For 20 years, Hg has had a unique position as Europe’s largest specialist software & services investor, with an investment remit that covers the complete size spectrum from the smallest bolt-ons to the largest software buyouts in Europe. This 360-degree viewpoint gives us deep insight into the opportunities and challenges that face software companies as they mature, particularly in a European context. We look at how rising private investment fuels the growth we are seeing in the Software-as-a-Service (SaaS) business model, from both new and existing providers.
David Toms, Head of Tech Research, Hg
Originally published on the Megabuyte CEO Hub, specifically discussing European SaaS and the UK’s position in this sector.
The last decade has seen a material acceleration in venture and growth funding, driving an accelerating pipeline of future investment opportunities and stimulating the development of a vibrant ecosystem for tech companies.
This is true across Europe, but is particularly prominent in the UK – which is the clear European leader in terms of capital raised, in part reflecting the dominance of London. However, even if we remove London from the equation, we see that “UK ex London” still sees more investment than almost any individual country in Europe.
This highlights the importance of thinking “outside the box” (or at least the M25…). Some of Hg’s most successful UK investments have been based beyond London’s infamous orbital motorway – Citation, in Wilmslow; Iris in Langley and Manchester; Relay in Belfast; and Dext in Altrincham. Nothing matters more to a tech company than attracting and retaining top quality staff, and we consistently find major pools of talent located well away from London. Furthermore, the intangible nature of the “product” lends itself well to remote working – this, coupled with the high levels of competition for talent and the impact of COVID, makes us very alert to the growing opportunity set outside London.
The rise in early stage investment also exemplifies how investors have gained confidence in the long-term structural opportunities in the sector. A further effect of this has been on the relative attractiveness of growth. Below we show the value of each percentage point of growth, in terms of EV:Sales multiple. In 2010, 10% growth was worth around 4x EV:Sales, and by 2020, the valuation of an identical company with the same growth rate had risen to 8x EV:Sales. The rising value of growth incentivises companies to devote more effort to seeking out and investing in that growth.
Nowhere is that growth more obvious than in SaaS. Since 2012, all growth in the sector has come from this delivery model. Crucially, this means that the accelerating growth is also yielding greater predictability. Until recently, SaaS has been largely fed by new business, but increasingly our 2019 prediction is gaining momentum – companies are re-appraising their on-premise legacy IT estate and starting to migrate to the cloud. We see a huge opportunity from this; evidence from our own portfolio, public companies, and our market diligence, consistently points to a 3x revenue uplift when an on-prem customer migrates to a cloud subscription model.
This is a trend that we have been backing for over a decade, and the rest of the investment world is starting to see the same attractions that have been apparent to us for so long. Around a third of all capital invested in the tech sector is now going to SaaS companies.
However, building a successful SaaS business is not a given; our long association with the sector means we have lived through hundreds of millions of pounds of organic investment and billions of pounds of M&A investment. During this time, we have seen three particular routes to building a successful cloud business:
1) M&A-led transformation
This is typically the route followed by our larger companies, with substantial existing customer bases. By focusing on M&A targeting high growth modern cloud software companies, the existing business can acquire the necessary cloud DNA. This can be as much cultural as product, and in acquiring this, the parent company also enhances its ability to accelerate its own organic transformation. This is best exemplified by the transformation of Hg’s largest portfolio company, Visma, which now has over $1bn cloud-native revenue.
2) Organic transformation
We find that this route is best suited to businesses which have one particularly significant product which can be re-engineered. At the very least, it requires an acceptance that the transition will cause growth to slow and margins dip, and at the extreme, it can mean a sharp drop in revenue and profit. However, the resulting benefits of stronger customer relationships, better long-term growth and improved predictability typically yield a high return on the investment. We have lived through this transformation with many companies including Allocate Software, P&I and IRIS. Although we describe it separately from “M&A led transformation”, typically any one company will include elements of both.
3) Building/scaling a pure SaaS business
With businesses such as e-conomic, Intelliflo, and our recent investments into businesses such as Dext (formerly Receiptbank) in the UK, Silverfin in Belgium, and Prophix and Benevity in Canada, we have long experience of building and scaling “born in the cloud” businesses. These yield a different set of challenges to a transformation process, in particular, balancing investment and growth. Typically such companies are growing at 20-60%, and it is a race to build the supporting infrastructure of the bridge as fast as the road across the top. One such example is below – by 2016 the business was five times the size of the one in which we’d originally invested, requiring scaling of systems, processes, staff and technology in order to maintain an exceptional customer experience throughout.
Rising investment, more growth, greater predictability and a growing pool of opportunities gives us huge confidence in the outlook for the next decade.
The software and services industry has proven its mission criticality time and again particularly over the past year, supporting customers in their most challenged times and helping position them for the inevitable recovery from which all will benefit.
We look forward to seeing the fruits of this investment for many years to come.