At best VSaaS clients see the provider as a long-term partner who is integral to supporting internal processes. At worst, they see a software application that would be painful and disruptive to step away from. You may choose to cancel your Peloton subscription in a heartbeat, but a strategic choice to move away from a VSaaS platform isn’t taken lightly.
However, no strategy is ever without its downsides. In the case of VSaaS the most likely drag is often around growth, which can be constrained by a smaller total addressable market (‘TAM’), higher customer acquisition costs and long, and often painful, sales cycles.
We regularly meet strong VSaaS providers who are arguably punching above their weight with fantastic rosters of sticky enterprise clients, but who struggle to grow further. There are certainly worse positions to be in but naturally these drags can temper valuations and investor/buyer appetite.
VSaaS profiles
Broadly (very broadly) the VSaaS companies we meet fall into two categories, which influences the likely optimum exit route for shareholders. These are:
A. Cash Burners - Emergent rapidly growing players seeking to prioritise ARR expansion and customer lifetime value over day-1 profitability. Typically, Venture Capital (‘VC’) or Growth Equity (‘GE’) backed with sophisticated sales and marketing functions. They will ultimately drive to sustainable profit…or fail.
B. Cash Cows - Mature, highly profitable players that are heavily embedded with clients. Sometimes bootstrapped to date. Technically strong but potentially underinvested in areas such as UX. Modest sales and marketing spend as a percentage of revenue.
What are the M&A options for VSaaS players?
For profitable VSaaS companies – whether successful Cash Burners or established Cash Cows – there are three primary exit routes (or four in the rare case where an IPO is viable):
A - Private equity (‘PE’)
PE investment differs significantly from its earlier stage VC/GE peers. They are typically seeking to take majority stakes in VSaaS players who boast at least £5m ARR, moderate to strong growth potential and are profitable (or at least show a very clear route to profitability).
Their goal is to exit in full and achieve typically at least a 2.5x+ return on investment within 3-5 years with everyone winning – founder shareholders and investors alike. Higher returns would be a positive, but that won’t lead PE investors into being tempted into high risk/high reward cash burn investment propositions, particularly post 2021. Profit margin here is just as important as revenue growth.
In recent years mid-market PE investors have become increasingly sophisticated and specialised. They’ve learnt from their successes (and mistakes) and when they encounter a VSaaS player who fits their investment criteria closely they tend to move decisively.
Valuation wise PE’s approach can vary hugely and while they typically seek to value slightly more conservatively than trade buyers, we do see instances where they are outbidding strategics. They look for situations where founders roll some of their value into the deal – so less cash out than a trade buyer, but potentially significantly more upside potential. Earn outs are fairly uncommon.
Fundamentally mid-market PE still desires a higher concentration of VSaaS assets and has vast reserves of capital to deploy to achieve this.
B - Trade buyers
Trade buyers can obtain deeper synergies and therefore arguably stand to gain the most from an acquisition, providing integration is successful. The ability to increase market share or enhance capability is compelling. And therefore, can stretch to the highest valuations where the ‘fit’ is strongest.
The flip side of this is that a trade buyer requires a higher level of fit culturally, technologically and operationally, often making them more cautious and less likely to acquire unless the alignment is very high. This caution can often mean trade buyers move more slowly in processes than their counterparts.
Often the trade buyer is an already known entity to the VSaaS seller. Perhaps it is a direct competitor or a provider with a complementary offering within a vertical niche. The seller may have even successfully won work against the buyer, shining a light on a competitive advantage they possess.
From a structure perspective, acquisitions are made outright but can have some element of earn-out.
In almost every case these days the trade buyer will have a PE investor themselves or be listed on the public markets, which means final sign off on any deal is required by the backers. This can drive a desire for the selling shareholders to roll value into the acquiring entity.
Acquirers taking minority stakes to seal a commercial alliance are sometimes seen, but this can be a double-edged sword for the receiving party. The VSaaS seller may receive commercial advantages, but does this ultimately limit the future buyer pool by aligning with one potential future buyer? Caution is advised.
C - Vertical acquirers
The most prolific individual acquirers of VSaaS globally by volume, typically seeking to acquire profitable players with between £2m-£50m ARR (although most of the action occurs between £5m-£20m ARR). Acquisitions are 100% outright.
Vertical acquirers generally adopt a ‘buy and hold’ philosophy, with a strategy of amalgamating VSaaS players in distinct and clearly defined niches.
Synergies and cross sell opportunities between the respective portfolio companies are of interest but the real focus is on giving the leaders of these acquired VSaaS players the autonomy to continue to successfully lead without excessive constraints. Where guidance and support come it tends to be on a relatively light touch, but supportive basis. Most challenges a VSaaS experiences have probably already been seen within the portfolio and that knowledge and collateral can be applied to assist.
Vertical acquirers are generally only willing to acquire owner managed businesses and have reluctance to consider VC or PE backed entities.
Valuation ranges as always vary but tend to be conservative, naturally lending themselves to a greater focus on mature Cash Cows vs rapidly growing Cash Burners. Earn outs are seen.
Deliverability, certainty and the straightforwardness of approach are differentiators vs other buyer/investor categories.
D - IPO
The IPO exit route has been particularly difficult since 2021 with the exception of a handful of large, rapidly growing, outstanding performers who have punched their way through the macroeconomic uncertain backdrop. The minimum bar for ARR to pursue an IPO has also increased in recent years.
You are as likely to encounter a take private led by PE than an IPO in the space at present.
What strategic options do the underachievers have?
What happens to those underachieving or failed Cash Burner VSaaS companies in the end who don’t have the luxury of the potential above exit routes? The picture can be messy with VC’s losing interest in assets where their desired return is clearly not going to be achieved.
All is not necessarily lost, however. Many VSaaS players will still possess underlying strengths that a trade acquirer would benefit from. For example, the ARR may be modest and loss-making, but the technology may be strong with an intrinsic value a buyer could leverage and enhance its capabilities with. Here some return could still be delivered, and founder shareholders may still be able to attain sweet equity in the buyer (and continue in their roles).
