The first quarter of 2023 was noisy. Despite the epic failure of Silicon Valley Bank – for reasons totally outside the health of the software ecosystem – software valuations increased, and major companies reported improved revenue and earnings. The NASDAQ posted its strongest quarterly performance since the COVID explosion of 2020/2021, ending the quarter with gains over 16%. Salesforce and Adobe reported year over year revenue increases of 23% and 19% respectively. Evidently, a market recovery is underway.
So why are M&A deal and dollar volumes down? We saw just over 1,000 transactions in Q1 2023 with reported deal values totaling $47 billion, roughly half the deal value of Q4 2022. The decrease is partially illusory, or less relevant to our core markets, for three reasons:
First, the debt market has gotten significantly more challenging, even before SVB vanished (with part of its team joining MUFG). On the price side of the equation, SOFR has increased from 0.3% a year ago to 4.9% today. Risk premia have also increased. On the volume side, banks are less willing to lend at larger multiples of EBITDA. This can be reflected in the prices on offer, which might incentivize some companies to wait to transact. Indeed, there have been some high-profile deals pulled in the past few months, many of which depended on a significant debt component.
Second, the phenomenon of very early stage companies acquired simply for their technology has disappeared alongside more the aggressive venture funding that enabled those acquisitions. In Q1 2023, there were 4 companies with fewer than 50 employees that sold for over $50 million. In Q1 2022, there were 30. Of course, most of these transactions will be undisclosed. In Q1 2023, there were a total of 144 deals with disclosed transaction values, or about one in seven. That suggests the actual number of early stage technology acquisitions was possibly 200-300 in Q1 2022, enough to make a significant impact on the totals.
Third, as we’ve noted, the COVID deal environment inspired many companies to accelerate sale timelines and go to market in 2021 or early 2022, reducing the available population of companies that would have otherwise sold in 2023; thus, impacting 2023 transaction volumes.
One might reasonably object that dollar volumes are down more than deal volumes. However, this is misleading. Deal values are, and always have been, highly dependent on a relatively short list of very large transactions. In Q1 2023, the largest software deal was Thoma Bravo’s $8 billion acquisition of Coupa Software. In Q1 2022, Afterpay, Nuance and McAfee alone accounted for nearly $60 billion – nearly half the deal value of Q1 2022 (and that figure doesn’t include the now-blocked Microsoft Activision acquisition).
We are currently in an M&A environment where debt is available but more expensive, investors are holding onto broken companies, and the population of transactable companies is reduced. Buyers are ready to deploy capital. Multiples are up, and they’re consistent with 2019 multiples. The venture world is making a lot of noise, but growing software businesses should not be deterred from the road to exit. Ignore the lights and keep your eyes on the road.