What Happens When Private Equity Firms Fall for Tech Companies

New research argues that PE firms’ attraction to tech companies is shrinking the window between IPO and buyout.

Illustration by II

Illustration by II

Private equity firms are increasingly targeting publicly traded technology companies for buyouts, including Thomas Bravo’s deal in early March to buy cybersecurity firm Sophos. As a result, some tech firms may be staying public for a far shorter period of time, according to a new report from data provider PitchBook.

“Private equity firms are taking public tech companies private sooner than they have historically,” according to PitchBook’s recent report on buyouts of public tech companies. “The median time from IPO until buyout has dwindled since the financial crisis and now sits at around six years.”

The report analyzed the tech companies that private equity firms have taken private and how they differ from public competitors, including the time between a public offering and a take-private transaction.

“In the years preceding a buyout, the public tech companies that were taken private often saw their valuation drop more quickly than their peers who stayed public,” the report said. “This means PE firms are likely watching dozens of companies and strike after a period of price weakness.”

The research follows PitchBook’s recent analysis finding that global take-private transactions have been increasing in size, but not in actual deals. Private equity firms have also been increasingly investing in technology companies, prioritizing a company’s growth prospects over profitability.

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PitchBook said public technology companies are being purchased at far higher prices than similar companies outside the tech sector. They have also been acquired at prices higher than buyouts of similar private firms.

Vista Equity’s $1.8 billion acquisition of Marketo in 2016 kicked off the trend, according to PitchBook. Since then, the median deal size has been around $1 billion, with three-quarters valued between $400 million and $4 billion. The research categorizes companies that closed between $400 million and $1.25 billion as small and those that closed at or above $1.25 billion as large.

Between 2009 and 2015, the median time between IPO and take-private was 12.2 years for the smaller companies and 9.8 years for large firms. Between 2016 and April 16, 2020, the median smaller company was public for 5.9 years. Larger tech companies were public for slightly longer, at 6.4 years.

Vista Equity took Mindbody private for $1.9 billion four years after the company went public.

Private equity firms have been targeting younger tech companies, in part because they are more likely to have appealing growth prospects compared with older firms.

“Tech take-private targets in both of the size cohorts exhibit higher revenue growth and outpace public comps,” according to PitchBook. “This is consistent with the evolution of the PE playbook, with tech-focused buyout firms focusing on top-line growth rather than reviving mediocre businesses.”

Looking deeper at the financials, PitchBook found that private equity firms took public tech companies private that had above-average gross margins. Operating margins of these companies were much more closely aligned with public peers.

“Indeed, we see a healthy number of firms targeting public tech companies with lower to negative operating margins than in years past, as they tend to indicate higher growth profiles,” according to PitchBook. Software companies, which have made up a large part of take private activity, fit this profile.

Even with tech, private equity firms are still focused on getting a bargain so they can fix a company and sell it at a higher price.

“Tech companies that were taken private almost always saw gross margins fall in the three years preceding their delisting, possibly allowing GPs to swoop in and quickly mend their financials,” according to PitchBook.