The software sector in Private Equity

Louis Flamand: In this video, I'm going to talk about a sector that has become central to private equity: software. Why does it attract so many investors? What are its unique characteristics, and why are software companies so profitable? Historically, software was a domain reserved for Venture Capital funds. In the 80s and 90s, software companies were high-risk ventures with high R&D intensity, long development cycles and uncertain profitability. In those days, the business model was based on the sale of perpetual licenses, making revenues irregular and unpredictable. To ensure a minimum of recurrence, publishers charged maintenance fees. But this was not enough to convince LBO funds, which were looking for companies with stable cash flows. Then, from the 2010s onwards, the SaaS or "Software As a Service" model totally transformed the sector. Rather than selling software on a one-off basis, publishers adopted a subscription model, offering recurring, predictable revenues and therefore much more attractive to buyout investors. At the same time, the rise of the cloud has facilitated the distribution of SaaS software, accelerating its adoption by businesses of all sizes. Today, this model is dominant, and this is what has made the software sector a must-have for private equity funds. Software has a number of assets that make it one of the most profitable and resilient sectors.

Louis Flamand: First of all, these are mission-critical tools, indispensable for companies, whether for financial management, human resources, cybersecurity or the supply chain. These solutions are deeply integrated into business processes. Replacing them is costly and risky, which explains why customers remain loyal. The churn rate is often less than 5%. Secondly, the profitability of software publishers is exceptional. Why is this? Because once a software product has been developed, adding new customers generates almost no additional costs. The product is already designed, tested and ready to deploy via the cloud, with no logistical constraints or production costs. This ability to grow without significantly increasing costs enables the best software publishers to achieve EBITDA margins of 30% to 40%, a level very rare in other industries. What's more, software publishers do not depend solely on acquiring new customers to grow. They have powerful levers at their disposal for monetizing their existing base, notably upsell, which involves selling more advanced versions of a product to existing customers. Cross-sell, which involves selling complementary solutions, such as combining a human resources management module with financial management software. These strategies increase the value per customer without generating additional acquisition costs, significantly improving profitability. Finally, software publishers have considerable pricing power. Subscription fees remain relatively low in relation to the value they bring to companies.

Louis Flamand: What's more, by regularly adding new features, it justifies progressive price increases. Contrary to popular belief, the transition to SaaS and the cloud is far from complete. Today, only 36% of enterprise workloads are hosted in the cloud. This figure is set to rise to 53% by 2026. This gradual adoption still leaves enormous growth potential for SaaS vendors and their investors.

Louis Flamand: [00:04:08] Another growth driver is the modernization of IT infrastructures. Many companies still operate with aging, often poorly optimized software, creating a technology debt estimated at over $1 trillion. Artificial intelligence and automation will play a key role in modernizing these systems, offering a new growth driver for the sector. AI is often perceived as a threat to certain sectors, but in software, it represents above all an opportunity. The publishers who will benefit most from AI are those with privileged access to proprietary data. AI doesn't work on its own. It needs structured data to be effective. Systems of records, software that centralizes critical data such as ERP or CRM, are therefore particularly well positioned. AI will optimize software performance by improving data analysis, automating certain tasks and reducing customer support costs. The expected productivity gains are significant.

Louis Flamand: According to studies, the market expects EBITDA margins to increase by 5 to 12 points thanks to AI, notably via the optimization of sales, R&D and customer services. A final important point concerns valuations. The best software companies have always been expensive. Their profitability, growth and resilience justify these high valuation levels. But this means that it's essential to invest alongside industry specialist funds that know how to differentiate between what justifies a high price and what is simply overvalued. Specialist funds have a real competitive advantage. They have in-depth sector expertise and know where to find the best opportunities. They have privileged access to companies, as founders and managers often prefer to work with specialists rather than generalist funds. They have proven methodologies and a playbook for transforming these companies and maximizing their value, notably through external growth strategies, commercial optimization and data monetization. In short, today's software sector is one of the most attractive for private equity. It combines strong structural growth, profitability and resilience. The transition to the cloud and AI will continue to accelerate innovation and value creation in this sector. And to capture these opportunities, it's essential to partner with the best specialist funds capable of identifying quality players and maximizing their potential.