The reason for the acquisition, however, could be troubling. As we stated earlier, earning 25% IRR – the benchmark for private equity (PE) returns – has been nothing if not elusive in brick and mortar. Merchants have amazingly long sales cycles and pay very little for solutions. Many investors tell promising startups to take whatever solution they’re building and focus on an industry, any industry, so long as it’s not brick and mortar.
Given the federal reserve’s money printing schemes of late, private equity coffers filled rapidly and left firms with money to deploy ASAP. Undoubtedly firms had to be a little lenient with their investable criteria in order to put the money to work. Our guess is that Serent did some diligence yet still purchased Compeat thinking they would be able to attain market share with some capital investment. After a year of operating history they learned the truth:
- The back office space is incredibly commoditized
- Implementation is a nightmare
- Very rarely are solutions sold out of the box; there’s often customization needed
- Merchants are cheap and take forever to make decisions (see above)
Serent’s thesis has most likely changed, and they are needing to rework the asset to reach their 25% IRR. While their previous thesis was likely about hitting their milestones through traditional sales and marketing, their new thesis probably falls into one of the following categories:
1. Cross-sell/upsell solutions from Compeat to Ctuit customers and vice versa. This is what TPG believed they could pull off with HotSchedules but preliminary data is not promising. Until we see a CIM (a document a PE firm makes to sell an asset) we won’t know how TPG is financially engineering HotSchedules. You can see this potential thesis playing out in the quotes from the press release:
By combining, we will be able to solve our customer’s pain points faster by providing our customers access to more products with deeper features… Specifically, Compeat customers will gain access to additional inventory features, an employee scheduling mobile app, a manager operations mobile app, an event management module and hundreds of additional customer centric intelligence reports. Ctuit customers will gain access to an integrated accounting product, an onboarding and applicant tracking product in Hire, as well as Payroll products and a true ad hoc analytics intelligence platform.
2. The other thesis is around establishing a market leader position and creating a premium brand. This would go hand-in-hand with higher pricing – like just a BMW is more expensive than a Kia. Again, one could read the tea leaves in the press release as such
The combination of these two great companies will provide our customers with more choices and an obvious accounting, back office and workforce market leader. Our customers and employees are going to be the true benefactors of this combination
For customers to “benefit from this combination”, they might need to pay more.
Neither thesis leads us to believe 25% IRR will be possible without some financial engineering and debt structuring on behalf of Serent. We’ve yet to see anything in brick and mortar (minus the few tech exceptions) deliver good returns, so we’re incredibly skeptical this works out. That’s not to say it won’t, but if we were to gamble on this approach we’d take the short position.