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PitchBook financial writer Marina Temkin interviews Union Square Advisors' Emily Anderson, who leads the firm's private equity practice. Anderson shares her thoughts on the current M&A environment in a time of declining valuations and rising interest rates and how it could affect private equity activity. Plus, host Alexander Davis shares some insights from his recent reporting at SXSW, as well as the PitchBook news team's two-year retrospective on the pandemic.

In the Upwork segment of "Innovations in Private Equity," special guest host Tony Buffum talks to TPG's Anilu Vazquez-Ubarri about diversity, equity and inclusion. Anilu discusses the impact and contribution diverse teams with varied perspectives have on innovation within PE firms.

Listen to all of Season 5, presented by Upwork, and subscribe to get future episodes of "In Visible Capital" on Apple Podcasts, Spotify, Google Podcasts or wherever you listen. For inquiries, please contact us at podcast@pitchbook.com. Transcript Marina Temkin: Today with us, we have Emily Anderson. She's a managing director at Union Square Advisors, a technology-focused investment bank. Emily leads the firm's private equity practice. Emily, hi, welcome to the podcast.

Emily Anderson: Thank you for having me.

Marina: Great. Why don't we start out by you telling me a little about what it is that you do day-to-day and what kind of advisory it is that you're doing?

Emily: Union Square, as you said, is a tech-focused investment bank. We work as advisers in selling private companies which can be venture-backed, PE-backed or bootstrap/founder-owned, selling them to both strategic and private equity buyers. We also do buy-side advisory work—we've helped Permira, as an example, buy several companies. Then we also agent capital raises, so any large capital raise that is more of a minority-type investment, we will act as an adviser to those clients as well.

Marina: Could you describe a little bit, where you get involved in the sell side, how early in the process you get involved and also on the buy side?

Emily: In terms of the sell side, we at Union Square, because of our deep focus in technology and specifically in certain verticals within technology, we like to meet our clients very early and develop a long-term relationship. I would say in terms of size and scale, there are a lot of factors. One can be inbound interest, which is one of the major catalysts for M&A. If somebody comes knocking at that company's door, maybe it happens a few times, it starts to get more competitive, starts to get more serious in those conversations, then we would start to spool up a process and we would work with the management team to prepare all the necessary documents, marketing materials and such. At that point, we'd think about who to go to in terms of the buyer/investor landscape, leveraging some of that inbound interest.

In more mature verticals—I'll use marketing technologies as an example, although there are evolving aspects of that too—it's going to be something usually more in the high teens to 30 million in ARR. [In] some of the very, very super high growth verticals such as fintech—which is, again, just an example—all of that can happen earlier, because there's just so much competition for these innovative leading assets that the food fight just starts to happen at a much earlier phase in a company's life cycle.

Marina: I'm wondering, are these companies that come to you when they're still standalone or there are some companies that are already PE-owned and are looking to sell themselves?

Emily: Yes, it's both. One of my roles at Union Square is to cover private equity firms as a whole, which is a twofold relationship. One, it's making sure that we are showing them product, meaning companies that they can either invest in or buy. Then, it's to be sure that we're being thoughtful around their existing portfolio and when it may make sense for one of their portfolio companies to transact.

That could be a function of us spending time in a space and knowing that a certain strategic buyer is interested in a certain asset within their portfolio, or it could be the PE group [reaching] out to us ... [to] say, "Look, we've owned this for—fill in the blank—three-plus years. We're thinking it makes sense to recapitalize the company." Or they're getting some knocks on the door [and asking], "Can you come in and share your thoughts around what a process may look like?"

Marina: I'm wondering, right now for PE firms, has the criteria changed in the recent years? Because last year and the year prior, primarily last year, valuations have increased tremendously. We've obviously seen big declines this year. Also, a lot of volatility in the public markets. I'm wondering, how are they looking at it? What kind of companies are they looking to buy right now?

Emily: It's a great question. I wish I had the perfect answer, because it would make my job so much easier. But I would say, well, there are a couple factors. One, the amount of dollars flowing into private equity funds is so massive, and there's a need to put that capital to work. In terms of valuations, I think we'll continue to see high valuations for the best assets out there. Just because the competition is such that [for] most of these funds, regardless of interest rates or some of the other factors, there's certain assets that are kind of a must-own ... and so you'll continue to see some outside valuations for the top-tier best assets.

I think it's the middle layer below that that's going to ebb and flow a little bit more in line with the market, and that's really due to just decreased competition, and some of those other factors. I think the overarching theme that private equity funds tend to think about, and I don't want to generalize too much because they do all have very differentiated strategies, is this focus on rule of 40, which is the summation of revenue growth plus margin. And anything that gets you to north of that from a financial profile standpoint is going to generally be attractive to these buyers.

Marina: So rule of 40, that's meaning if there's a 20% growth [and] a 20% EBITDA, that in totality would be of interest to PE firms out there.

Emily: Correct. That's, again, generally speaking. Even if it's a rule of 40 company in a space where they're not focused, then they're probably not going to look at it. But if we're trying to generalize and be as high level as possible, people will usually take a look or lean in. This is their sniff test, if you will.

Marina: In terms of sectors, because you said there are some assets that everybody wants to own and some that are just more middle layer, what would be the assets that people want? Are these in a particular sector, are there other spaces that are more hot than others, are there geographies that are really peaking? What is it that PE firms are going after these days?

Emily: It's a good question and it really varies by fund. I think some of the areas of focus that I hear on a consistent basis are fintech. Well, a lot of it is B2B software. I think consumer goes in and out of favor. It's somewhat in favor now, I think more so than it has been in the last few years. Now everything I say has a caveat because there are consumer-focused funds and that's all they do and they'll continue to do that.

I think if you look at a traditional private equity firm focused in software, [they're interested in] very much anything enterprise software. They're high recurring revenue-based models, long-term contracts, typically have very high renewal rates and a lot of predictability in terms of financial profile. Those assets will continue to be very interesting. In terms of actual sectors, I mentioned fintech, I believe. Anything in cyber, so security-focused. Anything in supply chain just given everything that's going on in and around supply chain. [And] a lot of the ecommerce enablement companies, so ... you [can] think of Shopify as one of the key players in ecommerce enablement.

There are so many other companies solving point solutions or really focused on a specific vertical with a long tail. Those assets continue to be very attractive to private equity buyers. And that's because it's a completely changing ecosystem. Coming out of COVID, retail just completely changed, and so I think we'll continue to see interest there. Human capital management, remote work is going to continue to be a theme where people are focused, and this is all in response to evolving ways of life and technology having to catch up.

Marina: What about valuations? Are you seeing both, for the companies themselves as well as the buyers, struggling to come up with the right valuation right now? Is there a discrepancy between the two, because obviously things have shifted so much and we also have this prospect of [an] increasing interest rate. Is there a gap between what people are willing to sell themselves at and what buyers are willing to pay?

Emily: I think there is. I do think there is more so than there was last year. I think just to your point the volatility has buyers wary and the sell side, while they can typically and again, I'm generalizing, appreciate the various volatile factors in the market, will still look at the most recent deal comp and want that valuation. Buyer sentiment has changed whereas seller sentiment hasn't shifted quite as much, which I think creates a little bit of this gap.

Now I do think there's still a point where the two come together, and typically those types of buyers and sellers have been in dialogue for some existing period of time and know one another quite well such that they're able to get to a meeting of the minds. I think where the gap is a little bit more apparent and again, this is just one perspective, is in some of the new relationships—meaning buyer doesn't know, seller quite as well, and vice versa—that you're going to see a little bit more of the spread.

Marina: I'm wondering if you saw any deals fall through earlier this year, because there was such a massive drop-off in the stock market. I've heard of a few through the grape vine, and I'm wondering how that happened and whether the two parties ended up coming back to the table and renegotiating, or if it was just completely walking away from each other.

Emily: We have seen the market has certainly had an impact on many of the companies in the areas that we cover, including our clients and other people's clients. Definitely, I think that there are just a lot of factors impacting both publicly traded buyers, but also the PE firms and LPs' perspectives on risk and tolerance for risk. We have seen that.

In terms of coming back to the table. There have been times where we've had a buyer so close to transacting and everything fell apart and goes dark for six months, and then conversations reengage and then go dark for three months and then suddenly two buyers are at the table and we get a deal done.

Marina: That's not atypical, that's something that's very common of the M&A in general. I was just wondering if you saw something that was very stark and different at the beginning of this year, because obviously the valuation reset was just so pronounced, much more than it has been in years and years probably. COVID notwithstanding because that was a quick drop and then things went back on track, but this pullback seems more protracted and people are probably getting more used to lower valuations, but I'm wondering what happened [in the] January, early February timeframe, where there are a lot of jitters around the dealmaking tables.

Emily: They're definitely were. We did see [in] some of the deals that we thought were likely to go through ... some jitters on the buyer side that had nothing to do with the quality of the seller. In fact, some of the businesses, some of the assets that were being sold, continue to outperform and simply because of certain market volatility and jitters, as you say, these deals got put on hold.

Now, it's not necessarily time wasted, because that relationship continues to foster and now that buyer once things settle out or anything could change. There could be a competitive dynamic that makes the asset being sold, the seller more attractive than it even was previously. So much work has already been done that that deal can then happen faster. We do see markets impact M&A and deals getting done, but you do actually more often than you think, see them ultimately transact, if there is enough strategic merit to the deal. To your point, we definitely saw that.

Marina: I understand that [in] a lot of the advisory you do, the ultimate valuations are below a billion dollars, but I'm wondering if you're hearing, or if any of the deals you were involved [in], are companies that were possibly looking to IPO in 2022? Because this was supposed to be big IPO calendar year. Obviously, the IPO windows are shut tight right now. Are some of these companies looking to possibly sell themselves? Is there some a dual-tracking happening?

Emily: Almost everything is always a dual-track even if it's not a dual-track. There are many strategic alternatives and while someone may be on an IPO track, there could always be a bid that comes in at the eighth inning and puts up a higher number than what the public markets were going to garner. We certainly see that, now just by way background Union Square, doesn't a work on IPOs, so we're less likely to be involved in a scenario that could go that route.

That said, we obviously are working with companies all the time who have plans to go public in the next 12 to 24 months. As they consider that option, because of the public market volatility, maybe they're now looking at more of a majority recap transaction, whereby you hand the keys to somebody else, management gets to roll a piece in the new deal and then you postpone the IPO for another three to five years, whereby perhaps the equity markets are a little bit smoother and are open by then. Then, that gives the management team the quintessential second bite at the apple in terms of valuation.

While we're not helping companies prepare to go public, we will help them with that final slug of capital, whether it's a minority or a majority recap transaction. And then, the other thing that we do is SPAC transactions. While we don't work on IPOs, we're decently close to the public markets through SPACs.

Marina: I was just wondering if some of these companies that were looking towards the public market are maybe considering the M&A option more than they have in the past.

Emily: I think that's true. Things that were potentially wanting to go public this year, they're probably still doing the work to be ready for when that window, knock on wood, opens. That said, I think the great companies that really will have a great IPO are going to wait for the opportunity. Whether that's 2022 or 2023, they care more about going at the right time than going within the fiscal year.

Marina: Last year was a record tech M&A deals market. What do you think [about] this year? Are the headwinds from lower valuations and rising interest rates going to slow down that statistic or [do] you still think there'll be lot of deals getting done?

Emily: Well, I definitely wish I had a crystal ball as there are a number of deals that we would like to see get done, and there's a lot of money that needs to be put to work. There are a lot of great companies out there that are looking to raise capital and or take out some of the investors that have been long in the tooth. I do think that there continues to be a lot of M&A that can, and potentially will, get done this year.

That said, back to the point we were talking about earlier, there's a little bit of a valuation gap and there are some jitters on the buy side. Probably impacts the corporate buyers more so than the private equity buyers because they still have a mandate to be putting money to work. They'll still be out looking for a certain number of platform assets. What's slightly lower risk is going out and deploying capital on bolt-on transactions, meaning adding different functionality to your existing platform assets.

So there are several ways to continue to put money to work. I think that, again, it varies based on firm mandate and amount of dry powder and where you are in your deployment phase versus calendar timing around raising your next fund. I think that we'll continue to see capital get deployed.

Marina: Yes. There's certainly a lot of it and it has to go somewhere.

Emily: Exactly.

Marina: What do you think will be the big drivers of PE buyout activity this year? Sectors platforms, whether increased antitrust activity on the big tech will be a positive for PEs now that they can swoop in and buy assets at a more reasonable value.

Emily: I'm certainly not an antitrust expert, but as regulation around it gets tighter it does add a hurdle to some of the corporate buyers' processes. Private equity is obviously going to have an angle there because it's less of a factor for them, although, it's tightening in both ecosystems. Private equity firms will have an advantage around the changes in antitrust. I also just think that there are so many factors driving PE M&A volume and antitrust is just one of them and probably not in my mind, at least.

That's just one opinion. May not be the most important factor. They continue to focus on areas where they're doing a bunch of work, where they know the three top asset; they've gotten to know the management team; they know what sort of a deal would make the most sense for both management and existing investors; they have a thesis around being able to pay a strategic multiple, even if you will, and have a list of 10 bolt-on transactions that they can go do after they buy asset X or whatever the platform investment may be. It's that strategy that enables them to pay a strategic multiple, because they will, through the series of bolt-ons that may follow the platform investment, they'll realize a number of synergies that ends enabling them to meet their return threshold.

Marina: Are platforms still the big thing that a lot of the PE firms work on?

Emily: Yes. A very common strategy in private equity is to buy a platform asset in an area where you have a team doing a ton of work. Then identify five to 10 similar assets that are subscale relative to your platform asset and go buy them up at decently attractive valuations because they are subscale. It continues to be a strategy that works well. They can then create a category leader, Space X, or whatever it is, and either take it public or sell it to a larger PE fund or do any number of things. We continue to see that be a compelling strategy, a smart strategy and I think we'll continue to see it throughout the year.

Marina: Will there be more interest in buying VC-backed companies? Or will VC-backed companies will be more willing to sell themselves to a PE firm? In the light of very high valuations last year on the VC side. There may be some difficulty raising a subsequent round at a higher, even a flat valuation. I imagine that some companies may be forced to do down rounds. I'm wondering, what would be the dynamic do you think for the VC-backed companies that really overvalued themselves last year and ... [are] having a hard time raising again this year?

Emily: Again, it's very company-specific and vertical-specific within technology. Sometimes that you'll see based on where a company is in its life cycle, market appetite for cash burn as an example, ebbs and flows. Sometimes it's more acceptable when investors are willing to over invest and take on more risk. I think we're seeing because of everything going on in the market, that threshold, and this happened during COVID as well, that threshold for cash burn, definitely reduced. That's when I think you can see deals get done in a down round situation, because regardless the company needs that next slug of capital in order to achieve the next phase and its life cycle.

While it may be not an optimal outcome to do the down round, thinking long term, which most investors and management teams do now, it is the best thing for the company. Because if you can get that company back into a rule of 40 scenario, then you could then garner a great outcome for everybody.

We see that a lot with our clients where they just need that final slug of capital. This is where we'll see, instead of a down round, a company may choose hybrid security where you don't necessarily need to set valuation. It allows the company to get the capital they need, get back on their feet, reduce cash burn, either get to profitability or achieve growth. Either one would contribute to that rule of 40 mechanic and then exit at a valuation that makes sense for everyone involved.

Marina: Do you think there'll be more PE firms buying VC-back companies this year given that a lot of companies, a lot of startups, raised very high valuations last year and may be having a harder time raising a subsequent round now?

Emily: I think it's very logical to assume that we may see more private equity activity on the buy side of VC-backed companies, given that IPO markets are somewhat closed and valuations have come down a bit. I think there are obviously a number of factors, but, these VC companies that may have been looking to go public this year, they're going to have a set of investors who have their own fund-timing thresholds to meet, and they may need to exit.

While they would've loved to go public they maybe have their backs against the wall in terms of fun dynamics. That's where private equity can be a very compelling exit option. I think it always is and varies depending on the type of company. But yes, I think in the current market, we'll probably see private equity start to dip into some of these venture-backed assets that are really attractive but just don't necessarily have the traditional way IPO option available today.

Marina: What about earlier stage VC-backed companies? Are we going to be seeing some of those also go out on the block and be bought by PE firms?

Emily: I think you continue to see private equity, growth equity and venture work well together, at least from our vantage point. I think that they all have different strategies and they can help one another throughout their fund dynamics. Sure. Does everybody love to sell their prized asset to a strategic buyer or take it public? Of course. I think that all investors are seeing merits to VC to PE and PE to PE as viable options as well, and just knowing that that may be the best option for the company. Yes, I think we'll do definitely continue to see that.

Marina: What do you think is the most surprising thing about the current market and what are you most worried about?

Emily: I think I'll start with the second part of that question. Given the conflict in Ukraine and everything going on in Europe, but also globally, I think it's so difficult to have a perspective on what's going to happen. I think everyone is sympathetic, empathetic, worried, all kinds of emotions around what's going to happen both from a humanity standpoint and then secondarily from an economic standpoint. I think to say that I have a real view on what is going to happen would be a misstatement because I'm just as uneasy, worried and unclear as you know the next person around what to expect here.

Then in terms of surprising, I don't think we've seen what's going to surprise us the most this year yet. I think with everything going on in Europe and globally, we all thought we were coming out of this pandemic, supply chain was starting to get sorted out and then all of a sudden, we're facing a potential war, or a war. I think it can have a slew of impacts on people and markets. I think we're just in a situation where we don't know what to expect. I know that's a non-answer to the question, but I truly don't even know what we're going to see here.

Marina: It's a very difficult time. Especially as far as geopolitics go, Emily, are you seeing deals being put on hold because of the geopolitical issues that we have now? Is that impacting what's happening here at home?

Emily: It's difficult to say. I think it depends on where processes are in terms of phase. I think things that have been announced and are closing, that's more just procedural and will likely continue to completion. But I think in earlier phases of processes, you may see a little bit of nervousness mostly on part of buyers or anyone putting capital to work.

There are other situations where a buyer knows that they want this asset and they'll do it regardless because they know that they need to deploy capital and this is the best opportunity available. It really varies and runs the gamut but, I think to your point, you do see a little bit of hesitation.

Marina: Thank you, Emily. This was very informative. I really enjoyed our conversation and learning about your view on PE M&A markets.

Emily: Thank you very much for having me, Marina. I enjoyed the conversation very much.

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