Software Growth Equity White Paper: SaaS and The Rodeo Region

Bow River Capital has raised a new investment vehicle to acquire software technology companies: the 2019 Software Growth Equity (SGE) Fund.

The SGE Fund is focused on firms very different from those that Bow River’s Buyout Fund will consider. SGE’s focus is on companies whose primary business model is software technology, targeting firms that have created business-application Software and offer “Software as a Service” (SaaS) products.

SaaS: The Future is Here

SaaS products are purchased by customers as IT services housed on a shared platform and accessed remotely (via the “Cloud”) and deployed over the Internet to a web browser or mobile devices, rather than purchased and downloaded or installed on a company’s onsite servers. Enterprises of all sizes are quickly shifting their data from in-house data centers to the cloud because they have begun to understand the transformational aspect of cloud computing for their businesses. Organizations are investing in SaaS platforms to improve their digital customer experience, achieve strategic and business goals and boost employee productivity. In 2008 only 12% of businesses were utilizing cloud-based applications; in 2017 about 1/3 of US business organizations relied mostly on SaaS cloud services (BetterCloud: 2017 State of the SaaS-Powered Workplace). The same report reveals that within the next two years 80% of US businesses will employ cloud-based software to manage their customer and employee workplaces, enterprise data management, and business intelligence applications.

Source: Battery Ventures; Forrester; Gartner; Yankee Group; BEA

The market is predicted to expand exponentially because of the benefits that cloud-based software applications deliver to both employees and customers: more immediate availability of relevant information to users at lower costs, easier implementations, better scalability, and budgetary flexibility. Annual worldwide spending for cloud-related/SaaS applications now eclipses the spend on non-cloud (i.e. on-premise and mainframe hardware) IT infrastructure. IT infrastructure spending is growing 12% on a compound annual growth basis 2017-2022, moving from around $60 billion today to over $80 billion in three years. The enterprise SaaS market by itself is presently growing at an annual compound rate of 32% (International Data Corporation Worldwide Quarterly Cloud IT Infrastructure Tracker).

All of the many forecasts out there that predict the future of SaaS point to continued growth; one of them– Global SaaS Market (2018-2023) predicts that the worldwide SaaS market will grow at a compound annual growth rate of 21% over the next four years. Software and SaaS development and adoption still has a long way to go. While SaaS solutions have become popular for various business functions like marketing, sales and HR, there is still a shortage of mature solutions for core business processes in, for example, online banking in financial services, or mobile/remote patient management in healthcare.

SaaS Businesses are a Good Target for PE investment

Investment markets have taken notice of SaaS industry growth. M&A purchase prices effectively doubled in 2018 vs. 2017, reflecting growing strategic interest and unprecedented levels of funding by private equity (PE) shops like ours, now competing with strategic acquirers. Before 2014 strategic buyers dominated these acquisitions due to the high revenue multiples they were willing to pay. Subsequent to 2014 private equity buyers have stepped in to compete for tech companies and SaaS in particular, and the multiple gap has narrowed. Today PE firms are finding opportunity to buy into smaller assets, growing them to the point that they better fit the specific interests of strategic buyers.

Will Bow River be Successful in Software Acquisitions?

We’re confident in our ability to execute and have high expectations for this new SGE fund. Bow River sees much to like in SaaS investments; in addition to the attractive industry growth figures cited above we particularly like some of the aspects good SaaS businesses offer:

  • Recurring revenues with good visibility to future income
  • High (80%+) gross margins
  • Relatively low capital expenditure requirements

Bow River’s optimism in SaaS investment is anchored by three ingredients: an experienced and strong team, “tweener” investment size, and the geography that we are focusing on:

1. The Bow River SaaS team.
John Raeder alongside his three hand-picked lieutenants David Walters, David Ramich and Maitlan Cramer have together invested more than $100m in ten SaaS companies over the last two decades with an expected return of almost 5x (includes realized and expected/unrealized returns). The experienced and successful team knows that SaaS firms are specialized companies—you must understand the quality and scalability of the product, how to match the market size and opportunity and competitive advantage/disadvantage. The Bow River team consists of proven money-makers—these guys know how and what to buy in the software business world and have the proven ability to actively participate with management in each company to optimize operating effectiveness.

2. Target “not-too-big/not-too-small” SaaS companies.
The Bow River SGE Fund will operate in the space between PE and VC—finding and pursuing companies that have reached some level of critical mass in revenues and product adoption. This size is uncomfortable for VC’s who seek higher risk (and return), and equally ill-suited to larger PE buyers who want profitability and more established market success, often because these PE outfits lack the internal subject matter expertise possessed by the Bow SGE Team. This in-between sizing focus greatly narrows the competitive landscape and fences out many.

3. Our Rodeo Region focus.
Bow River will be investing in the center of the country which provides us, we believe, a competitive advantage. A Citylab report (The Extreme Geographic Inequality of High-Tech Venture Capital, March 2018) highlights the “spatial inequality” of venture capital dollar distribution in the US. The five leading metro areas—large cities on the west and east coasts—sponge up more than 80% percent of total venture capital. A full 90% of VC/tech investment is directed outside of the 17-state region where Bow River focuses. We think that this VC investment data is a good proxy also for the PE element of M&A.

Source: Citylab

Most tech investors ignore the center of the country. The Rodeo Region represents more than 25% of the nation’s population and workforce, yet in 2018 this region saw only 15% of the VC deal count and a paltry 7% of 2018 investment dollars in the US (Pitchbook: Q4 2018 NVCA Venture Monitor).

We are of course very aware of the tech hubs in Silicon Valley and Seattle. The Rodeo Region is under-represented in tech investment not because there are no opportunities—the likes of Salt Lake City, Phoenix, Colorado’s front range, Austin and other Texas metros are home to scores of interesting software/SaaS startups, but because the bulk of software investment capital comes from the east and west coasts, and that money tends to be spent closer to home. Bow River will exploit this seam in the investment markets.

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