M&A software sector outlook 2024

A period of flux and time to innovate

Software continues to be a competitive sector for mergers and acquisitions (M&A), with both corporates and investors competing for quality assets, but what does 2024 look like for transactions in the sector? In our first software sector market update, we look back at recent market trends, share our own perspective and look forward to what we expect to see in 2024.

Overview

It was inevitable that the market highs of 2021 and 2022 wouldn’t last forever. In 2023 a subdued global economic environment impacted financial markets which in turn hit investor confidence. The outcome was reduced deal volumes of c.30% year on year. In 2024 we have already continued to see layoffs by some of the world’s tech giants including Google, Amazon and Paypal, but there are reasons to be optimistic. A stabilisation in the economy, interest rates and inflation has positively impacted the global software public markets. Total enterprise value (TEV) / revenue ratios have increased from 6.5x at the end of 2022 to 8.9x by the close of 2023. We expect to see this confidence flow through to mid-market deal valuations in 2024. Private equity (PE) remains active in the sector having pared back deal activity less than corporates in 2023, particularly in the second half of the year. 

Fintech is likely to continue to generate the highest volume of transactions in 2024, but increasingly our conversations with acquirers are turning to mission critical software and those sub-sectors that drive profitability and efficiencies such as business process improvement, AI and data-analytics. 

Deal volumes to pick up in 2024, particularly in the second half of the year

When M&A activity in many other sectors slowed significantly during the global pandemic, the software sector soared. Investors and acquisitive corporates remained attracted to the certainty of recurring revenue streams and growth in the sector as digitalisation accelerated. 

However, the software sector was not immune to the financial market turbulence in 2022 and this impacted volumes in 2023, particularly in H2 with only 250 transactions completing. This excludes venture capital (VC) transactions which were even more impacted and saw a 38% decrease year on year.

So what key drivers have we seen that have caused this sharp decline?

• The availability and increasing cost of debt causing many acquirers to pause until they have certainty of the true cost of finance.
• Consolidators focusing on fully integrating acquisitions made in 2021 and 2022.
• Tougher trading conditions and cost inflation meaning growth rates have slowed for some software businesses resulting in delayed decisions to sell.
• A focus on profit / cash generation as opposed to rapid annual recurring revenue (ARR) growth.
• A lack of independently owned targets with ARR of sufficient scale.
• Intensive and more rigorous technology due diligence has increased deal preparation time and pushed transactions to the right.

A level playing field

The software industry’s robust fundamentals, high margins and low capex, continue to make it an appealing target for investors. Despite recent headwinds, the sector has demonstrated resilience and has untapped future potential. It is not therefore surprising to see such a strong continued presence of private equity in software transactions. 

What has driven PE’s strong appetite and competitive position versus corporates?

• PE have an estimated amount of dry powder in excess of $160bn following record amounts of capital raises in 2022 which they must continue to deploy to generate returns even in times of uncertainty.
• PE offers a credible alternative to a full trade sale but can be unable to compete on price with a strategic corporate who can factor in significant cross-sell and synergy opportunities. The reduction in market valuation metrics has therefore made PE more competitive against the backdrop of declining valuations from corporate acquirers. 
• The statistics suggest that during the pre-pandemic period between 2017-2019, global PE IT-focused firms sampled delivered an average return of 28.3% versus global PE performance of 15.0%. A recent softening in this represents a good entry point for private market investors with little to no exposure to the technology sector.

As well as a significant number of bolt on acquisitions made by an ever-maturing portfolio of PE backed software businesses, there have been significant platform investments made throughout 2023. CapVest acquired Kerridge Commercial Systems in a $1bn transaction in July 2023. PE big spending continued later in the year with ECI’s £257m investment in Commify in September 2023 and Francisco Partners £175m public-to-private LBO of Blancco Technology Group in December 2023. The year came to a strong close with Leonard Green & Partners’ co-controlling investment in IRIS in a transaction that valued the tech giant at £3.2bn.

RSM has strong relationships with the most prolific global software and technology PE investors globally. From our regular dialogue and direct experience of transactions in the sector, there is no sign of the PE appetite for the sector slowing down. Software-focused PE funds are incredibly active and strategically focusing on niche verticals to get ahead of the next hot sub-sector. Generalist investors are also increasingly narrowing their sector focus with software and technology typically featuring high on the agenda. We expect this to continue in 2024 with quality assets highly sought after.

Valuations on the up

The sector witnessed a remarkable surge in investor demand during the pandemic, propelling valuations to extraordinary heights. This was fuelled by escalating growth expectations as digitalisation accelerated and valuations reached levels that were ultimately unsustainable. The subsequent decline through 2022 was inevitable fuelled by a risk of recession and a recalibration by investors. The recent bounce back in valuations in the public markets gives a positive outlook for 2024 with TEV/ total revenue ratios up 37% at the end of December 2023 compared to the previous year. With public market valuations back at 2020 levels, we would expect this to start filtering through in private market transactions in H2 2024.

Fintech to remain a dominant sub-sector

In 2023, Fintech was a standout sub-sector in terms of transaction volumes with a 21% share of all software transactions involving UK target businesses. It is a widely defined sub-sector including banking, trading platforms and payment processing, with payment processing accounting for the greatest proportion of transactions. With continued evolution and modernisation, we would expect Fintech to remain the most dominant sector in 2024.

In mid-market transactions (excluding VC), we see that business process technology is a close runner to Fintech. This fits with a slowing economic climate, as acquirers lean towards software that is mission critical so cannot be turned off and can also drive cost efficiencies. 

In a world hungry for data, we also expect data analytics to remain important particularly where that data is combined with artificial intelligence and machine learning to improve outcomes and profitability and to allow businesses to finally use the enormous amounts of data that they hold to gain a competitive advantage. 

Our 2024 predictions

Competition will remain strong for high quality, business critical assets and those technologies that drive profitability for their customers, including AI and data analytics. We expect to see an uptick in value and volumes in the second half of the year as elevated listed market valuations filter down into the private sector. Whilst we don’t expect valuations to hit the frenzied ratios of 2021, quality software assets will be very much in demand from an ever-increasing pool of buyers.  

For more information please contact Nick Wyatt or Clodagh Tunney.