Software distribution and its rising demand – UKTN

In an increasingly digitised world, software has become essential to businesses. The industry has thrived in recent years, with more businesses adopting cloud-based solutions, providing remote access to software applications, usually via a subscription model.

The software distribution industry is particularly attractive to investors for several reasons:

• A large and growing market: Rapid digitisation is driving high growth rates, with many industry subsectors growing at an average annual rate of over 10%.
• Recurring revenues: Many software distribution business models feature recurring revenue streams – such as annual subscription charges.
• High customer retention rates: Churn rates are typically low, owing to high switching costs for customers.
• Potential for value-added services: Value-added resellers (VARs) and distributors (VADs) provide secondary advisory services at higher margins, increasing profitability. These advisory services can also improve customer loyalty.

The M&A market

Historically, M&A activity in the software distribution sector has mirrored broader market trends. While activity was high during periods like the dot-com boom and the bull market preceding Covid-19, the industry decoupled from the broader M&A market during the pandemic. Despite economic headwinds, deal values reached record highs as software distribution was well-positioned to support the shift to remote working. This included the sale of Nuaware, a specialist in DevSecOps and containerisation distribution advised by Moore Kingston Smith Corporate Finance, to Exclusive Networks.

Since then, M&A activity has boomed, becoming a primary driver of growth for businesses in the sector. M&A remains a preferred route for leaders to expand market share, access new talent and capabilities, and leverage technologies without developing them in-house.

Key trends in the M&A market

Financial investors are increasingly driving the software distribution M&A market, joining traditional technology players in acquiring targets. This trend is exemplified by acquisitions of companies distributing enterprise software, including customer relationship management (CRM) solutions, tools for digitising core operations, and analytics applications.

Recent analysis by Moore Kingston Smith (M&A in the UK IT Services Sector: Q3 2024) revealed that software distribution accounted for 36% of all Q3 transactions in the outsourcing and distribution space.

One driver of this trend has been strong cross-border activity. A key cross-border deal was the acquisition of UK-based office management software provider SmartSpace Software by US Private Equity (PE) firm PSG Equity. PSG is a PE firm that partners with software companies to help them achieve transformational growth and the acquisition of SmartSpace Software demonstrated why UK business owners should expand their search criteria when looking for M&A partners.

Acquirers in the market

Recent years have seen a shift in the nature of acquirers of software distribution businesses away from traditional corporate buyers. Moore Kingston Smith’s analysis has discovered that during the past three years, the number of deals attributable to acquisitions by corporate technology companies has been 27%. During this period, the number of deals attributable to Private Equity, PE-backed and Venture Capital (VC) backed firms, was 73%.

Corporate acquirers tend to follow a similar route. For them, increasing their overall valuation by adding and integrating software assets is a key value-creation approach. First-time buyers of software distribution companies primarily create value through business model innovation and, potentially, new products. More mature companies are more likely to focus on consolidating the market and scaling up their business.

Financial acquirers tend to recognise the potential for high returns to maximise their exit proceeds. They often make an initial platform acquisition and then rapidly build upon that with subsequent acquisitions, developing asset values, rather than improving profits.

Though both corporate acquirers and financial acquirers have their benefits, finding the best acquisition partner requires business owners to assess both the valuation they will receive for their business as well as the cultural and organisational fit.

Maximising your valuation

Different acquirers prioritise various metrics when valuing software distribution businesses. However, there are certain aspects of a software distribution business that will always influence valuations:

• Customer concentration: The distribution of revenue across the client base.
• Product mix: The number and variety of product lines offered to customers.
• Project/consulting revenue: Revenue obtained from value-add project and consulting fees.
• Annual recurring revenue: Calculated by aggregating the total contracted revenue at a particular point in time.
• Renewal and retention rate: Percentage of customers renewing their contracts.
• Growth rates: Apply across many different metrics, including profits, cash flow, expenses, etc.
• Sales and marketing metrics: How marketing and sales efforts are focused, including specific industry or sales channel prioritisation.
• Customers and customer acquisition costs (CAC): Total marketing and sales expenses divided by the number of customers acquired during a period.

Maximising these metrics is key for business owners to improve valuation multiples.

Looking Ahead

Moore Kingston Smith expects the M&A market to continue to grow as demand increases among buyers looking to acquire software distribution businesses.

Contrary to concerns that emerging technologies like AI may overshadow traditional software distribution, both can coexist and complement each other to drive synergy potential. In short, software distribution is unlikely to be snubbed by investors as AI grows in popularity. If anything, the rise of AI will only increase the demand for software and drive businesses to adopt innovative solutions to modernise their technological architectures.

To navigate this landscape and achieve a successful exit, software distribution business owners would benefit from collaborating with specialist advisors like Moore Kingston Smith, who can leverage sector expertise to optimise the M&A process.

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