“Software companies taste like chicken. They’re selling different products, but 80% of what they do is pretty much the same.”
This is part of my operating manual series opening up the playbook of private equity and company building luminaries. Check out past ones with Mark Leonard, Andrew Wilkinson, Robert F. Smith, ESW, John Malone, Felix Dennis and Mike Speiser.
If you are interested in buying, growing, and selling small companies, check out my course & community on it at IndiePE.com.
Who is Robert Smith? What is Vista Equity?
Robert Smith is the founder, Chairman, and CEO of Vista Equity Partners.
Vista Equity is a private investment firm that focuses entirely on enterprise software companies and as of August 2021 manages $75+ billion in assets across private equity, permanent capital, credit and public vehicles.
They have bought over 500 software companies and still hold 70+ with 70,000 employees and 700,000 customers across 175 countries. Their combined revenue would make them one of the top 5 largest enterprise software companies in the world after Microsoft, Oracle, and SAP.
Vista is unique in that it has a well defined system of how to grow companies after it buys them. It's a focus on the system over individuals. They have been called the "Alabama football" of PE.
Robert Smith is the richest African-American in the U.S., ahead of Oprah Winfrey and Kanye West, with a net worth of $9 billion as of August 2021.
Some other random facts about Robert F. Smith:
- In 2019, Smith paid $34 million to settle the loan debt for the nearly 400 students who graduated that spring from Morehouse College. He still has a Zoom meeting with this class monthly.
- In 2015, he married a former Playboy playmate of the year, Hope Smith.
- He is the board chairman of Carnegie Hall
How has Vista performed?
Vista has consistently generated a 30 percent rate of return for its investors since its inception.
Today Vista has $77+ billion under management across all its funds.
Vista has never lost money on a buyout which is unique in the world of boom and bust LBOs. Its largest fund has consistently been in the top quartile of comparable funds formed the same year.
What did Robert Smith do before Vista?
Robert Smith is the son of two Ph.D.'s who became Denver school principals and put education first at home.
In 1981 Smith headed to Cornell University to study chemical engineering, spending many nights and weekends in a three-person study group that met in the basement of the engineering school's Olin Hall. During summers, Smith worked at Bell Labs back home in Denver, a college internship he landed as a high school student after persistent cold-calling.
After graduating from Cornell in 1985, Smith took engineering jobs, first at a Goodyear Tire & Rubber chemical plant outside Buffalo, New York, and later at Air Products & Chemicals in Allentown, Pennsylvania.
In 1990 Smith moved to Kraft General Foods, where he focused on coffee-machine technology. He won two patents: one for a stainless-steel filter and another for a brewing process that makes crema, the layer of foam on top of an espresso.
In 1992 Smith went to Columbia Business School. He says he learned that "while inventing things was a great way of life, capital and utilization of capital can actually be much more effective."
After business school in 1994, he joined Goldman as a mergers-and-acquisitions banker, eventually moving to San Francisco to advise companies like Microsoft and eBay and becoming the co-head of enterprise systems and storage. He was part of the team that helped Apple recruit Steve Jobs back.
Where does the capital come from?
At Goldman, Robert Smith worked with Houston auto-dealership software maker Universal Computer Systems Inc. Its margins were higher than any software business Smith had advised, and he was stunned to learn the company's owners were plowing its cash into certificates of deposits.
He eventually persuaded its founder, Robert Brockman, to buy other software companies and improve them using Universal’s operating principles.
In 2000, after a Brockman family charitable trust agreed to commit $1 billion in two phases, Mr. Smith started Vista. They were the sole investor.
He recruited partners including a business-school classmate, Stephen Davis, and a young analyst who worked under him at Goldman, Brian Sheth. Sheth would provide the yang to Smith's yin, focusing on acquisitions and divestitures, so that Smith could concentrate on investors and the companies themselves. They are very close with Sheth serving as Smith's best man at his wedding.
When Smith quit, most of his colleagues thought he'd lost his mind. He was set to receive a multimillion-dollar windfall given Goldman's upcoming initial public offering.
Banks also wouldn't lend against software companies because they didn't have hard assets. Vista helped persuade them that companies with subscription-based businesses can tolerate debt.
His first acquisitions were all equity. Smith eventually got lenders to finance Vista's first leveraged buyout and bought Applied Systems, an insurance software maker, in 2004.
Smith's first buyout fund returned 29.2% annually net of fees. Smith raised money for a second fund from institutional investors, returning a net 27.7% annually. In 2011 Smith moved Vista's headquarters to Austin, Texas seeking to escape the Silicon Valley bubble.
"Software contracts are better than first-lien debt. You realize a company will not pay the interest payment on their first-lien until after they pay their software maintenance or subscription fee. We get paid our money first. Who has the better credit? He can't run his business without our software."
Why did Robert Smith start Vista Equity?
While at Goldman, he started to see the same sort of inefficiencies in how software companies were running across hundreds of companies he was evaluating. It was a new industry. And because it was a new industry, there were very few operating procedures on how to run a software company.
He found one company, Universal Computer Systems, that had some standard operating procedures to make software companies efficient and he thought you could adopt those methodologies across a number of software companies.
What he really wanted to do is create value creation mechanisms that can scale across the portfolio companies.
He realized that none of the PE firms of the day were really thinking about software as an area of investment. There was a focus on semiconductors and services businesses. He also saw a lack of awareness of the impact of software.
He saw that there was an opportunity to actually create a sustainable competitive advantage by becoming an expert in the software market.
“No one was doing buyouts in tech startups. These software companies were truly value plays, from my perspective.”
Why is B2B software attractive?
Software is a 95% gross margin business at the end of the day.
Once software is built you can sell it as many times as you want. There's no inventory so you never use it up.
There is negative working capital associated with the business.
Software provides high ROI benefits so you're creating massive amounts of productivity for your customers.
Software is also durable. You have the ability to be in that industry, not for quarters or for years, but for decades. Vista does a survey every year, across all of their portfolio companies, and today the average return on investment of the products that they sell to their customers is over 600%.
There are just very few products or activities that give you that sort of ROI, but software does it fairly consistently. Then if you continue to innovate, you can drive more adoption and provide more benefits to your customers.
“Moats have to be dug over time. It may take 15 years to create a moat.”
What is in Vista's Standard Operating Procedures (VSOPs) or Vista Best Practices, otherwise known as their 110-point playbook?
The playbook is what Vista is known for and is a closely guarded secret. The best practices most of which run three to ten pages, with reams of attachments and examples, are now numbered in the hundreds of PDFs. Printed out, they fill binders.
They are stored in a password-protected online library, available only to authorized portfolio company managers. Even the top executives of portfolio companies only get access to the sections that they need to know about.
The playbook includes exhaustive details on things like contract administration and steps needed to ensure a company is being paid for all the code or services its customers use.
Another set of playbook commandments revolve around sales, including incentives for salespeople cross-selling and upselling additional products.
Many of the playbook's best practices are pretty standard. But software companies are often inefficient with legacy processes that come from startup culture. Things like weekly deal-pipeline meetings, commonplace at MBA-driven corporations are often absent.
By sticking to the rules in Smith's playbook, his software companies are transformed. Add some modest leverage and you get Vista's amazing returns.
The playbook is always evolving. Best practices are being added and changed. They have very effective feedback and feed forward loops with structured times when their senior management teams get together and learn from each other.
Note: if you've seen the playbook, I would love to talk to you :)
“We don’t underwrite to hope. We underwrite based on critical factors for success under our control.”
What happens to businesses after the sale to Vista?
The goal is to transform business-software companies into profit machines.
Derek Jones, managing director at longtime Vista investor Grosvenor Capital Management, says “their process is like a factory. A deal comes in and it gets compartmentalized, and they apply experts on each compartment. After it goes off the assembly line, the margins are higher.”
Cost cutting is critical to Vista’s model. Some of the companies Vista takes over are located in markets with a high cost of living, such as Southern California or New York City.
To cut back wages and other costs, Vista will relocate part or all of the company to a less-expensive city such as Dallas. Many employees won’t make the move, allowing Vista to hire cheaper replacements. Vista often keeps a company’s headquarters in place and encourages it to expand in lower-cost markets.
In a textbook Vista deal, operating margins at a company might be around 20% when Vista buys it. Once its “best practices” are implemented, 4-5 years later, profitability is at 50%.
On average, Vista doubles the Ebitda of its companies within five years. This enables Vista to recapitalize, adding more debt, and then pay dividends to its investors.
One of the things Vista did very well early on was focus on product development. It yields massive benefits
Often enterprise software companies are started by a person who was really good at developing a product to solve some problem. That person wasn't necessarily professionally trained to be a product development manager, but was a good product developer.
Beginning with the first few portfolio companies, Vista would bring their CEOs together to share experiences and learnings.
Vista spends a lot of time and money getting together the execs and upper-middle management of Vista companies today. They have "seniors" teaching the "freshman" tips on running the plays.
What is Vista Consulting Group (VCG)?
To implement Vista's playbook, Smith created an in-house McKinsey: Vista Consulting Group. They have 100+ people now, almost equal to their number on the investing side.
VCG also runs the training and testing of employees.
What does Vista look for in businesses to buy?
Before it buys a company, Vista evaluates whether its software is “mission critical” and whether it has control over its “critical factors for success” or the key drivers of its performance. If the answers are yes, Vista often pays what its competitors see as a high price, confident it can boost the company’s profitability with its best practices.
The most important thing is does the business provide a real sustainable value to the customers that they're serving.
After that Is it a recurring revenue business? Does it have high retention rates with its customers and why? Is there an opportunity to upsell existing products to that customer base?
Does the management team really understand the value that they are creating for their customers and how their customers are actually using the product?
Then does this management team have the capacity to scale and grow or do they need a different set of training or tools or experiences or relationships to enable them to grow those businesses? 70-80% of the companies they buy are led by someone where it is the largest company either they've been in or the largest company they've ever led.
Example businesses Vista has purchased?
- Misys, the banking-software provider, a $2 billion acquisition in 2012
- Transfirst, a payments-processing software maker, was bought for $1.5 billion in 2014, then sold it for $2.35 billion in just over a year, tripling Vista's money once leverage was factored in.
- Tibco Software, which makes business-intelligence software, was purchased by Vista in 2014 for $4.3 billion.
- Solera Holdings makes software for auto and home insurers and was purchased by Vista in 2015 in a $6.5 billion deal.
- PowerSchool makes education-management software. It was purchased in 2015 for $350 million. It's spent another $1 billion on add-on acquisitions.
- Cvent, which makes software for managing and planning corporate events, was purchased by Vista in 2016 in a $1.7 billion deal.
- Marketo is a giant in cloud-based marketing automation software. It was purchased by Vista in 2016 for $1.8 billion.
- Ping Identity makes identity-security software and was purchased by Vista for $600 million in 2016.
- Finastra makes risk management software for banks and financial firms. It was created by Vista in 2017 through the merger of D+H and Misys.
How Vista launches new businesses?
Why do Founders sell to Vista Equity?
Robert says it is because they see how Vista enhances the value of not only their business from a financial perspective, but creates a business that actually is much more durable. One that's more reliable to their customer base and has the potential to be around for decades.
How long does Vista hold companies?
On average Vista's exits tend to occur 4.7 years after purchase, compared with 5.7 for Blackstone. They have some permanent equity vehicles where they can hold companies indefinitely as well.
How connected are businesses in Vista Equity?
Monthly meetings are held to cross-pollinate best practices among Vista employees from different companies in similar roles. It’s not just hey you should do this, but "here's a commission template we’ve built, and it has seven tabs in the spreadsheet, and there are the formulas.”
Vista’s also does bolt-on acquisitions, buying other software companies suitable for merging with its existing holdings. It often does strings of deals that enable it to boost revenue while streamlining its general and administrative functions, freeing up resources to expand development and sales.
Example: Bullhorn, which Vista sold to Insight Venture Partners and Genstar Capital LLC in 2017, completed five acquisitions while the Vista owned it.
They also encourage cross-selling of products across companies through commissions.
How does Vista Equity hire? What is the testing process?
When Vista buys a company, all employees and recruits are required to take a personality-and-aptitude test. The hour-long test assesses technical and social skills, and attempts to gauge analytical and leadership potential.
The aim is to determine which people are suited to which jobs. For example, salespeople are better off being extroverted, and software developers more introverted.
For Smith, the test is particularly important because it attempts to bypass inherent biases, such as where people grew up or went to school, race, and gender. Vista touts the tests to its investors as a great equalizer, helping make its companies diverse meritocracies.
35% of Vista’s portfolio-company employees are women. Women also run two of Vista’s five funds, which is unusual in the male-dominated world of private equity.
The test inspires consternation and fear among existing employees. Vista primarily hires job applicants who do well, often young people with modest credentials or experience. These are its “high performing entry-level” workers, or HPELs.
These HPELs may have gone to state universities and be willing to do a job for $75,000 that an Ivy League graduate in a high-cost market would demand twice as much for.
Former employees say low scorers aren’t fired, but they are less likely to be promoted. But the test does keep them from hiring experienced candidates who received low scores.
Some examples are a woman who ran a Domino's Pizza franchise in North Carolina who was deemed to be a good sales trainer and got promoted to do so for a Vista company. Another from the mailroom, scored high on Vista's test and became a programmer.
Last year Vista companies administered 850,000 tests to hire 6,000. This is all run by VCG.
How does Vista Equity develop employees?
After Vista has people where it wants them, there are boot camps that train employees, not just for two weeks but for six to nine months. In the past three years, Vista has put 12,000 new hires through these boot camps. They start by giving employees the big picture: how the Vista company makes money and the way customers use its products. The focus later shifts to specific corporate roles.
Vista University provides "nanodegrees" in things like artificial intelligence. This is all run by VCG.
What is Vista Equity's culture like?
It is molded in Robert F. Smith's image.
The workplace is an unusual mixture of formal and informal.
Many employees copy Mr. Smith’s office uniform—a three-piece suit. They are known to show up to startups' offices like this.
On the other hand, they are friendly. They greet each other with hugs. Board meetings start and end with hugs.
When Vista sells a company, Smith often gives its CEO an expensive Swiss or German watch. It is supposed to represent the system they created together. Finding the right person who is going to be the best gear in the machine.
How much debt does Vista Equity use?
More than others. They pioneered leveraged buyouts of software companies.
If you are interested in buying, growing, and selling small companies, check out my course & community on it at IndiePE.com.
If you know of anything I should add to this please reach out @ColinKeeley or Colin@ColinKeeley.com. I’ll continue updating as I learn more.