Software sector lures increasing amounts of capital in CEE

European software companies have never lacked the attention of private equity and venture capital investors. However, interest in the software sector in CEE is on the up and was especially prominent in Q3. The number of technology deals in the region has been gradually increasing over the past four quarters, with software companies taking a major slice of the action. In total, 10 out of 11 tech investments during the period were deals in the software sector.

Q3 saw the biggest investment in a software company in the region in the past decade, with Cinven's acquisition of Warsaw-based RTB House for an estimated €262m. Other major deals include TPG's €53m investment in Cyprus-based Au10Tix, a €30m series-B funding round led by Battery Ventures for Prague-based Mews, and Partech's €18m backing of Hungarian software-as-a-service (SaaS) Bitrise.

The success of CEE software companies in the European private equity market is driven by the increased maturity of businesses in the sector. According to Reza Malekzadeh, general partner at Partech, and Henri Tilloy, a senior associate, interest is increasing as more companies meet the key investment criteria of being strong, promising and globally orientated businesses, run by talented teams. In 2019, Partech significantly strengthened its footprint in CEE and has already deployed capital from its latest pan-regional funds in three software companies based in the region.

The software sector is perhaps the most thriving branch of the tech investment industry, driven by the creation of a range of services based on various hosting models.

Piotr Misztal, a partner at Polish private equity house Value4Capital (V4C), which has backed SaaS e-commerce platform developer Dreamcommerce, says that V4C particularly favours SaaS businesses, as they are typically characterised by a high degree of automation and scalability: "What's more, with moderate capex requirements and predictable and growing cashflows, they work well with leverage. I have not heard of any private-equity-backed late-stage SaaS deal that have failed. They have proven to deliver good or extraordinary returns."

Pay to play
The issue that may arise when considering investing in software companies is their valuation. "Valuing high-growth software companies can often be more art than science, resulting in quite ambitious valuations," says Vasile Tofan, partner at Horizon Capital. Misztal says that not every private equity firm is willing to pay double-digit valuations, so they rather focus on more traditional sectors. "However, more private equity houses have started to realise that buyout investments in the technology sector can deliver exceptional results and at the same time are not necessarily carrying a high technology risk. Even large funds tend to change their strategies in terms of scale, to tap into high-growth, attractive technology deals, including those based on SaaS business models," he says.

Meanwhile, there are divided opinions as to what investment approach works best in the region. Early-stage/expansion supporters argue that as the tech sector in the region is fast-growing but still fragile, buyout deals have not shown great results. "In more developed economies such as the US, there is a higher rate of corporatism that facilitates buyout deals. In emerging regions such as CEE, there are mostly young, first-generation entrepreneurs running tech companies, which are more open to growth equity capital than a full buyout," says Vasile Tofan. However, V4C's Misztal says that since we can observe more software companies of a proper scale and with a stable position on the market in CEE, there are more possibilities for such investments. Software buyouts in the region are not a trend, but rather a possibility that requires selective targeting and a cautious approach.

Although the sources across the board are being positive about potential growth in the region's software sector, the private equity market in CEE is still far from hubs such as London and Berlin. The investors identify some challenges that the software companies in CEE tend to face – usually those related to the organisation's development and the growth facilitation. And while the appetite for the software deals in the region is growing, the number of investments is still the smallest among other European regions.

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