Episode 27: Driving Profitable Growth in Enterprise Software

Q&A

Let's start by talking about the criteria you use at Thoma Bravo to consider and prioritize the investments you're making in software companies. How do you weigh factors like technology, market opportunity, and management teams?

We evaluate software companies for investment based on several key criteria: 

• First and foremost, we seek out innovators with the potential to become great businesses. We focus on large, growing segments within the software market such as applications, infrastructure, and security. Fortunately, the digital trend has created ample opportunities in these spaces.
• Market leadership is crucial to our assessment. We target companies that hold a dominant position in their chosen sector, often recognized as upper-right quadrant players in assessments like the magic quadrant. These companies tend to excel in terms of NPS scores, brand recognition, and product capabilities.
• Additionally, we place great emphasis on the quality of a company's products and technology. We look for products that fit seamlessly into business processes and industry sectors, ideally built on modern, flexible architectures.
• A strong, collaborative management team is another vital factor. We prefer to work with existing management—not replace them—and value their capabilities and willingness to partner with us closely. Teamwork, adaptability, and a strong desire to compete are essential attributes.
• Furthermore, we prioritize products that are mission-critical to customers, making them indispensable rather than optional.
• Lastly, we assess financial aspects, favoring recurring revenue models, high gross margins, and strong cash flow characteristics. 

You mentioned not replacing management teams and collaborating for growth. What are some of the other unique aspects of the way you partner with your portfolio companies? 

Our approach revolves around guiding portfolio companies on a path to profitable growth. We have an operations team comprised of experienced software industry leaders who have been CEOs, CFOS, and have real expertise in software operations—and they serve as mentors to the company's management teams. These mentors join the boards of the companies we invest in and conduct regular operational reviews. These reviews encompass a comprehensive set of operational processes and metrics that reflect best practices in the software industry.

We make strategic investments in product and technology with a focus on features that drive long-term revenue growth. We also allocate resources to sales and marketing initiatives, ensuring they are directed effectively to generate incremental growth and improve profit margins. Throughout the investment horizon—which spans several years—we aim to enhance products, technology, and operational efficiency. Our operations team plays a crucial role in mentoring and implementing these strategies, contributing to the company's growth and success.

Acquisitive growth is an undoubtedly valuable part of your software portfolio, but there are integration challenges to consider. How do you navigate these challenges and avoid accumulating integration debt while merging various teams, management structures, and software components?

We do three types of acquisitions: The first is where we acquire small competitors who can no longer invest in their product or technology, allowing us to support their product and provide an upgrade path to our customers. This type of acquisition requires minimal integration.

The second type is a product extension type of acquisition that complements our core product but may require more integration. We seek businesses with strong standalone product functionality and technology. Just like in our platform evaluations, we look for modern and flexible technology in these tuck-in acquisitions. 

Our integration strategy focuses on API or UI/UX integration rather than rewriting the entire platform or acquired product in the same technology stack. Therefore, we avoid acquisitions with significant tech debt built on outdated systems, as integrating such acquisitions becomes more challenging.

What are some of the common challenges that software companies face as they strive for profitable growth? Do these challenges differ in the different markets that you invest in, health care, finance, energy, et cetera?

The primary challenge software companies face on their path to profitable growth is often a cultural one. In the software industry, there's a natural tension driven by their entrepreneurial origins, venture capital backing, and rapid growth potential. Initially, the focus is on investing for growth, capturing market share, and building the best products, technology, and management teams. Investors in this phase prioritize growth over profitability, a strategy that makes sense.  

However, when companies mature, attain market leadership, and look toward profitability, a cultural shift becomes necessary. This change involves transitioning from a growth-oriented mindset to one focused on consistent innovation and generating strong profits. This shift can be challenging because the entire organization, from the management team to employees, has been accustomed to the growth-centric approach for many years. 

So, the biggest obstacle on the journey to profitable growth in the software industry is often the need to adapt the company's culture to align with a more balanced approach that emphasizes both innovation and profitability. 

As for challenges among different industries, there's very little differentiation between markets, whether that be the end market or the type of software solution, an application software business or a security software business, finance, or in healthcare. The basic processes and metrics usually stay the same, and that’s what we love about software and our models.  

Of course, each sector has its own dynamics in terms of competition, business processes, and where the market is going, but the way a software company is operated stays the same for the most part.

What does digital mean to you? 

To me, digital means one word: software. Software is what's enabling digital transformation across every business sector. It's allowing banks, car companies, and pizza delivery businesses to go from being old-world businesses to technology companies. Software is really the key to this digital revolution.