A private-equity takeover is coming for startups

The exit doors are closing for venture-backed software companies.

Scott Arnold was preparing to take his company, AuditBoard, a Southern California provider of audit and risk management software, to the public markets.

Hg had other ideas. The European private equity firm had been eyeing the late-stage startup for five years, impressed by its traction and focus on customer success. When word got around that AuditBoard was seeking potential investors for its initial public offering in early March, Hg pounced. It wanted to snap up the company and spur on the next phase of growth, and it was willing to pay through the teeth for it.

The parties hashed out an offer over a half hour at an airport bar. Four weeks later, they landed on a sale price of roughly $3 billion, over 20 times AuditBoard’s valuation when it last raised primary funding from VCs.

The speed of the deal, and the flashy multiple, illustrate how private equity funds are able to swallow startups more often lately. Though many founders still pine for an exit in the public markets, a period of high interest rates has late-stage startups staying private longer. Meanwhile, an antitrust crackdown, especially in Big Tech, has starved some venture-backed companies of another way to exit.

The exit freeze has some founders giving private equity a second look, said Michael Brown, a general partner at Battery Ventures, a firm that backs companies at all stages, from seed and early to growth and buyout. Battery was also AuditBoard’s largest institutional shareholder.

“They move very quickly. They’re actually paying very good prices for things — as attractive as a strategic,” Brown said, adding, “and you get immediate liquidity, whereas if you go public, management can’t just sell day one.”

PitchBook data shows software buyouts are on the rebound, with an estimated 59 deals in the first quarter. That might not sound like much, but it’s significant as a growing share of all outcomes, said Derek Hernandez, a PitchBook senior emerging technology analyst.

The number of corporate mergers and acquisitions of software companies has fallen to about 20% below pre-pandemic levels, while software buyouts are trending toward a five-year high, according to PitchBook.

The software-as-a-service category is especially ripe for consolidation, said Aaron Fleishman, a software investor at Tola Capital. The software market exploded during the pandemic, with people working from home and businesses spending more on all things cloud. But in the face of rising inflation and interest rates, software customers from tech startups to mom-and-pop shops trimmed their budgets.

Fleishman noted that when software spending saw a significant pullback, many companies with subscription-based revenues in the $20 million to $50 million range found themselves at an impasse. Their slowing growth made it difficult for these companies to appeal to new venture investors. They’re not big enough to go public, and they’re not likely to be picked up by an incumbent.

“There’s not a lot of buyers for those assets because it just feels like the last generation at this point,” Fleishman said.

Their tricky spot is private equity’s gain. Firms like Thoma Bravo or Vista Equity Partners — leading providers of private equity in tech — may buy a company, strip it, build it to a few hundred million of annual recurring revenue, and flip it or take it public. They might also bolt on other businesses to create a new Frankenstein software giant.

“You’re going to see a lot of that consolidation over the next year, two years,” Fleishman said.

The bought-out becomes the buyer

In this market, some software companies are looking to sell to private equity more. Others are doing the buying.

This spring, Metropolis, a startup building a better parking app, followed private equity’s playbook by taking private SP+, one of the largest parking networks in North America.

Yoni Rechtman, an investor at Slow Ventures, which first backed Metropolis at the seed stage, said the growth buyout has helped Metropolis not only expand its market presence but also capture more value. “Owning the assets means owning all the upside,” Rechtman said.

The deal follows the October news that Metropolis raised $1.8 billion in funding led by Eldridge Industries, a provider of equity and debt financing. Flush with cash, Metropolis is effectively “using our equity to acquire companies rather than acquire customers,” Rechtman said.

But it’s not just startups mimicking private equity. Sequoia changed its model so it could hold on to public companies longer. General Catalyst bought a healthcare system. Andreessen Horowitz plans to invest in the private equity asset class through its family office division.

These trends point to the worlds of private equity and venture capital colliding in new ways. Startups are caught in the middle, weighing the allure of faster liquidity against the traditional dream of going public.

With high interest rates and a liquidity crunch reshaping the landscape, private equity is seizing the moment.