Start-Ups Are Being Bought Up by Private Equity

Start-up founders and shareholders used to hope for a flashy exit in the public markets. They’re increasingly being swallowed by private equity instead, according to PitchBook.

Oliver Bunic/Bloomberg

Oliver Bunic/Bloomberg

Flush with cash, private equity funds are snapping up venture-capital-backed start-ups.

The number of private equity buyouts of start-ups funded by venture capital grew at an annual rate of 18.1 percent between 2000 and 2019, according to PitchBook. That compares to a 9.5 percent annual growth rate for all buyouts over the same 19-year period. The figures illustrate how private equity firms, once big buyers of old line companies that needed a financial and operational makeover, are now involved with developing acquisition and other strategies for fast-growing technology and growth businesses.

Almost one-fifth, or 19.2 percent, of VC-backed companies, primarily technology companies, were exited through a private equity buyout. In 2000, that figure was just 2.4 percent, according to PitchBook analysts Stephen George-Davis and Van Le.

“The proliferation of PE buyouts of VC-backed companies (referred to here as VC-to-PE buyouts) stems from PE firms seeking earlier exposure to tech companies that are often staying private for longer,” George-Davis and Le wrote in an analyst note published Monday. “While PE firms may not be specifically pursuing investment in VC-backed companies, the growing overlap between buyout barons and tech entrepreneurs appears here to stay.”

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The PitchBook analysts explained that private equity fund sponsors are increasingly looking to tech companies, particularly as they can no longer rely on financial engineering alone to generate high returns. This means that private equity is now in the mix with other cash-rich buyers for VC-backed tech companies.

“PE firms specializing in software buyouts often act like strategic acquirers and increasingly outbid them for high-growth VC- backed companies,” the report stated.

Like many trends in the private markets, this one can be blamed on an abundance of investors wanting to put money to work in the sector, as well as low interest rates. Private equity firms’ traditional targets have gotten more expensive as more competitors fight over them. At the same time, many venture-backed companies have gotten more mature as they stay off the public markets longer. VC-backed firms have higher revenues and valuations and a higher number of employees than they did in the past.

“Therefore, while it was previously more common for PE firms to source technology investments from public markets, they can now go straight to the source,” the PitchBook analysts wrote. VC-to-PE buyouts represented 4 percent of all buyouts in 2019, according to PitchBook, while take-privates — when a private equity firm takes a public company off the market — account for 0.97 percent of deals.

Once tech firms are in the private equity world, they may end up getting passed around.

In 2019, 63.6 percent of portfolio companies that were acquired in a VC-to-PE buyout were subsequently sold to another sponsor, PitchBook found. This is above the rate for the broader private equity market, where 50 percent of all portfolio companies were sold to another private equity firm.

“To PE firms, buyouts of VC-backed companies represent a way to maintain mid-double-digit returns, while for VC-backed companies and founders, they can be a lucrative exit option with additional upside potential,” the PitchBook analysts wrote. “We expect these deals to continue proliferating as tech-focused PE funds multiply and spend down dry powder.”