M&A in HR Software: Who’s Buying?

In terms of maturity, the HR space is among the more established verticals in the software industry.

The addressable market for HR software is and always has been massive, and there are many large-scale horizontal providers who offer the full gamut of features.

Despite the fact that the big names in HR software have been offering end-to-end solutions for some time, with the current dynamics related to onboarding, attrition, and engagement, the focus of the space has shifted. Matching the right candidate to the right role, managing a remote workforce, ensuring employee engagement and retention, all have been brought to the fore with new intensity.

As a result, companies who offer point solutions to specifically address these and other timely HR challenges are seeing great growth and lots of opportunity from an M&A/investment perspective.

What exactly does that opportunity look like? Here’s what we’ve seen.

Who’s Buying?

Different categories of buyers introduce different dynamics to a process. Here is what you should expect in the HR software space from public strategic, financial, and PE-backed strategic buyers.

Public Strategic Buyers

Given that HR tech is dominated by blue-chip horizontal providers like Workday and UKG, founders of HR software companies may expect that these large strategics would represent the best or most active buyers in the space.

Founders wouldn’t be fully off mark. The big strategic players have well established M&A strategies and even non-specialists like Salesforce and IBM are known to flex some M&A muscle in HR tech.

However, founders may need to temper their expectations regarding who would participate as a buyer in a process. While items like market opportunity and product innovation are important criteria for buyers to close a deal, in many cases, whether or not a deal happens is purely based on its size. Generally speaking, acquisitions by big players only make sense when the acquisition is either:

• Large (>500M valuation), enough to constitute a major strategic acquisition.
• Small (<50M valuation), and therefore more likely to look like an acqui-hire rather than a true acquisition.

In other words, multi-billion-dollar companies have a hard time justifying middle market acquisitions (50-500M) because acquisitions in this range:

1. Are not big enough relative to the strategic’s size to significantly affect market capitalization
2. Are too big to justify the cost of buying a company that would effectively just be absorbed into a massive ecosystem
3. Have a relatively large workforce to be integrated or otherwise handled, which creates challenges

So while it’s certainly possible for an HR Tech company to be acquired by a large, publicly traded strategic, a more likely outcome is an acquisition by a small public company or private equity-backed strategic.

There is a huge universe of smaller strategics for whom middle-market acquisitions make perfect sense. There is so much opportunity in this area, in fact, that when it comes to marketing your business for sale, uncovering all those rocks is challenging. Having the support of an investment bank to take your business to market can help you manage that aspect of the process.

Financial Buyers

In the last 10 years, almost every private equity investor in software has invested in an HR business in some flavor. Their attraction to the space continues strong because:

1. The market opportunity in the HR space is massive.
2. Investors’ historical experience in HR software creates greater willingness to invest again to capitalize on that experience.
3. The maturity of the industry results in fragmentation (i.e. many small companies delivering point solutions), creating opportunity for a roll-up acquisition strategy.
4. The new renaissance of HR software focusing on an asynchronous and remote workforce creates opportunity for new growth.

Again, the universe of investors here is large. The more parties you can bring under the tent as part of a structured process, the higher likelihood that you’ll achieve a great outcome with a good fit.

PE-Backed Strategic Buyers

In recent years, a category of buyer who has represented an emerging opportunity for founders has been the private equity-backed strategic.

A PE-backed strategic is a company that a private equity firm has added to their portfolio and to which they apply several types of growth strategies, including growth through acquisition.

In the case of HR software, we’ve seen some very aggressive M&A activity on the part of PE-backed strategics. This class of investor has built very large businesses in this sector and are comfortable underwriting acquisitions for roll-up strategies.

And since HR tech is such a large market, there are sub-niche players that have grown to considerable size, which creates space for highly synergistic relationships with verticalized and point solutions technologies.

In many ways, PE-backed strategics are the "Goldilocks" option for founders because they embody the best of both the private equity universe (speed to acquisition) and the strategic buyer universe (high valuations due to synergies).

What Do HR Software Founders Need to Know?

What we’re seeing in the HR software market is prototypical of a mature market. Given the size and maturity of the space, a founder can focus on a specific sub-vertical within HR software and still carve out a massive market. In doing so, the parties they’re most likely to attract the attention of are not so much the publicly traded horizontal software providers, but more the:

• Privately owned, verticalized strategics
• Private equity firms with experience in the space
• PE-backed strategics looking to operate a roll-up strategy

Consequently, the best way for a founder to succeed in the sale of their HR software business is not to target their efforts towards a few sleepy bears, but rather to ensure their message is being broadcast to a wide swath of right-sized buyers/investors with experience in the space.