A welcome and a webinar + some thoughts on Physics, Private Equity and Cap Tables
Hello there and a happy first day of Summer to you. I’m pleased to be back in your inbox with a newsletter with some thoughts on private equity and cap tables. Before that, a couple of quick announcements.
A Warm Welcome
I’d like to welcome Carter Hawthorne as the newest member of the Bigfoot team as our VP of Originations. Carter joins us from Cambridge Trust Company where he worked on the Innovation Banking team providing venture debt and prior to that was on the life sciences team at SVB. We’re pumped to have him onboard and point him towards our ecosystem of great partners (i.e., the fine folks such as yourself who read this newsletter).
Webinars
On June 27th (next Thursday) I’m joining Driven Insights to chat debt and equity for software companies - considerations, diligence, similarities/differences, how they play together.
I joined them a couple months back to discuss budgeting (!)
Also, heads up - we’ll be sending out our 3rd annual capital provider market sentiment survey next month. Always appreciate your participation.
Physics
All of my immediate family works/has worked in healthcare. I was not particularly good at/interested in science. I took physics my senior year of high school and while our teacher was awesome (he was hilarious, played the sax and we were all convinced he was high most of the time), I really didn’t grasp the concepts all that well.
When I saw Eric Paley’s Tweetstorm (people still use that terminology?) on startup physics and actually understood it all, I really felt like I had come up the curve a bit in the intervening 24 years since senior year. Here was my take below (links to the original LinkedIn post which links to Eric’s tweets).
Private Equity Ponderings
Powder Paused
Make no mistake, the PE dry powder phenomenon is real. For all you CAGR fans, PE dry powder is CRUSHING IT with an 11.3% 20-year CAGR since 2003. Today, we’re talking $2.6 TRILLION, which is like like 10% of GDP.
The problem is it’s still just sitting there, which really isn’t all that helpful to the capital markets. We’ve all heard about the dry powder that’s going to come flowing off the sidelines in Q1 (didn’t happen), wait Q2 (nope), make that second half. Er, next year. Well, we’re still waiting…
Platform Scarcity / Exit Paralysis
This dry powder will only truly be liquified (realized) with a meaningful step up in platform investment activity
Simply put, platform investments just aren’t really happening these days and it really comes down to 3 simple reasons:
Credit Markets - less leverage at a higher cost and thus more equity required make LBO IRR math harder to work for platform investments.
The leveraged lending and private credit markets for buyout deals have rebounded a bit with spread compression between the two. However, the primary activity there continues to be refinancings and, somewhat surprisingly, dividend recaps rather than issuance for new deals.
Funding smaller add-ons or minority growth investments with equity is one thing, but it’s tough for larger buyouts.
Lack of compelling investment opportunities - The combination of continued performance challenges and a sticky bid/ask spread between sellers and buyers (especially for sponsor to sponsor deals) just makes it hard to get deals done. Sponsor to sponsor exits are representing a much lower % of overall M&A volume, accounting for 30.4% of PE exit value in Q1 2024, compared to the previous two years’ quarterly average of 46.3%. Take privates are a potential avenue for new platform deals, but there has not been as much activity there as may have been anticipated.
Concentration of PE capital and lack of proceeds - There are really on about 25 PE firms that can make true platform investments at scale. They’ve basically got all the dry powder. The rest of the PE market may have some powder but their ability to generate cash from exits (which remain anemic) and recycle that cash into new sizable investments continues to be very limited.
Given this, private equity activity is dominated by add-ons. According to Pitchbook,
Add-on acquisitions accounted for 76.1% of buyout deal count through the first three quarters of 2023, the second highest since 2008.
Furthermore, data from Pitchbook shows that platform investments represented 19.0% of all PE deals in Q1 2024 at ~400 deals for the quarter. Q1 average deal value was at $69M, compared to an average deal size of $87M in 2023, a 21% decrease in average deal size.
Additionally, with PE still comprising 56% of all SaaS M&A activity in Q4 2023 (see below from Software Equity Group), it’s interesting (and validating) to see that only 20% of that is comprised of platform investments with the remaining 80% being PE-backed strategics making add-on acquisitions.
Crummy Cap Tables
Our #1 pass reason over the past 6 months for deals we’ve dug into where we like the business profile and trajectory along with the operators is the legacy equity capital formation. I touched on this a bit in a previous newsletter re: getting off the VC train, where I said:
Getting off the VC train is not an easy feat. Sometimes companies have a choice, many times they don’t and are just forced by the market. I’d say it’s much easier to get off (and back on) the train if the amount of VC injected has been moderate at reasonable valuations.
Unfortunately, there’s a whole generation of companies for whom that is not the case. It does not mean their business or its potential is broken, but their capital structure very likely is and their optionality has certainly been dramatically reduced. We’ve seen a lot of these this year and it’s unfortunate.
We’re passing because there’s just been too much money raised and too much cap table sold for where the company is and where it’s projecting to be. In our view, the opportunity for: 1) stakeholder success (the equity investors in the preferred classes and the operators in the common) and 2) future capital formation optionality, has been materially negatively impacted, so we pass.
Some lenders feel fine providing a $3M loan to a company that has raised $30M and is doing $5M in revenue. The justification is “we’re senior and we’re covered by the equity, so we’ll be fine.” I’m not knocking this approach and they may be right, but this is not a credit justification we subscribe to.
We want to come into a situation where we believe there is still an opportunity for all stakeholders to have a successful outcome (i.e., make money). If that appears to be the case, which is generally when the company is performing and the capital structure is not a total mess, then we’re often able to contribute to a positive outcome.
About Bigfoot Capital
Bigfoot Capital offers growth-oriented loans for B2B software companies with $2M- $20M in revenue. We pride ourselves on partnering with companies and their stakeholders to provide a capital partnership that comes with stability and support.
If you operate or support a B2B software business and want to learn more about alternative capital options that preserve equity, get in touch with our team today.