AVCJ Awards 2022: Fundraising of the Year – Mid Cap: Potentia Capital
For Australia’s Potentia Capital, the beauty of its sophomore fundraise was not that it took four months, but that it took two years. Putting out feelers well before the official launch created buzz
Raising its first middle-market technology buyout fund, Potentia Capital faced all the classic obstacles: a debut fund, a new team, a country-specific approach, a sector-focused strategy.
But the Australia-based private equity firm’s founders – Andrew Gray, formerly of Francisco Partners and Archer Capital, and ex-MYOB CEO Tim Reed – were able to weave a convincing narrative that combined their personal credentials with a data-based thesis about a thriving tech scene ignored by global investors.
“Our contention was that by being focused solely on a single thematic of technology and software we generate differential insights and deal flow, and that’s certainly been the case so far,” Gray said.
“The challenge is, do [global investors] need to add Australia to that thematic? Our pitch is that there is a lower competitive environment down here and therefore we can generate superior returns, even to what they’re seeing in the US.”
Fund I closed in January 2021 on AUD 458m (USD 326m), mostly from local LPs, beating a target of AUD 300m after 18 months in the market. It is currently marked at more than 2x, in part thanks to a 4.3x return on the sale of compliance software provider CompliSpace to UK-based Ideagen for AUD 110m after a less-than-two-year hold.
That exit, in November 2021, provided the proof-of-concept required for a formal launch of Fund II, although background work had been ongoing for 18 months. The target was AUD 500m, but Gray claims to have fielded almost AUD 1bn in demand. Last June, it achieved a first and final close on AUD 670m, including a AUD 70m GP commitment.
Two other exits contributed to the proof-of-concept, albeit in indirect ways. They included software provider Micromine, which was not formally exited during the fundraising period but considered well on its way to a trade sale. That deal was finalized one month after Fund II closed, generating an almost 10x return.
The third exit driving the Fund II result was not even part of Fund I, although it did feature co-investment from some returning LPs. Potentia acquired a controlling stake in payroll software specialist Ascender in 2015 with support from the likes of HarbourVest Partners and MLC at a valuation of around USD 25m. It was sold to a US strategic in January 2021 for USD 500m.
HarbourVest participated in Fund II, as did the likes of New York State Teachers' Retirement System, Neuberger Berman, and Asia Alternatives. The latter two were maybes from Fund I that required more proof. Only one Fund I investor, a high net worth individual (HNWI) facing liquidity challenges, did not re-up.
A broader base
The plan was to transition to a more US and Europe-centric LP base while retaining a backbone of Australian institutional investors. It worked. Australasia represented 71% of Fund I and 50% of Fund II, while the US and Europe went from 24% of Fund I, combined, to 37% of Fund II.
There were 25 LPs in Fund II versus 12 in Fund I. Fund-of-funds weighed more; HNWIs weighed less. Big tickets were scaled down in the process.
The process was effectively 100% virtual, with only one LP, a European foundation, making the trip to Australia. There was a few months’ hiatus at the start of the pandemic, but almost everything went online immediately thereafter. There were virtual data rooms, virtual office tours, and virtual annual general meetings. Only 13% of Fund I capital was raised virtually.
“If you think about businesses that can be diligenced virtually, software and technology are at the top of the pack. You’re looking at desks and computers – that’s it. There’s nothing to see. It’s all virtual anyway,” Gray said.
“We’ve bought businesses without visiting their offices [hotel platform NewBook]. We’ve exited businesses where the team never met the buying company [CompliSpace]. We did stuff right in the eye of the storm with COVID and managed to continue to grow the businesses and do well.”
The fundraise also featured two virtual on-sites, hosted by placement agent Asante Capital. These were talkshow-style affairs intended to increase engagement and create a sense that opportunities to participate were dwindling. Questions were given anonymously. None of the LPs knew who else was there.
“For the past 12 months, it seems like most fundraises are either a single close or a protracted series of rolling closes. The first close, final close model is no longer prevalent in the current landscape,” said Ricardo Felix, head of Asia at Asante. "So, it was crucial to drive scarcity value on the back of strong LP interest at the outset."
Felix emphasises that the success of the Fund II raise was in starting early in a pre-premarketing phase. Hundreds of prospective LPs were given updates quarterly, sometimes more often, about everything from upcoming deals and co-investment opportunities to what’s going on in Australia versus the rest of Asia Pacific. A rapport was established without a pitch.
“It’s all about what happens when you’re not in the market. Premarketing is no longer enough to map out an efficient process, and so we have incorporated an earlier seeding stage of preparation for new fundraises,” Felix added. “Now, I ask GPs to let us know when they’re at 40% to 45%, not closer to 70% to 75%. This has been an important part of our recipe for success.”
Keen to deploy
The strategy for Fund II will mostly stick to Potentia’s established formula. Australian and New Zealand B2B software B2B software companies with scope for global expansion will be the preferred targets. Asia will be targeted for expansions through bolt-on acquisitions and perhaps some core investments given Potentia recently established a team in Singapore.
“We would certainly do platform investments there,” Gray said of Asia, flagging recent bolt-on success in Singapore and Japan offset by limited scope in China. “I think it’s a market that we will develop over time. We’re not in a rush, and we want to make sure we walk before we run.”
As a mid-market buyout specialist targeting profitable companies, Potentia appears unfazed by the chill in market sentiment overcoming earlier-stage tech companies globally.
Indeed, Gray observed some momentum in talent leaving loss-making software companies to join the more mature players in Potentia’s crosshairs. This could help alleviate a painful period of labour shortages in Australia, which has been surprisingly challenging even in a seemingly borderless industry.
Investment activity so far this year appears to support this optimism, at least in terms of deal flow. One investment has been confirmed with Potentia taking a 25% stake in mobile messaging systems technology supplier Soprano Design for AUD 66.3m.
It is hoped three more deals will come together in the first quarter, including a buyout of listed e-signing player Nitro Software, despite repeated board-level rejections. Potentia, which has a 19.8% stake in the company, is in competition for a controlling position with KKR-owned Alludo of Canada.
Like its predecessor, Fund II will make eight to 10 investments, reflecting a need to accommodate rising valuations and help companies scale. At least two of the transactions under review are sizeable enough to mobilise both of funds.
Historically, about half of Potentia’s investments have leveraged LP support, and this is expected to continue. Soprano, Nitro and the other two prospective deals all involve co-investment. So, does a snowballing tech opportunity set and a growing appetite for large deals mean the next vintage will be outsized?
“Maybe we’ll do more [than USD 600m of external capital] in Fund III, but we do like less than USD 1bn in terms of capital under management,” Gray said. “We don’t have a lot of capacity, but we’re keen to add a couple of good names. There are folks we’d like to start having conversations with early.”
Pictured: Michael Bryan of Potential Capital receives the Fundraising of the Year - Mid Cap award from HQ Capital's Jacob Chiu
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