Private equity firms have been a bright spot in the M&A market this year. Private equity led 57% of public-to-private technology deals in the first half of 2023—almost double their share of public-to-private technology deals in 2020, 2021 and 2022.1 Morgan Stanley bankers say the rise of private equity in technology dealmaking is just beginning.
To discuss the landscape of opportunities in technology M&A, Morgan Stanley’s Capital Connections Summit brought together top executives from the private equity and venture capital community. Investors gathered in Pebble Beach, California to discuss the M&A outlook for software companies and key themes to watch for the next wave of M&A.
“We brought together the top private equity and venture capital funds in the world, because these two cohorts will inevitably work together on deals—more so than they ever have in the past,” says Umi Mehta, Global Head of Technology Private Equity and Venture Capital Investment Banking, which hosted the Capital Connections Summit. “The intention of the Summit was not only to highlight private equity firms as the most active tech M&A buyers in the near- and medium-term, but venture capital funds as partners that help scale and monetize private equity’s future assets.”
Private Equity’s Evolution to Tech M&A Dominance
Private equity firms have evolved into subject matter experts that offer technology companies operational expertise and the opportunity to invest in sales, marketing, and research and development, according to EB Kapnick, Head of East Coast Technology M&A. They are looking for quality technology companies with the potential for growth, with enduring business models that have large total addressable markets.
“Private equity companies have growing expertise and specialization in software technology, and they are making tech companies more interesting to strategic buyers,” Kapnick says. “With their experience, they can make good companies even better, which makes them a competitive buyer. They’re not just reducing costs but increasing margins, accelerating growth and bringing in new leaders.”
They are also raising larger funds—available capital now stands at a record $2.49 trillion.2 In this market, private equity firms will often pay comparable or even higher premiums than strategic buyers. Melissa Knox, Global Head of Software Investing Banking, notes that the bid-ask spread between technology buyers and sellers is finally narrowing this year. This is helping to fuel more private equity M&A activity, especially as sellers temper their valuation expectations following peak levels in 2021.
How the Macroeconomic Environment Cooled IPOs
In 2022, higher interest rates, inflation and recession concerns weighed on companies’ profits and share prices in the consumer spending, advertising, and tech industries. In 2022 and 2023, public tech companies felt pressure to do more with less, prioritizing operational efficiencies and cost reductions. However, these efforts can take time and public markets are not always willing to wait, which is why some public tech companies will consider returning to private ownership. Selling their companies to a financial sponsor gives them the opportunity to rebuild without the pressure of delivering returns in a difficult market environment.
Private companies, meanwhile, are now more hesitant to consider IPOs and more open to the possibility of selling. “The bar to go public is much higher in terms of scale and financial profile,” Knox says. “It’s hard to manage employees and financials on a quarterly basis. A lot of private companies will rather merge or be acquired than go through an IPO.”
Private Equity Firms Eye Cloud Companies Amid AI Disruption
The consolidation of cloud-based software firms could also create additional takeover opportunities for private equity companies. Many cloud companies flourished after the boosts to remote work and e-commerce in 2020 and 2021, but more recent innovations in artificial intelligence may obviate some of these businesses, while creating greater demand for others. For example, a cloud-based customer support company might be negatively affected by AI’s potential to disrupt customer relationship management, while companies that provide cloud computing and optimization could benefit from the massive amounts of data and computing power that AI requires. “There will be cloud companies that get disrupted by AI,” Kapnick says. “Not everyone is going to be a winner in this.”
AI may also spur more strategic M&A activity, as companies seek new capabilities, customer segments and buildouts of their own platforms. AI companies are also attracting venture capital, as firms seek opportunities to provide growth-stage money and fund future M&A targets.
“It’s going to be another wild ride in tech in the next few years,” because of the revolutionary “platform shift” of AI, Kapnick says. “Like 1996 before the dotcom wave, or 2017 before the big cloud wave, the amount of spend that moves to technology is going to be unlike anything we’ve ever seen.” In addition to AI’s domino effect, private equity firms are also watching vertical software companies with large total addressable markets in sectors such as healthcare, media and industrials.
