In the face of a shifting tech investment landscape, where a competitive buyer’s market looms on the horizon, investors and portfolio managers must be prepared to add significant value to their software assets.
In the landscape of technology investments, strategic planning and foresight are paramount. As we enter a phase of shifting dynamics, characterised by reduced exits, prolonged holding periods, and ample dry powder reserves, it’s crucial to prepare for a burgeoning wave of tech asset exits. This impending wave will give rise to a crowded and fiercely competitive buyer’s market according to Bain & Co., where those who have taken proactive steps to stand out will thrive, while others may struggle to divest mature assets in their portfolio.
The Current Tech Investment Landscape
The volume of technology deals has experienced a notable slowdown since mid-2022. Several factors have contributed to this deceleration, including limited debt availability due to rising interest rates and a decline in asset values, which has rendered buyers incapable of meeting sellers’ asking prices. Successful deals have hinged on greater equity contributions, partial equity sales to fuel growth, and an increased focus on add-on acquisitions rather than standalone or platform assets. The pace of tech deals since the third quarter of 2022 mirrors the broader deal market’s sluggishness.
Exits have also seen a decline, with an average of approximately $20 billion per quarter in the first half of 2023 compared to $107 billion per quarter in the first half of 2021 and $75 billion per quarter in the first half of 2022. This dip in exits has contributed to longer holding periods for tech portfolio companies. In 2023, nearly half of tech portfolio companies have been held for over four years, and 15% have surpassed the six-year mark. This backlog of long-held portfolio assets is growing at a faster pace than the substantial dry powder reserves, setting the stage for a buyer’s market once deal activity picks up.
Strategies to Add Value
Given the prevailing market conditions characterised by declining multiples and an imminent competitive buyer’s market, investors must focus on adding value to existing tech assets. This can be achieved through several key strategies:
- Focusing on Margin Improvement: As market valuations decline, investors are shifting their focus from growth at any cost to rewarding profitability. Companies must prioritise building scale, increasing automation, and boosting productivity while managing the costs associated with growth. Operational metrics and benchmarks become increasingly important as companies streamline processes, automate tasks, and explore offshore opportunities.
- Addressing Go-to-Market Weaknesses: In a slowing economy, sales and marketing capabilities regain prominence. Companies can enhance their go-to-market models by aligning sales, marketing, operations, and product functions. Synchronising these functions enables the design of focused, repeatable sales strategies. Moreover, the emergence of product-led growth allows software companies to engage customers through self-service models.
- Leveraging AI-Driven Efficiency: The surge in AI usage in both consumer and B2B applications has opened doors to new use cases, particularly in R&D and enablement tools. Portfolio companies are assessing the potential of generative AI and directing their R&D efforts towards growth areas while eliminating distractions.
- Exploring New Growth Vectors: Companies should develop comprehensive growth strategies that encompass adjacent markets, new geographical regions, and growth through mergers and acquisitions.
When to Add Value
Adding value to tech assets is a multi-faceted process that can yield significant returns throughout the investment lifecycle. Portfolio activism can pay off at various stages, including early-stage due diligence and preparation for exit. The most substantial returns often arise from early engagement, where strategies are implemented close to the acquisition date. Similarly, late-stage engagement can result in substantial value addition, transforming a good asset into a great one, thereby boosting exit potential.
Those who have taken steps to improve earnings, streamline operations, and align with market realities are more likely to thrive amid a growing pool of mature assets. As we navigate this transformative period, strategic planning and a proactive approach to value addition will be key to success in the ever-dynamic world of tech investments.