Technology M&A Outlook 2019

At the beginning of each new year, we look back at the previous twelve months to reflect, review and make predictions for the market in future years. This allows us to improve as a company both in terms of the services we offer and the advice we give clients when planning exits or making investments in the space.

Whilst FE International operates in a very specific sector of the technology M&A industry, reviewing the market as a whole can help identify trends and is usually strongly correlated to activity and confidence in the sector.

2018 was a record year for technology M&A and IPOs. Deloitte reported in The State of the Deal: M&A Trends 2019 that technology acquisitions were the driving force behind M&A, a finding consistent with the high levels of strategic SaaS, e-commerce and content acquisitions completed by FE International and our clients over the past year.

On the IPO front, several notable companies went public, including DocuSign, Dropbox, and GitHub, and while stock markets slowed towards the end of 2018, the BVP Nasdaq Emerging Cloud Index showed software companies up c.37.1% year-on-year (c.290.8% since 2013 versus c.82.7% for the Nasdaq). One of the largest megadeals in 2018 took place in the e-commerce industry, as Walmart’s acquisition of Flipkart for $16 billion brought greater e-commerce presence to India—a market of increasing importance in the e-commerce industry.

Whilst the majority of deals completed by mid-market M&A firms like FE International are not publicly reported (making a complete market overview nearly impossible) global M&A grew year-on-year for the third consecutive year, as reported by the Institute for Mergers, Acquisitions and Alliances, which is consistent with our own observations.

Specifically, within technology M&A, the industry has reached a new peak. Investors have learned from previous false dawns and are focused on acquiring companies that have a strong financial foundation versus following the latest trend (more commonly observed in venture capital activity).

Sellers are also better educated in growing, scaling and optimizing their businesses. This means that businesses are better prepared for exit which benefits all three main parties in a transaction: investor, seller and intermediary. Intermediaries like FE International will continue to invest in this area as the benefits for all parties continue to amplify.

Indeed, 2018’s record valuations reflected the rising quality and education within communities of business owners. The macro-markets correlate: 2018 saw 40 major tech companies go public (more than one-third were SaaS) and 2019 has shown no sign of this trend slowing. Further, analysts predict these SaaS companies are better placed than most to withstand the forecasted market turbulence expected in 2019, as was demonstrated in the later stages of 2018.

FE International’s own research in the mid-market concurs and we expect this rising confidence in SaaS and other technology businesses to continue.

2019 M&A Forecast

Over the last decade, the technology sector has more than doubled the share it occupies within the global M&A market.

As the e-commerce sector topped all past years for record sales volume—2018 saw worldwide consumers purchase a record $2.86 trillion online—digital businesses of every kind are capitalizing on this momentum to grow at unprecedented rates, with a continued rise in the number of self-funded stores (built on platforms like Shopify and marketplaces like Amazon) being launched.

Due to increased online browsing and consumer activity, digital advertising spends grew to $49.5 billion in the first half of 2018 alone, setting a record for the most advertisers have spent on digital media in the first half of any year. This will continue in 2019, meaning content businesses will maintain their relevance and popularity with investors.

Other key factors, like a growing reliance on the efficiencies created by cloud computing (to both businesses’ operational margins and individual consumers alike) which is driving growth in both B2C and B2B SaaS, as well as a rise in receptiveness to international and cross-border investments (e.g. Walmart’s Flipkart acquisition), have contributed to the growing need for expert advice in mid-market acquisitions. We predict this will continue to rise with the number of international deals being completed, particularly as U.S. investors seek deal flow which is exacerbated by their relative buying power compared to domestic acquirers in smaller countries.

Valuations for 2019 will continue their rise as more business owners look to exit fundamentally strong companies, encouraged by strong market activity and the fact that investors in private equity firms look to deploy existing capital and complete more transactions. Many of these investors were present in the market several years ago and have started themselves to exit previously acquired technology businesses, giving further confidence in the industry as a whole and thus, deploying capital at increasing rates.

2019 is therefore set to be another record year in the technology M&A sector and FE International is firmly focused on ensuring that the quality of advice in the industry remains high, to ensure safe, secure and successful deal making for technology entrepreneurs and investors alike.

Valuations for Technology Businesses

Five-second overview:

Valuations for Technology Businesses in 2018

As anticipated at the start of last year, small- and mid-cap M&A activity in 2018 rose comparatively with 2017. However, for the first time in recent history, the increase in activity seen in 2018 outpaced historic annual growth rates, leading to a record year for the sector.

This trend was apparent across business models and size ranges. Where multiples used to be at a premium at both the lower and upper ends of the market (and depressed relatively in the mid-range), 2018’s increase in multiples were evenly distributed across the spectrum as a result of more entrants in the market creating competition with incumbents who had traditionally enjoyed more time, flexibility and leverage when making acquisitions.

Across business models, the highest valuations were attributed to businesses with the following attributes:

• Consistent delivery on key growth metrics;
• Above-average market fit (measured as a ratio of size-to-age);
• Above-average margins;
• Low margin volatility (providing for strong and predictable free cash flows);
• Low revenue concentrations (either by customers or type);
• Above-average business-relevant KPIs (i.e. revenue churn for SaaS businesses);
• Low owner involvement, driven by teams (both internal and external) as well as streamlined operations; and
• Businesses that had successfully completed exit planning ahead of an acquisition.

Valuations for Technology Businesses in 2019

Valuations for technology businesses are expected to rise again in 2019. This will be predominantly driven by the influx of new investors into the space (with increasing levels of sophistication) while the overall supply levels will remain relatively constant.

There are a few important factors to these points that must be explained in full.

The industry has continued to see a rise in the overall level of investor activity since the last global recession, which started to thaw in 2011 and 2012. During this period, the industry was still very much dominated by both very small firms flying under the radar, and much larger enterprise firms which were well on their way to multi-million- and billion-dollar IPOs (many of which materialized in 2018). However, despite having just seen one of the largest recessions in global history the levels of available funding for M&A activity did not drop much, if at all, even if sentiment for institutional acquisitions did.

This led to an influx of investors from unrelated spaces who were used to high returns but had seen their yields (and trust) in traditional investment options erode and were consequently willing to look at these ‘alternative’ investments as a serious asset class.

At the time, the values of acquisitions were still relatively low, which was reflective of an industry in its infancy. This played into the hands of fellow technology entrepreneurs in the space, who for nearly half a decade were able to take advantage of the fragmented nature of the industry to acquire businesses for very low multiples. This hit its peak between 2006-2010, a period very much referred to as the ‘wild west’ days of the small- and mid-market technology M&A industry. Businesses would often trade hands for one to one and a half years discretionary earnings as supply was high and investor demand was low.

It can therefore be said that the global recession kickstarted investor appetite for small yet reliably profitable businesses in the technology space. These investors changed the industry just as quickly as they entered it, and almost overnight acquisitions were trading in the two to three years discretionary earnings level and have continued to rise ever since.

Ever since this turning point there has been more demand than supply in the industry. Even as the dominance of e-commerce has become fully apparent and SaaS is present in more online and offline businesses than ever before, the amount of successful e-commerce and SaaS businesses available for acquisition has not been able to outpace investor demand.

To compound this further, investor demand has switched from not only technology entrepreneurs and early entrants, but now also private equity firms, funds and strategics who have been able to leverage the global media coverage and success of companies like Salesforce, Amazon and others to gain approvals from their own investors for these types of acquisitions.

With four active classes of investors now all competing for the same deals (high net worth individual, PEs, funds and strategics), business owners have invariably demanded higher multiples as the balance of power has shifted over time. The increased education and information made available to business owners by M&A firms in the space has helped to speed this process along, too.

That said, it has not all been one-way traffic. While investors across the spectrum have continued to be accepting of increasing multiples, it has become apparent that this demand will only be matched where a business is able to demonstrate a clear competitive advantage. This has become increasingly important with more entrepreneurs trying to enter the space (i.e. building businesses to sell), Google, Amazon and Facebook continuously re-writing their algorithms and the rise of the conscientious consumer that is now just as interested in branding and ethics as with quality and value for money.

This business positioning is not something that can be achieved overnight (even for technology firms) and as such, investors are willing to pay more for companies with strong brands as they provide a defensive runway to acquire, refine and grow the businesses long term with additional capital and management oversight, without the fear of being put out of business by rampant competitors while they implement change.

Therefore, valuations are expected to continue to increase in 2019, however, premiums will be allocated to those companies where investors can build an investment case around the merits of the business as a going concern; and not for merely being a technology business. While it is true that technology allows for great scale, technology is now so integrated into the wider global ecosystem that many of the more traditional business tests can now be applied, and importantly, many technology businesses are passing them. This proves that these traditional values are valid indicators of a business’ strengths and will continue to be a focus for the increasingly sophisticated investor base.

Business owners who seek exit planning advice ahead of a sale will invariably be better placed to meet and exceed these metrics and will post record acquisition multiples in 2019.

In order to do this, it is important to start by understanding the metrics on a model-by-model basis.

SaaS Business Valuations

SaaS businesses tend to earn the highest multiples among their e-commerce and content-based counterparts, often due to:

• Recurring revenues;
• Lean cost structures;
• Strong market demand; and
• Increased customer demand of services.

Mid-market SaaS valuations are increasing faster than any other business model, with the average multiple hovering around 3.8x SDE and some acquisitions going as high as 4.75x-5x.

Companies and individuals are spending more on SaaS—Gartner predicts cloud industry revenues to reach $85.1 billion USD in 2019—which means business owners have room to capitalize on growing demand for SaaS tools. B2B SaaS in particular will drive a product-led focus in 2019 especially as an increased focus on end-user-experience improves sales and customer success. More sophisticated incorporation of customer feedback, as well as optimized onboarding processes, have improved churn rates for those willing to invest in updates, since ultimately it is the end-users who influence senior executive buy-in.

Understanding of the SaaS model has also helped make it more popular for entrepreneurs, investors and end-users alike. The requirement for licenses with support, updates, and other technical operations is no longer a hurdle to business operations. A detailed understanding of how SaaS valuations are conducted will not only serve entrepreneurs who are planning for exit, but also help improve operations to realize profitable gains in the short term. For a more detailed understanding of SaaS valuations, head over to our complete guide on How to Value a SaaS Business.

In conclusion, small- and mid-market SaaS businesses are expected to continue their rise in value during 2019, driven by a greater awareness and importance in the global economy as a whole. That being said, investors are more experienced than ever, so SaaS business owners must be ready for their businesses to be measured and tested by seasoned investors that are seeking only the best firms as they stand the best chance of growth at scale once additional capital and management oversight is deployed. The SaaS businesses that achieve a premium are almost always products that are prepared for growth at scale.

Content Business Valuations

Increases in digital advertising revenues across the globe have fueled a wave of entrepreneurs to rise to the challenge of meeting this increased global demand for content online. Valuations for content businesses therefore continue to rise as entrepreneurs gain a stronger understanding of how to use lead generation, affiliate partnerships and advertising to generate income.

The affiliate and advertising models are the two most common monetization strategies of content businesses. Read our complete Guide to Valuing an Affiliate Business and our Guide to Valuing an Advertising Business for a more comprehensive overview of content business valuations.

In brief, the valuation of an affiliate website is highly contingent on the terms of the affiliate program and its longevity, the product category, the seasonality of the product, commission tiers, content quality, and the backlink profile. Affiliate websites that can score well in all of these areas will likely have above-average earnings, margins and longevity which proves attractive to investors. Advertising businesses share many similarities with affiliate businesses for valuation purposes as they also rely on content and end-user intent to generate income.

Content monetization (i.e. affiliate and advertising) partnerships are not just limited to online businesses; many have been observed partnering with offline businesses seeking a greater direct access to end-users. This is an area of particular focus for investors, many of which come from traditional backgrounds and may have existing relationships to leverage.

Summary

As consumerism continues to migrate online (with mobile leading the charge), these advertising and affiliate websites will see increasing levels of investor demand, and at FE International we have seen the value of well-built websites in the space rise in value over the last 12-24 months, primarily driven by investors who are more aware, understanding and willing to acquire these businesses in an attempt to capture more of the value chain in the digital economy which will undoubtedly take over the global economy in time.

E-Commerce Business Valuations

The domination of e-commerce in 2018 was apparent for all to see, with $2.86 trillion spent online worldwide. The dominance of Amazon as an e-commerce giant remains, with the company being the second to ever achieve a $1 trillion market capitalization, but other giants have emerged in other countries too (such as Alibaba in China and Flipkart in India, acquired by Walmart for $16 billion).

This has led to a global ‘gold rush’ in e-commerce stores, with Amazon and Shopify leading the way. Both have provided simple yet effective ways to get up and running quickly, with the latter also allowing store owners to build a brand for additional longevity. Valuation activity has also been led by platform activity, which saw a significant increase in 2018. Adobe provided one of the largest acquisitions, taking over Magento for $1.68 billion in an acquisition that was widely anticipated for some time.

Despite the heightened activity, the fundamentals of e-commerce valuations in 2019 will remain; you can learn more about e-commerce valuations in our Guide to Valuing an E-Commerce Business.

There has been a significant movement to multi-channel advertising, again demonstrated by Adobe in their acquisition of Marketo for $4.75 billion in 2018. This, coupled with the acquisition of Magento tells investors everything they need to know about the future of e-commerce, which is consumer focused. Stores that fall in line with that vision today will stand the test of time and will ultimately be rewarded in terms of higher valuation multiples.

Funding for Acquisitions

2018 saw an influx of funding for e-commerce acquisitions, as PEs, funds and strategics all started to compete for a piece of the online retail market. High net worth individuals were not left out, with SBA loans more readily available and more stores than ever qualifying for the government-backed financing program.

This invariably had an impact on valuations, as PEs, funds and strategics are accustomed to paying higher multiples and SBA acquisitions mean high net worth individuals paying as little as 10% to acquire businesses. As such, multiples did not become arbitrary, but certainly were a secondary focus relative to establishing the value of a business based on its merits. This is set to continue in 2019 as debt is forecast to remain relatively cheap and as such will continue to fund acquisitions in the space.

Summary

E-commerce has emerged as one of the most accessible and densely populated technology business models over the past decade due to the relatively low barriers to entry and the lucrative gains to be made by being a first entrant to market. As the market matures, investors are now focused on whether stores will be here in 10 years or more, and are increasingly relying on data and traditional business analysis to determine this. While the act of purchasing is certainly carried out online, the rest of the value chain is tied up in offline activities, and as such, businesses that are well-organized, efficient and have streamlined operations with a compelling brand that keep customers coming back (and thus pushing down the cost of acquiring that customer lifetime) will receive higher valuations in 2019 and beyond.

Investor Trends

Five-second overview:

Macroeconomic Factors Driving Acquisitions

In the US, tax reform and the increased GDP growth levels have presented favorable conditions for high net worth individuals, PEs, funds and strategics who are now utilizing the increased capital on hand to drive further inorganic growth through acquisitions.

We have observed the following trends with investors over the course of the past year, and expect the market will continue to trend in this direction.

Investor Overview – Key Points

• Interest Rates. Investors have enjoyed a prolonged period of record low interest rates, but are increasingly keen to deploy funds ahead of further anticipated rate hikes.
• Business Positioning. Investors are keen to acquire multiple opportunities in a short timeframe (especially PEs and funds) and as such, businesses with strong brands, teams in place and strong customer loyalty metrics are most valued.
• Recurring Revenues. We have observed a noticeable increase in demand for the recurring revenue model. Even investors with no technical expertise have demonstrated a willingness to jump into ownership of SaaS, due to the steady cash flow and scalable cost structure. More and more investors are interested in becoming portfolio investors, with their primary concern being to continue building a portfolio of businesses generating predictable returns.
• Platform Risk. Investors are more seeking businesses with diversified sales channels (including offline) over those with a single revenue source, but are also willing to work with those that do not currently fit the profile, yet have strong enough brands and customer loyalty to successfully transition away from incumbent platforms in the medium- to long-term.
• Changing Investor Demographics. Investors are increasingly taking the role of financer in acquisitions, taking on younger and more tech-savvy entrepreneurs (aged 22-29) with the skills but not necessarily the capital to complete acquisitions. This is especially apparent with PEs.
• Trickle-Down Economics. As 2018 saw a record year for IPOs, exited founders and investors are increasingly operating in the small- and mid-market M&A space (often SaaS) to invest for long term returns.

Businesses Demand: A Business Model Breakdown

FE International recently conducted a business model demand survey from across our 41,000+ strong investor network. We discovered the following trends exhibited by small- and mid-market investors, from all ranges of experience, age, professional backgrounds and financial brackets (note: investors were able to vote for more than one area of interest and expertise).

SaaS proved to be the most popular business model among investors, though a majority were open to many different monetization structures among online businesses.

Close to the top of self-reported areas of expertise was operations, indicating that new owners are mostly looking for practical investments with strong business fundamentals.

Final Thoughts

Global economic conditions have contributed to a record year for online businesses investments and global M&A as a whole in 2018, and this is set to continue in 2019. Any increase in economic uncertainty has historically resulted in more entrants into what is already becoming a crowded investor base, and valuations are set to benefit as a result of this, and wider understanding and acceptance of the asset class in general.

However, businesses are facing ever rising investor expectations and those that have the ability to grow at scale will see meaningful valuation premiums today and for years to come.

Record Growth in 2018

At FE International we are proud to report a continued unbroken streak of yet another record year for mid-market SaaS, e-commerce and content deal activity. We set out to double our deal volume at the outset of 2018 and thanks to the incredible clients we worked with, once again achieved a growth rate of over 100% year-on-year. With over 6,000 businesses inquiring to list with FE in 2018 we saw more business owner activity than ever before, but we still only listed 1.9% of businesses analyzed (similar to 2018) as we strive to only take the very best businesses to market.

It is a privilege to serve our clients as the market leading M&A advisory firm. 2018 was a landmark year for FE’s expansion and involvement in the industries we serve, including:

In 2018, we successfully executed 145 acquisitions, with an overall success rate of 94.1% and an average discount from target price of 5.8%. Our industry leading M&A team maintained an average multiple of 3.1x across all business models (with SaaS acquisitions up to 4.75x) and acquisitions closing in 60 days on average (faster with content businesses, slower with e-commerce).

2018 also brought another year of rapid business and operational expansion for us here at FE International; we opened a new headquarters in New York City (Rockefeller Plaza), ran the fourth annual LTV Conference, launched the first edition of SaaSMag, published the 2018 SaaS 1000 Awards and made several notable acquisitions in the M&A advisory service space to consolidate our leadership in the industry. In 2019 we expect more of the same, including opening an office in San Francisco in Q2’19.

FE International Launches SaaS Mag

The launch of SaaS Mag, which now encompasses the SaaS 1000 List, was one of the most exciting milestones of 2018. It was a great way to begin the conversation with the SaaS industry around readers’ demand for a print publication. It focuses on SaaS-related news, interviews with SaaS founders, and actionable SaaS management and growth-related articles. We are thrilled that the magazine was met with such an enthusiastic and positive response, and has already come to be regarded as the authority for commentary, news and insights in the industry. This quarterly magazine was launched to offer a platform for the rapidly-growing SaaS industry to explore growth strategy, stories of success and experimentation. We look forward to continuing to build the magazine and its online counterpart into a must-have resource for up-to-date industry insights, trends and information. Regular content is posted on the SaaSMag.com blog, which operates on a free subscription model—with some articles being free-to-view and others requiring users to create a free account.

FE International Acquires SaaS 1000

The SaaS 1000 is a list that highlights the top growing SaaS companies based on a proprietary algorithm that includes hiring trends, growth indicators and number of employees using a seamless algorithm to track a SaaS company’s growth. The site has been publishing a curated list of the fastest growing SaaS companies for several years now, and SaaSMag was a natural fit for a partnership upon FE’s acquisition of the list. By bringing together the SaaS1000 list with our internal expertise, we will be growing the authority of the SaaS1000 list by moving it under the authority of the larger SaaSMag brand.

We are especially excited for how this collaboration can grant visibility to SaaS entrepreneurs in the future, as the SaaS1000 list is a traffic-heavy site, and thousands of people check it every month to see which SaaS companies are really growing.

FE International Acquires Transferslot

We are incredibly excited about our latest acquisition, Transferslot, a curated marketplace for entrepreneurs to match their side projects with reliable investors. Our first acquisition of 2019 for FE International, Transferslot, fills a gap in the market for small SaaS/app businesses which do not have a need for a full-service M&A firm like FE International, but which may still be highly attractive to investors interested in acquiring a business that are just starting to gain traction. This acquisition brings with it new synergies in a fast-paced approach to helping founders exit a business, allowing FE to advise a wider set of entrepreneurs and business owners in reaping the rewards of the business they have built.

FE International is excited to further consolidate the market and bring its considerable resource and experience to growing Transferslot as a standalone brand and a place for people to get started in the industry.

FE International Acquires iAcquisitions

This late 2017 acquisition of iAcquisitions, a one-time competitor grew to maturity with a major platform update in 2018 and has helped FE gather a new network of investors in the e-commerce space. As leaders in the historically fragmented e-commerce industry, we are glad to be able to help consolidate the space to create more opportunity for entrepreneurs and investors alike.

This acquisition was a great way to bolster market share in the e-commerce space and added a local presence in Chicago, a market FE International has been active in for some time.

Continued Focus on Conferences and Industry Events

FE remains active as ever in the conference and events community. Over the course of the year FE has attended dozens of conferences and networking events around the globe. This year the team attended, hosted and spoke at nearly 40 conferences and events, expanding our reach and fostering productive conversations with new and established friends, clients and fellow experts in digital industries.

We also hosted more than 15 networking drinks at events, on top of the many speaking engagements led by FE International founder, Thomas Smale, and the team.

One of the most exciting conferences from 2018 was LTV Conf, which brought together leaders in SaaS to collaborate and learn from the greatest minds in the industry. We are incredibly excited to be hosting LTV Conf again, this time in New York City on April 3-4. The speakers, workshops and collaboration fostered at the conference brought about fantastic conversations and actionable insights from topics like GDPR, improving churn, marketing growth strategy and scaling up.

It was a privilege to hear how much attendees gained from the event, since our aim for the conference was to help SaaS leaders, founders, operators and investors take away valuable insights that could be applied to their growth strategy.

This coming LTV Conf 2019 features speakers like Dan Martell, experienced SaaS Founder of companies like Clarity.fm, Nathan Barry, Founder and CEO of ConvertKit, April Dunford, product positioning expert, Kathryn Minshew, CEO & Founder of The Muse, Kerel Cooper, Senior Vice President of Global Marketing at LiveIntent, and many more. We are incredibly excited for this next installation in the world’s premiere SaaS conference, and can’t wait to see the many successful founders and investors we have had the privilege to work with over the years!

Let us know if you are planning on attending the 2019 conference either by commenting below or emailing us at info@ltvconf.com. We will send you a discount code and enroll you in the FE International-exclusive exit planning workshop, completely free to ticket holders.