Private equity firms are showing increased interest in technology companies, especially software-enabled services companies, according to Raj Seth (pictured), managing director at GE Capital.

Part of the interest is driven by the sharing aspect of newer software programs, which have lower up-front costs for middle-market and are cheaper to deliver and deploy. Before buying these types of software companies, PE firms can also get a good read on the lifetime value of a customer, says Seth. Firms will likely be looking for businesses that they can build on.

Recent transactions that underscore private equity interest in the arena include San Francisco private equity firm Thoma Bravo LLC’s investment in SailPoint, an access management group; the Riverside Co.’s investment in Censis Technologies, a health care software company; and GTCR-backed Opus Global’s acquisition of Hiperos, a third-party management software firm.

What M&A trends are we seeing in the technology space?

We are starting to see a broadening of interest among sponsors in the technology space. More precisely, software in particular is an area where we see increasing deal activity and interest. I would say if there is any one area that stands out, it is software, especially software-enabled services.

Why is software attracting private equity attention?

There are a couple of things that drive this. The clients we work with are not venture capital companies; they do not want to take technology risk, and software is really the point of innovation in technology. Whether it is cloud or software-as-a-service or the Internet of things, software in general is hot. It will take 10 years to play out, but the shift in software toward SaaS models makes the financial model characteristics appealing to the private equity guys, who tend to like predictable, visible financials.

One of the big shifts is that you used to buy software, put it in the machine, pay up front and then pay maintenance to the software vendor. What you are beginning to see — best illustrated by public companies such as (NYSE: CRM), Workday (NYSE: WDAY) and others — is that the trend now is to rent software and have it sit up in the cloud. You pay for it like a rental – a certain amount per month, including updates — and that makes it more accessible to folks in the middle market because it costs less up front and it is cheaper to deliver and deploy.

If private equity companies can get a good read on how much it costs to acquire a good customer, how much they are churning in or out, then they can get an idea of what the lifetime value of a customer is. Private equity guys are paying up for growth – two thirds of what I see in software tends to be SaaS-related offerings in industry-specific applications.

How will companies with older software models catch up?

It is a combination between both developing and buying it. The big guys like Microsoft Corp. (Nasdaq: MSFT) and Oracle Corp. (NYSE: ORCL), they have big legacy businesses that at some level are threatened by the little guys taking pieces of their business. They begin to try to extend their own platform through organic developments, and I think this will drive a fair amount of M&A. Sometimes you’ll see Oracle CEO Larry Ellison invest in companies like Salesforce privately. But unilaterally, when these things get to scale, consolidation and acquisition of some of these folks is definitely in the cards.

What will attract PE firms to certain software companies?

Private equity sponsors are looking for platforms to do M&A, and I think that is a big theme with both software and in other technology spaces. There is also an interest in M2M, a subset of the Internet of Things. Machine-to-machine, known as M2M, is when you start getting machines talking to machines, and then you can make smarter business decisions. That is a space that people are looking for platforms they can build on and acquire companies on top of, I would expect that to continue.

The volume of technology deals that private equity firms look at and interact with will continue to go up as a broader number of private equity sponsors get more and more comfortable with tech companies. It is not a blip.

Subscribe Now

Complete access to real-time information and analysis of news and trends in the industry.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.