Why PE is a key player in the software economy

Jeff Vogel, EY-Parthenon US Managing Director and Head of the Software Strategy Group, joins Winna Brown to explore the complexities and key trends shaping the software deal landscape. Visit ey.com to read our latest private equity perspectives. The “software economy” is comprised of companies that sell or license software as well as software-enabled business services companies that differentiate themselves on the basis of their software. Because a software asset is especially complex to valuate and diligence, PE firms and the advisors who serve them have transformed their talent strategy to attract a wide spectrum of operational experts ranging from serial CTOs to young entrepreneurs. A passion for technology combined with partnering experienced executives with curious young talent helps teams remain agile and responsive to rapid change. A software asset is different from a traditional asset for three important reasons: Markets are amorphous and difficult to size. Revenue potential and gross margins are high; however, R&D expenditure is also high because the product is must constantly evolve to stay competitive. Technical debt, unlike traditional debt, is difficult to quantify and does not appear on a balance sheet, so a PE investor may unwittingly sign up for obligations requiring significant capex. Five trends shaping the PE/software deal landscape: Role of PE: PE is shaping the software landscape by providing access to capital and focusing on building companies. Long-term value: PE is increasingly prepared to hold software assets for longer and are therefore optimizing for LTV. Growth: high valuations require PE to underwrite for growth, not solely for cash flow. Hybrid deals: PE firms that were traditionally majority stakeholders are now considering minority stakes. PIPE deals: private investment in public equity (PIPE) deals are leading to cross-fertilization in management and strategy between public and privately held companies.

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Listen to the NextWave Private Equity podcast series, where Bridget Walsh, EY Global Private Equity Leader, will speak with industry leaders to discuss emerging opportunities and industry trends shaping the global private equity landscape.