Alternatives

Some private equity managers looking for firms ready to move to SaaS model

Updated with correction

Company executives hoping for venture capital or private equity investment are dreaming up ways to get customers to subscribe to a service.

Subscription models are popping up in portfolio companies selling everything from razors and makeup to dinner.

The reason? Most private equity and venture firms prefer to invest in companies that have recurring revenues. For software companies, this model is known as software as a service or SaaS.

Some private equity firms are breaking from the pack and investing in companies that don't yet have a subscription model.

Executives at credit asset manager Golub Capital LLC are investing in technology companies that are converting to the SaaS model from the older sales model.

"We are seeing a lot of companies convert from the perpetual license (sales) model to SaaS. We are seeing a lot of transition," said Peter Fair, managing director in the San Francisco office of Golub Capital. "We fund a lot of that."

Companies that are in a conversion have a "cash crunch" in that they need capital to make the conversion, he said.

Vector Capital also is investing in companies converting to the subscription model, said Robert Amen, a managing director in the firm's San Francisco office.

"So much money has been raised that there is a tremendous supply of capital and not the commensurate supply," Mr. Amen said. "There's not enough subscription-model software companies to meet the demand."

This has made the price of investing in SaaS companies much higher, sometimes twice as much as similar companies without a subscription model, he said.

That's why Vector Capital is investing in companies with good management teams and business models that are converting to SaaS.

"We have a different perspective. We are contrarian investors," Mr. Amen said. "We look for pockets of value where other people are not playing."

Vector Capital executives buy software businesses with strong leadership and help them convert to a SaaS model because they consider these companies to be undervalued, he said.

"They (non-SaaS companies) are trading below what they should be because of their business model," Mr. Amen said.

For example, Vector paid 2.5 times bookings for Saba Software, a provider of cloud-based talent management software, when Vector took the company private in 2015. (The company did not have reliable revenue data at the time.) Cornerstone, a company in the same business was trading at 6.8 times revenue around the time of the transaction. The difference in price was that Saba had not yet adopted the SaaS model, Mr. Amen said.