Jul 19, 2022
Originally posted here.
Many are unaware that one of the biggest roles in this industry, are those played by Private Equity (including Growth Equity) and VC (Venture Capital) firms. From the learning system and learning technology standpoint (and yes, I see a difference) the PE or VC firm is the one to go to when you seek capital or seek to be acquired. They are the ones that many vendors still today, hear from, to gauge whether or not said vendor is interested in being acquired or receiving funding.
In the learning system and learning technology space, the Growth Equity firms lead the pack due to the number of early-stage companies who have the high growth potential. However, recent buys such as Cornerstone for example, came from a PE firm. Another big-time player in the learning technology/system space is Vista Equity, a PE, who at one-time in the 2009-time frame owned SumTotal. In 2021, they invested in Schoox.
PeakSpan Capital, is a Growth Equity firm. Their recent investments in our industry include Bongo Learn.
I spoke with Sanket Merchant, Principal, of PeakSpan Capital.
Q: Refers to the question, it will be bolded in Green. A: Refers to the response from PeakSpan Capital, it will be italicized.
Q: Consumers may not be aware of certain terminology and then, if they go and look it up, sometimes the explanations are even more confusing. For the non-financial person, what does a Private Equity firm, VC and Growth Equity firms do?
A: It’s a great question and certainly has grown in complexity. If we take a step back, the landscape for “private capital” investors is fairly broad with categories such as Venture Capital, Growth Equity (i.e., PeakSpan Capital), and Private Equity. The simplest distinction between each group is (i) the perceived risk (and type of risk) being assumed by each investor type, (ii) maturity of the business being invested in (oftentimes measured by revenue and growth), and (iii) returns target and how the investor typically generates a return.
Venture Capital firms are typically taking on more risk, writing smaller equity checks, and have greater returns expectations to compensate them for the risk of investing in an earlier stage business (smaller in terms of revenue scale but showcasing hyper-growth).
Growth equity investors like PeakSpan Capital stay on hymnal with our name – we’re typically investing after strong evidence of product-market fit and investing in growth. While risk is never zero; growth equity investors are typically taking on less product/technology and/or market risk and instead taking on more execution risk, particularly around go-to-market.
Returns expectations are slightly lower (likely 3-4x their invested capital) given risk of losing money on investments is innately lower as companies mature. Lastly, private equity investors are writing the biggest equity investments (tens if not hundreds of millions of dollars) and often will use some level of debt capital, particularly if it is an investment where the PE firm is seeking to purchase “control” or more than 50% ownership of the business after the investment.
Private equity firms are presumably taking on the least amount of “risk” given maturity of the underlying businesses. Like growth equity investors, they’re actively engaged and will typically bring in large operations teams to assist portfolio companies in accelerating growth, driving operational efficiencies, complete strategic tuck-in acquisitions (or M&A of smaller businesses) as a complement to organic growth programs, etc.
Q: I find that potential buyers of learning systems see that a vendor has raised X capital, and thus perceive that the system must be making a lot of sales, and be a great system – i.e. elite. However, that isn’t the case all the time is it?
A: You’re absolutely right – certainly not the case every time! The advantage of being a private company is that you do not need to publicly disclose your financial performance; however, there are a few things you can do to build a directional sense of how large a vendor is or how well they’re doing. First, I would look at their LinkedIn headcount, and, in particular, sales headcount to build a directional sense for the size or scale of a vendor (i.e., assume a $ of revenue per FTE to estimate directional size and revenue scale).
Second, I’ll caveat that I haven’t seen the most recent research but several analyses we’ve seen in the past that looked at how much equity capital had been raised to generate a company’s current revenue scale. For most Silicon Valley companies that number for at least $4 (or more).
What that means is that companies had to raise $40M of equity investment to reach $10M in ARR or annual recurring revenue. I’ll caveat that the number likely has changed and, importantly, every company is different in terms of how efficient they’ve been with any equity capital they’ve raised, so challenging to paint with a broad brush.
For example, Calendly (leading provider of scheduling software) raised < $500K to reach $100M+ in ARR before whereas other companies may have raised $400M to reach the same revenue scale. Keep in mind just because someone has raised lots of $$$ doesn’t mean they’ve been anywhere near as efficient in deploying that capital as you may have been!
Q: When a vendor seeks to raise capital, in your experience, what are they focusing on (area or areas)? And from your perspective, what do you look at, key indicators or variables to determine if that vendor (in this type of scenario) is a good candidate for receiving capital from you?
Vendors are likely looking at some combination of the following: (i) resource to accelerate growth, (ii) change in ownership in the business (founder or early investor requires or wants liquidity), (iii) access to network and operational resources, and, most importantly, (iv) want help scaling their business to the next level because an entrepreneur (or team) may not have the direct experience with the next few stages of growth/evolution in the business so critical to have an experienced investment partner in your corner.
From an investor’s perspective, it’s fairly simple – investors are looking for “alpha” or opportunities where there is high conviction in generating a return on invested capital.
That requires two things to come together nicely – (i) perception of a high performing business and (ii) attractively structured investment (valuation, terms, etc.). There are certainly some great businesses out there but given valuation expectations may not be great investments given performance required to generate an attractive return.
Let’s double-click on the above.
Investors are looking for businesses that are (i) showing product and delivery leadership in a large and strategic segment of the market (i.e., LMS for SMBs, Sales Enablement, Customer Training or Extended Enterprise), (ii) scarcity value or competitive advantage that can extend well beyond underlying technology, (iii) attractive financial profile (revenue scale relative to capital raised to date, strong accelerating growth, capital efficiency, etc.), (iv) attractive unit economic performance (i.e., retention (gross- and net-dollar / logo), acquisition efficiency, etc.), (v) strong leadership team led by a visionary founder/CEO, and (vi) clear evidence of opportunities to drive value in the business (accelerated growth, operational efficiency, etc.).
Q: Let’s follow up on more question around this above inquiry. Do you ask if you are the only vendor that vendor is seeking capital from? What is the typical approach when it comes to multiple PEs or investment firms or individual investor(s), when the vendor is accepting multiple funding partners? Is the majority based solely on total investment at that time, or over a period of time?
A: Despite the challenge of the current market environment, we’ve been living in a world of what I call a “supply-demand imbalance.” What I mean by that is there is considerably more capital available from a broader constituency of investment firms (i.e., demand) then businesses that are a great candidate for that growth capital (i.e., supply). As a result, it’s my view that any investor that thinks they’re the only firm that a vendor is speaking with is being naive! I suspect any high performing business I’m speaking with about a prospective partnership is likely talking to multiple firms.
Like selling your home, if you’re hoping to maximize the outcome (price, terms, etc.) then you want to have a competitive process, which means engaging multiple firms that you admire and believe could be exceptional partners to the business participate in a structured process where they’re getting access to information and following a consistent timeline.
It’s my job as a prospective partner to differentiate myself and the “product” we’re offering as a prospective partner from our peers that extends well beyond the capital we’re providing, which in my view has commoditized given the plethora of sources that have emerged over the years.
Q: Is there a typical percentage or requirements that a PE, Growth Equity or VC will ask for if they offer to provide capital to a vendor (supplier)? In other words, let’s say you want to provide Vendor X with 5M, what is the usual percentage (that you find or aware of)? Does any capital infusion come with a requirement of at least one board seat? (Assuming it is a private company – which in our industry – is the overwhelmingly majority)
A: That is really only applicable at the earlier investment stages (i.e., Seed) and less so at later stages of investing where valuations are governed by a value placed on a dollar of revenue (often the case because SaaS businesses that are growing quickly are incurring losses or not profitable) or dollar of EBITDA. It’s common that most lead investors will ask for a board seat given they’re a minority investor and don’t control the business. Some investors require it while others may request it.
In most cases, the founders’ control of the Board of Directors and, while biased, I think having your lead investor hold a board seat can be additive (especially with the right investor) as they can offer a complementary perspective based on prior experiences and be helpful in thinking through a variety of strategic topics to the business.
Q: Let’s say you decided to acquire a learning system vendor or a vendor in the e-learning space (could be a publisher), are the variables or parameters different than say, providing capital to the vendor (not an acquisition)?
A: It doesn’t change much from the eyes of an investor and largely a function of strategic objectives from existing stakeholders in the business. However, where it can differ is it is considered a “strategic acquisition” where either it is an independent (or publicly traded) software company or a portfolio company of a private equity investor who is looking at you [the target] as a bolt-on acquisition. In that case, I would say quality of product/technology and strategic fit within the acquirers existing portfolio (i.e., does it fill a strategic product gap or provide access to a new market/buyer) and synergies (i.e., cross-sell opportunities, added revenue scale, additional profitability, etc.) elevate in importance.
Q: I am going to pose a scenario to you, that I see often in our industry.
In the last five years, there are a lot of firms out there trying to acquire learning system vendors, and off-the-shelf publishers of courses to a lesser degree. It has only increased, and there are way too many vendors who think “they are the only ones” receiving these inquiries.
What would you tell a vendor if they receive one inquiry or multiple inquiries from investment banks/firms, PEs, individual investor(s)? How can they tell legit from snooping around?
A: First, I would meet with your existing stakeholders (or board) to discuss that interest and discuss key strategic objectives for your business today and going forward. Do you have interest in raising capital to accelerate growth? Have any existing stakeholders expressed interest in selling some or all of their equity? Do you want to explore a strategic sale of the business either to a PE firm or strategic to realize a full exit? I think it is important that businesses are developing relationships with investors that they think could be excellent partners at some point in the business as it does offer downstream benefits and building relationships with vendors that could ultimately acquire the business.
What you’re raising is a reasonable concern and would recommend folks consult with their boards to remain organized, consult with their lawyers to ensure they have appropriate confidentiality agreements in place if you’re sharing information openly (including non-solicit provisions if with a strategic acquirer), and most importantly, openly discussing “intent” to ensure those conversations are productive, aligned, and a good use of time.
Q: And if they are interested in pursuing further, what do they need to do on their side?
A: A well-structured process is the key to success, which can be either managed internally or outsourced to an investment bank that can assist with providing access to investors/acquirers, create marketing materials (including financial analyses, models, etc.), and assist with process management (which can become a full-time job on its own in addition to managing the business). I believe being able to complement that interest with other relevant investors/acquirers is key to driving the best outcome! If you’re unable to do that then I would ensure you’re consulting with your existing stakeholders and legal team to ensure you’re being presented with a deal that you believe is attractive absent competing offers!
Q: I tend to see that vendors who move forward with being acquired always seem stunned at how long it takes, and what is all involved. Can you provide a timeframe (in general and no, I am not holding it to you), of the process, what is involved in the process, who must be involved in the process and so forth? (Let’s assume it is a private company, and not public).
A: I would conservatively estimate 6-12-months to complete an acquisition. It can certainly be faster but unlikely to be less than 3-months in a best-case scenario!
Q: I’m a learning system or learning technology vendor and I want to raise capital. What should I do? Let’s say, I really don’t know who to reach out to, although I asked around and received a couple of names. Should I solely rely on that, or should I do my own due diligence, and if yes on the latter, where and how?
A: I would initially reach out to existing investors to get recommendations on firms that you should engage with as they’ll likely have a perspective on firms they admire that could be a great fit given sector, scale, stage, profile, etc. If not, I would get access to sources like Crunchbase or PitchBook to see if you can find investors that have been active in the L&D category (or exited prior LMS investments) where your current round and stage are a perfect fit with their strategy.
Upfront research on the narrowing on investor outreach that would be an ideal fit for your round will be incredibly valuable to ensuring you’re being efficient with your time, engaging with groups that you believe will be additive to your business, and those that will immediately appreciate what you’ve accomplished and share your vision for the market opportunity ahead of the business.
I would certainly conduct your own research and no harm in taking a look at their existing (or exited investments) and reaching out to a few entrepreneurs to get an off-list reference on the firm. If you like what you’re hearing/seeing, then I find a warm introduction (like with anything in life) is best – identify the partner that brings the relevant domain expertise and see if you can find a mutual connection to provide an introduction. Best of luck!
Huge thank you to Sanket Merchant from PeakSpan Capital.