Episode 47: David Bluth of GLC Advisors on How the Market Has Shifted for SaaS M&A

Episode Transcript

Shiv: Alright David, welcome to the show. How's it going?

David: Very good, thanks for having me.

Shiv: Yeah, excited to have you on. Obviously, we've done a lot of work together over the last five years in different transactions. So I wanted to have you on to share your insights with the audience. But why don't we start with your background and your firm and we'll take it from there.

David: Yeah, very good. Well pleased to be here Shiv. So I'm David Bluth. I'm a managing director at GLC Advisors. We are a national boutique investment banking firm, headquartered in New York City with offices in Denver, LA and San Francisco. And by quick way of background, I've spent the entirety of my career really in tech M&A. So I help lead the technology group here for the firm. And we spend all our time in sell-side, M&A advisory and capital raising advisory for middle market software and tech services businesses.

Shiv: And what are you seeing in the market being an investment banking firm and that helps PE firms and strategics and just offer founders get acquired or acquire companies? How are you seeing the deal market evolve, especially in the last year and a half or so?

David: Yeah, it's been an interesting time to be in M&A. I think, you know, at this juncture, it's probably not a surprise to the audience, anyone close to M&A that for technology in particular, 2023 was a tough market. And it was coming off of, you know, very high highs, historic highs from 2021, where in just about every respect, probably the strongest software M&A market we've ever been a part of in many, many ways from a volume perspective, value perspective. That started softening, of course, in 22. The first half of 2022 was good, but the second half really started to pull back and lead into 23 where after enjoying really strong public equity markets in 22, and or contraction 22, excuse me. The private markets really started to soften and in many ways lock up. And that was driven by rising interest rates, obviously having huge implications on private equity buyers. So the availability of credit tightened up. There was macro recessionary fears, of course, inflation was increasing pretty quickly, interest rates were going up. And that just really had an impact on the deal market. And for a number of different reasons, of course, know, software businesses were having to operate then with a different cost of capital. If they had debt facilities in place, you know, the interest expense was quite different. They were having to run the companies differently than they were accustomed to before, you know, the kind of downturn in the market. There's a lot of softness in bookings velocity, Shiv. I'm guessing you saw some of that in the work you're doing. And that led to a lot of software businesses in 23 missing ARR targets. And you kind of combine all those factors, you know, for businesses that were in-market for 2023. It just made for a very difficult climate to get things done. We spent, you know, most of last year, we probably advised most of our clients or prospective clients to wait. And wait out for a better market environment unless there was a really good catalyzing reason to do something because it was just the year of finding a reason not to do a deal. There was very much a risk off kind of market psychology that was very pervasive in 2023. And when you look at the empirical data, know, the volume was off. You speak to private equity firms or people in the business. Quality was very much diminished in terms of the type of assets coming to market. And that just led to a kind of broader pullback heading into this year.

Shiv: Yeah, how much volume drop over the last couple of years compared to that peak in 2021?

David: Yeah, so volume was off 20% last year in 2023 compared to 2022. I think what's more notable, it was off 45% in the US for software M&A relative to the highs experienced in 2021.

Shiv: And I get the reasons like there's more risk in the market, interest rates are higher, but what about just the idea that a good business by default has good fundamentals and still has a certain amount of enterprise value and seeing velocity there because we saw a slowdown on our side as well with the PE partners that we work with, but still we saw higher quality transactions still go through. And I'm wondering if you saw that as well?

David: We did. What was really interesting, and I know we'll spend some time talking about today's market, I would say in large part this holds true today, pretty large demarcation between the quote unquote A or A plus business and the type of reception that might receive in the market last year or kind of year to date so far this year versus everything else that quite didn't meet that bar. Really a tale of two different markets. So if you had really strong business, skilled ARR, great retention metrics, good sales efficiency and everything else, there was still a very strong market for those companies. Lack of supply for good businesses, they were able to generate, I think, good competition for sellers marketing those companies. But it was for those that maybe had to do more storytelling where it was just a very different dynamic, in terms of the amount of interest that could be attracted to those businesses and then ultimately how that process might play out.

Shiv: And then this concept of waiting, and I want to talk about the market now and how you're seeing it, but just is the idea that now as things turn or the bottom of the market is kind of found, a B or B plus business ends up becoming more attractive or is it that they've had time to become a better quality asset that investors are more interested in?

David: Listen, I think it's both some of those companies, you know, who chose to put their heads down, I think will reap the benefit for having done so. We're hearing from many private SaaS businesses. We're seeing it, you know, there's a renewed momentum across many categories from a bookings perspective. You know, of course, that's critical to driving ARR growth and in being successful and you know, telling a story where you're able to get buyers or private equity firms to look in price ahead. So the companies that maybe didn't quite hit the mark, whether it was growth rate or scale, or maybe there was a cash burn, if they've been able to remedy those issues, you know, they're going to be much better positioned in the market we're entering now. I think we're in the early innings of having already found the bottom and seeing some positive momentum going upwards. For those companies that maybe still are not checking every box to be the A plus, I think a more welcoming and active M&A environment, as things do pick up, volume does return, more buyers re-enter the market, that of course will help create a wider universe of prospective buyers or investors that will then go back to evaluating those opportunities and seeing value in those opportunities where certain assets, can be optimized under the stewardship of a new private equity partner or strategic buyer. And with some of the risk-off mentality is that begins to diminish, that will help those assets, I think have an easier time finding their way to the finish line.

Shiv: Yeah, it's funny. A lot of what you said definitely rings true with us and a lot of the PE partners that we work with saw we saw them shift their focus from not necessarily landing net new companies, but focusing on their existing portfolio and optimizing them and making them helping them have better fundamentals, better profitability, better CAC payback periods and things like that were previously when maybe capital was more easily available, you could kind of look over some of those areas and focus more on M&A and growing organically. So, I'm assuming you saw a lot of the same as well?

David: Yeah, we saw a ton of that. Last year was the year for finding a reason not to do a deal. So if all those different boxes didn't line up perfectly, or if you had a soft quarter and you're in the middle of diligence, that was a recipe for many owners to maybe not fully land on the outcome they originally had hoped or desired, or the deal's getting done. So I think there was this internal refocusing and that's where we think as the market begins to reopen, there's going to be a better or a more normal appetite for solutioning where not everything is just perfect.

Shiv: What were the top reasons why deals fell apart? And I'm sure some of that is like evergreen that you see and some of that was more market-dependent or context-dependent, but just for the audience, like what are some of the top reasons that you've seen, especially in the last couple of years as the market has shifted?

David: Yeah, when you know in our experience when deals generally don't get done, especially in a banked kind of auction or sell side marketing process, most often it is due to, you know, financials not meeting, you know, what was put in the, you know, offering documents. So the forecast is put out and you know, you have a soft quarter or successive, you know, soft months and it becomes clear you're not going to hit the forecast that was put out there. That's the number one reason we see things get off track because often it either leads to the price being recut or, you know, maybe structure being introduced into the deal, but a changing of maybe what was originally agreed to. And of course that can be difficult to overcome, you know, for a variety of reasons when that does take place. So that was probably the biggest issue. I think if you look at what has been a difficult tech M&A market over the last 18 months, of course, what's happening in the end market of software businesses that they're selling into, of course, is, you know, an important focus area right now as people are trying to underwrite a thesis or growth, how does the end market recover? Of course, that's going to be indicative of how the underlying asset performs if they're reliant, if it's a vertical SaaS business or something like that.

Shiv: Do you see when deals are falling apart, are you seeing just revenue quality and predictability being an issue or is it just like the uncertainty that's more the driver around that? Because we all know almost all businesses that we've worked with have seen a slowdown in revenue and that is often or in a lot of cases being caused by market conditions. And so it's hard to ding an asset for that, right? Because you could just have a slow quarter market is the overall market is slower. But I'm just wondering, is that fair to the end company? Are there opportunities being missed or is it just that there's a fundamental issue inside the companies themselves?

David: I think often it's the slowdown right now that you're referencing. Like I mentioned, the bookings velocity is slowing down. So we're seeing the same thing. That was cause that certainly would have valuation implications in this market. if people can see through bigger picture, okay, this isn't systemic to the business. This is maybe end market and perhaps this is cycle driven. They're able to see through that right now, you know, perhaps they're able to lean in and move forward. It probably then is a question of what's the right kind of multiple ARR multiple, et cetera. I would say the other thing, kind of going back to your question and the one before, know, it's one that folks are of course looking pretty closely at bookings growth, but as you're well aware, it's going up to the top of funnel. So it's also looking at what's the demand gen apparatus, what is that suggesting in terms of the leading indicator of what might be happening on the bookings front too. So that whole, you know, function, business function, the demand gen through sales cycle, everything else, there is, you know, I'd be curious if you agree with this, this is what you're engaged to do by your private equity clients, but there's as much or more emphasis placed on that function than just about anything else in looking at the underlying kind of stability and health of the subscription side of the business and where that might be headed.

Shiv: Yeah, for sure. We've seen that. And in a lot of cases, we're brought in to say, okay, we're spending X amount of dollars, let's say $10 million on our go to market efforts. Is that as efficient as it can be? Because we'd like to potentially find some cost savings here or find a way to ramp up our pipeline by 20 or 30% from our activities. And where are those levers? We've had a lot of those questions and engagements focused in those areas. And often there is a ton of waste and the market cycle has almost forced these companies to look inward to find that waste. I feel like this waste would have just continued if the market didn't turn. So in a way, it's built almost healthier companies that actually are looking at profitability or unit economics and CAC payback periods to make some of those decisions where previously you were very comfortable with maybe a two-year CAC payback period because you had the capital or you were able to exit and just cash was more readily available.

David: Yeah, totally concur. I mean, through 2021, growth was king. You know, if we were running a sell side business for a good process for a good SaaS business, you know, rarely was EBITDA being discussed. You know, if someone was overly focused on EBITDA, it generally was a pretty good indicator that that party was not going to be super competitive. You know, all the value growth. Big C change of course is growth is still important, but efficient growth is what matters. So being really smart to everything you just said, hey, what is LTV to CAC? What are the channels that are converting and have the right payback attached to them versus when it's a really hot economy, good bookings, velocity, companies didn't have to be as disciplined. You'd allocate your marketing budget, do whatever you do on the demand gen side. If bookings are up and to the right, there wasn't as much scrutiny applied. But it's different market now. You've got to find where there's value in return in what you're spending to drive those booking sellers.

Shiv: Great, and I think that's a good point to segue into current market conditions. So how are you seeing that transition from being super tight on the cash side and figuring out where those opportunities are to optimize within the existing operations to now the current market conditions where the bottom hopefully has been found and companies are starting to come out of it. Has that changed how these companies and investors are looking at targets and investments?

David: Yeah, it's interesting. So I would say we entered 2024 at the outset pretty optimistic about the prospects of this year and prospects being that I think we felt pretty strongly the second half of this year would seen a pretty notable kind of return from a volume perspective through this year. That's pushed out a little bit. You know, I think entering this year, we and many others in the deal ecosystem, you know, I think had a higher confidence that the Fed was going to be cutting rates, you know, maybe this June. Of course, that didn't happen. Important meeting going on now to indicate whether there will likely be cuts in September. Inflation was kind of more stubborn. That led to delaying interest cuts. So some of those things, I think that how quickly things, we expected things to rebound, maybe pushed a little bit, but now that we sit, you know, end of July and you look at, you know, all the Q2 data is now coming out. Q1 and Q2, two consecutive quarters now of increased US software M&A volume. So I think we are beginning to see, you know, our way back in the right direction where perhaps we have found the bottom. I think there is growing optimism again that we are heading the right direction. Certainly the foundation seems to be being laid for a likely strong recovery, we think, in 2025. But activity is picking up now. We do think, you know, hopefully that will continue through the second half of this year and I think what gives us some increasing confidence in that one are, know, in terms of our own backlog that's steadily kind of rebuilding as things become more active, but even our own top of funnel. the number of conversations we're having with business owners, sponsors around their, you know, I think renewed and sincere desires to, you know, take their asset to market, whether it's more imminently in this year or they're wanting to have conversations with bankers, get a line now, prepare for the balance of this year with the hopes of, you know, taking something to market in Q1 of next. That activity has gone up pretty notably over this last quarter. For those reasons, and then there's a variety of others, right? You spend a lot of time with private equity community as we do. They're still sitting on a tremendous amount of capital. you know, many of those firms, they've been, you know, sidelined relative to activity of the last cycle, and they're ready to deploy capital. They want to put that capital to work. They need to. But we need this volume to continue getting done. do believe there in some ways it will be a virtuous cycle that more deals get closed. It's going to draw more sellers to market more competition on the buy side for assets, which is good for valuation and everything else. And we think we might be in the early innings of that starting to transpire after what's been a fairly choppy kind of 18 months.

Shiv: It's a bit of a chicken and an egg problem, right? Because on the buy side, you have all this capital on the sidelines. There's record levels of dry powder sitting out there. And then on the sell side, founders and entrepreneurs want to sell their companies, but they want the market valuations to kind of climb up. So like, what's the first shoe that needs to drop here? Is it that PE firms need to be willing to take on more risk within these investments and be willing to pay a higher multiple? Or is it that founders need to be willing to take these companies to market and work with what investors, where the market is in terms of valuations?

David: Yeah, well for any deal to get done you have to have a willing buyer, willing seller. I think an important part in the tech landscape to help kind of catalyze this is at the beginning point of any cycle, meaning coming off the high, the first issue to contend with is the bid-ask spread between seller and buyer expectations. And you know, in the market we've been in, we came off of a historical kind of watermark in every respect from a value perspective in terms of what was happening in 2021. So deal volume were at all time highs, valuations were very, very strong. And, you know, the founder, you know, that's what sticks in their mind. And I think, you know, this market has been such, it's been persisting now, I think for a long enough period of time that there's maybe some more pragmatism in the market in terms of it has reset to some degree. And I think that bid-ask spread has tightened. It's also been on the buy side, right? Back to the commentary of A plus and everything else. You know, healthy market, it's not just A plus businesses that get sold. People need to see the value in the not perfect A as well. What can you do under your stewardship that helps loosen up, I think, the pockets as well and gets folks leaning into more opportunities. So it is on both sides, but I think that has tightened. And one thing we're really, we're seeing, we believe this, we're speaking with business owners about. We believe the pricing environment today for SaaS business is pretty emblematic of what we're seeing in 2018 and 2019. And in those years, before the highest experience in 21, never were we having a conversation with sellers or sponsors or deal attorneys that was questioning whether the market conditions, whether it made sense for a seller to take their business to market for a reason being it wasn't a strong valuation environment. It was a historically strong valuation environment, any way you can measure it. And in many respects, we've kind of reverted back to that type of environment, which is still a, listen, there's a lot of value still for software founders and owners out there. It just doesn't look like 21. And I think many, many more business owners of software companies are more attuned to those realities and also recognizing that 21 is going to prove to be rather anomalous long-term. 

Shiv: Yeah. Yeah, for sure. And I think even just the idea that if you can get your software founder and you can get five to seven X AR or whatever the multiple is like today, that's still a significant outcome based on where you are. And if you're trying to compare it to like getting 21 X EBITDA or whatever the margins were in 21, it's going to look like you're losing out. But in general, it is a significant outcome. And it is as a trend, it's trending upwards. So I think that's a great point. What about, I think there's a third party in this ecosystem, which is the LPs that the firms are raising capital from. And then there's a set of sellers, which are actually the PE firms themselves. And a lot of them have been sitting on companies that they need to exit, but then there's this pressure from their funds to find liquidity and return capital to LPs. So how much is that a factor here?

David: We think it's an important factor. It was one of the main considerations heading into this year that gave us some, you know, cautious optimism that we were going to turn a corner this calendar year. The reality is, yeah, private equity has largely been sitting, you know, on their portfolio companies, so they have not been widely taking their companies to market. And, that said, there's a real pressure from LPs. It's been heavily publicized. We speak to a lot of sponsors. They're saying the same thing. A lot of LPs are seeking and demanding liquidity. And of course, one way, and the great way to do that is to exit your portfolio company. So I think sponsors are starting to circle those candidates and their portfolios that they could, you know, take to market. There's also the side from the private equity perspective for folks looking to raise new funds. That's also a key element. If you're going to go ask for your, you know, the allocation from your LP for your new fund, I think there's some expectation that you're also demonstrating, you know, some wins, some liquidity from the prior funds and some good marks on, you know, what you're still holding on to. So, that is all to say that ought to drive some PE activity. We do think that's an important part, getting more sponsor portfolio companies in the market. It will help with quality in the market, which again brings more buyers to the table, good assets, trading at good multiples. That helps bring more sellers into the market too. That has been a big piece of maybe the market landscape that has also been sidelined and I think for good reason. As they look at the market conditions, no one wants to sell into a soft market but as we start again, turning the corner here, that activity we think will pick up considerably.

Shiv: And are you seeing that with the LP pressure for liquidity, are there other types of vehicles being used to provide that liquidity? We've had other guests talk about this where other types of facilities or even debt is being used to find that. So I'm just curious what you're seeing on that front.

David: Yeah, there are. There's a variety of continuation funds, people doing secondaries, whether they're recapping, bringing in another minority equity fund or debt recaps. Yeah, those things are being used. some of that is, I believe, if you don't fully want to take something to market and have a full exit, but you do want to satiate some of the liquidity desires, those can be strategies to extend the hold period, but maybe accommodate some of the other pressures or desires of your LPs.

Shiv: Yeah. And I think at the end of the day, truly, you need an exit to actually get the type of liquidity that you want. So I think a lot of the points that you said are true. What about larger deals like, you know, when in the historic run up with the M&A cycle, we also work with some large investors that were investing in these enterprise value type of platforms with over a billion dollars and it's called mega deals, if you will. Are you seeing that type of activity pick up as well on your side?

David: Yeah, that's been another, I think, positive indicator as to what is to come. You know, upmarket has, you know, also been troubled, you know, as credit availability was pulled back. You know, the ability to pull off large, large buyouts also was greatly constrained. And in Q1 and in Q2 of this year, each quarter, there were six you know, US software M&A deals announced with over a billion in enterprise value. So we think that is a positive indicator. Normally when things start reactivating up market, it is an indicator that that starts coming down market as well into the middle market and eventually of course, you know, lower middle market very different than, you know, the billion dollar enterprise value deals, but it's good because it's suggesting the financing is available to do those deals. There's value upmarket. And again, it normally can be an indicator of what is to come below those thresholds.

Shiv: Yeah, we've actually had a couple of our bigger PE partners pull us into deals like that in the last quarter or so. And we are seeing that pick up as well, whereas it was quiet for about a year. And so totally agree that there is more of a demand for it. And that signals other things, right? Because these big funds, they have so much capital to deploy and they don't want to write a small check size before they enter into a platform. So they're motivated to create larger platforms. So definitely a signal that there's more credit available.

David: Yeah, absolutely.

Shiv: What about in terms of just founders themselves and people that are trying to exit, what should they expect now going forward as the market is evolving? Like how should they adjust or prepare themselves as the market starts to become more active?

David: Yeah, great question. again, earlier innings. So I think there's a fair amount to be optimistic about. The market is still different. think preparation ahead of any process is critical because while things, know, volumes coming back online, I would say the bar still remains, you know, pretty high. So if you're going to go to market, you got to be ready to go to market and get through the institutional due diligence. The private equity sets the bar on the level of diligence done. It's a very high bar right now. So if you're not really ready for that process, it is an environment where deal timelines are extended. Time is not the friend of the deal or the seller. Rarely does good things happen with extended timeframes when you're trying to sell a business. So that's one thing you got to be buttoned up and ready to go. I had mentioned, you know, our views on the pricing environment. So of course, listen, there's edge cases to everything. But generally speaking, a 2018, 2019 type of environment in terms of how things are being valued on revenue or ARR. And then the other thing, so, as the bid spread kind of tightens, so what sellers are expecting versus what buyers are willing to pay, that is going in the right direction. There's a willingness to, again, I think a heightened willingness to be creative, find solutions to bridge value when there needs to be a bridge. What we are seeing though is increased use of some sort of structure or non-cash consideration. And I do think founders should be, know, eyes wide open to that. And that doesn't necessarily mean earnouts though, you know, we were seeing earnouts every so often. What we are seeing, especially on the private equity side, you know, whether you're a platform kind of candidate for a sponsor or you're being evaluated as a potential add-on for an existing portfolio company, the percentage rollover or taking stock in the PortCo equity is, we would say, much more prevalent than in prior cycles. And especially when selling to a PE-backed strategic, in many ways, you know, in the market leading up in through 2021. Often if we're entertaining those types of bidders, generally speaking, there is quite a bit of flexibility espoused as to whether, you know, the founders option on, hey, do you want to roll into the combined entity? Tell us how much you don't have to, we'll buy 100% of your business. If you want to roll, great. If not, great. More often than not, that was the conversation. And in today's market, I think that's flipped a bit, there is, hey, if you're selling into this market, seller generally knows more about their business than anybody else. There is a, hey, we need to make sure interests are aligned here. And a very good way to do that is you rolling. Again, whether you're into the platform or into the, you're an add-on taking your acquirer's stock and we're just seeing, not in all cases of course, but many, that being more of a requirement than a optionality for the founder.

Shiv: And that's not like the worst outcome in the world because you get a second bite at the apple when you go and flip the overall entity as well. So that can be pretty good for founders as well as long as those expectations are aligned.

David: Yeah, it can be a great outcome and many of our clients, they don't see that and I didn't state it suggesting it's a negative. I think it's more just a reality and for some folks, it's actually a great opportunity, know, often doing those types of deals that they believe in the combined, you know, prospects of the business and what their company could do as being part of the acquiring entity. So that can be really attractive. In other cases, know, sometimes founders, if they have maybe desires to move on or, you know, they just say, hey, I'm not going to have any control, I'm along for the ride, which, you know, is really the case when you're taking, you know, the buyer stock that, you know, is not looked upon as favorably. So, you know, that's all situational, but it can be a huge value, you know, generating opportunity.

Shiv: That's awesome. I think that's a good place to end the episode, David. But before we go, if people want to learn more about you and your firm, what's the best place they can go to find

David: So you can of course check out our website just to know learn more institutionally www  dot glca dot com. Folks are free to contact me, my email is on the website but it's david dot bluth at glca dot com. So yeah happy to share more. We also publish as you might expect a quarterly software capital markets update and to the extent that's ever of interest to the audience, we'd be more than happy to share it.

Shiv: Awesome. And yeah, with that said, David, thanks for coming on and sharing your expertise. think a lot of people have been trying to navigate these uncertain times and the markets as they've shifted. So thank you for coming on and sharing your insights and bringing some method to that madness a little bit. So appreciate coming on and sharing your insights.

David: Thanks for having me Shiv, I enjoyed it.

Shiv: Cheers.