short or medium run.
Second, the emergence of new "mega-trends" will force Tech companies, and software in particular, to invest and renew themselves more than they do today, with:
Increased challenges around cybersecurity, hosting, Green IT, data protection,
A transition towards SaaS business models,
Increased pressure on gross margins in a highly inflationary environment,
Lower barriers to entry with the development of no-code / low-code, generative IA, etc.
Finally, the Tech sector suffers from structural weaknesses which have been ignored for too long: little/no diversity, a barely nascent environmental awareness, a certain lack of proximity with regions, etc. Much remains to be done and it is up to the entire ecosystem to tackle these issues head-on to better assume its “corporate responsibility”. The era of “easy” money therefore seems to be behind us, and we believe that, in this new context, expertise and know-how to support the growth of profitable Tech companies will regain their full meaning.
Tech Buyout players will also have to prove their ability to diversify into perhaps less "mainstream" segments (marketplaces or other B2C models, for example) than Software and IT Services, which currently represent more than 70% of the amounts invested in Tech Buyouts.
Like Venture Capital in the early 2000s, we therefore anticipate a form of rationalization for Buyout funds, which will clearly have to equip themselves to address this market in all its complexity.
The fundamentals of this market remain strong and promising in the medium term. Tech companies, and especially B2B Tech companies, have relatively low exposure to the vagaries of logistics or raw materials; the needs for digitalization and productivity gains remain; and the expectations of entrepreneurs are numerous.
Building bridges between Venture Capital and Tech Buyout
Within the ISAI Expansion team, when we question our approach, our values, and the way in which we can progress in this chaotic context, an essential element resurfaces: what is our intimate understanding of the sector in which we operate?
As such, and even if the codes between these two worlds are very different, the links between the worlds of Buyout and Venture remain particularly strong due to the nature of the Tech sector. That is because start-ups are at the origin of many innovations that will, sooner or later, impact profitable Tech SMEs/ETIs eligible for an LBO.
A representative example, among others, is Product Management: initiated by start-ups, the practice of Product Management, this new, more agile and iterative way of designing digital products, is now being adopted by numerous SMEs/ETIs and the larger groups themselves.
It is this bond, this understanding of the Venture space, that strengthens the ISAI Expansion team today more than ever. Most of our specificities stem from this, including a minority culture, a way to influence through expertise, and our ability to co-invest when needed.
If Tech Buyout is now mainly focused on "bootstrapped" companies, with no real continuity with Venture Capital, we are convinced that the reinforcement of this link between start-ups and Tech SMEs / ETI under LBO is an incredible source of opportunities for the years to come, through the natural purpose of the latter to consolidate part of the former, and to offer a new gateway to liquidity for Venture Capital funds.
At ISAI, we are particularly enthusiastic about the idea of co-building this new stage of the Tech Buyout segment, now identified as one of the essential links within the Tech ecosystem.
Pierre Martini
Managing partner, ISAI expansion
[1] LBO - Leverage Buy Out - type of transaction in which a company is purchased using a combination of equity and debt.
[2] Source: ISAI, compound annual growth rate of ISAI Expansion current portfolio between ISAI entry date and 31.12.22.
[3] Source: Global Private Equity Report 2020, Bain & Company