I was surprised to see the degree to which software buyouts appeared to outperform. There appeared to be an advantage in both the loss rate (3.9% in software vs. 14.7% in non-software from ‘05-’14) and MOIC (1.9x vs 1.6x for the same time period).
One variable contributing to this success, per the paper, is that software firms are often so successful that they fail to successfully optimize their cost structure. The paper introduced the “rule of 40” in this context (which was new to me):
One rule of thumb used by experienced tech investors as a preliminary asset screen is the “rule of 40,” which says that software businesses should have organic revenue growth plus EBITDA margins of 40% or higher. A company much lower than 40 is probably investing too much relative to the profits it takes out. (By contrast, a company that far exceeds 40 may not be investing enough to support growth.) Most software companies and the vast majority of recent software targets for leveraged buyouts fall short of this goal, implying that there are significant opportunities to add value.
Ever a fan of investment check-lists, the paper highlights common tech investment pitfalls on page 29 and 30 of the document – I suggest checking it out.