FLEXing in Berlin: Germany's up-and-coming software buy & builder

Foreign investors aren’t exactly rushing to Germany these days. The economy is in recession. The trains are late. The tech sector is stunted by a lack of investment and red tape. 

Or so they say. 

A peek at the German small/mid-cap software and IT services buyout market reveals about a dozen highly active investment vehicles. 

They are making a killing. 

Jan-Hendrik Mohr has turned an obscure microcap business into a $100M+ revenue VMS HoldCo that counts the MIT endowment and the founder of Danaher on its cap table. Chapters Group share price has quadrupled in the past 5 years.

Deutsche Beteiligungs made a 4X return on Cloudflight, a digital transformation services rollup, which it sold to Partners Group after 3 years. 

In the mid-market software and internet buy and build space, one firm has been making waves: FLEX Capital. Established only 5 years ago, it had a knockout maiden fund (€130M AuM), and is now investing out of their second fund (€300M).

We compiled this profile based on public disclosure (articles in Handelsblatt, TechCrunch) and the excellent podcast that FLEX’s co-founders Peter Waleczek and Christopher Jost recorded with Devin Matthews, a co-founder of Parker Gale - a mid market US PE firm with a similar strategy.

Let’s dive in!

Stay humble, stay low

FLEX’s playbook is a focused one:

• Stay regional by going after technology businesses in the German speaking part of Europe. This includes software, internet  and tech-enabled businesses (e.g. agencies). According to Bitkom, Germany’s digital association, the country is home to 11,000 mid-sized ICT companies. 

• Stay small - sweet spot is €10-50M revenues and €1-10M EBITDA

• They target bootstrapped companies with a great product who are hitting challenges, such as rising churn rates or deteriorating value proposition

• Value-add angle: out of a team of 30, 20 are operators and 10 are investors.

FLEX’s take on buy & build

The larger funds in Germany (and elsewhere) are hungry for tech assets of a certain size. Let’s call it €10M+ EBITDA. 

A typical FLEX target has €6-7M revenues growing 10-15% p.a. and €2M EBITDA. There is limited competition on the way in. On the flip side, at these growth rates, even after 3-4 years exit options are also limited. 

You can’t have that if your goal is to make money by “buying below the mean and selling into the mean”, to quote Devin from Parker Gale. 

This is where buy & build comes in. A strategy that FLEX has pursued with gusto. Fund 1 comprised 5 platforms, which translated into 16 acquisitions. 

Let’s look at the case study of ComX, a B2B sales enablement business, and the 6th platform: 

• FLEX acquired the business in 2022…

• …promptly followed by the acquisition of two direct competitors, Tendex and Global Sales Leaders (both in Germany)

• Brought onboard Directors of Finance and Operations & People

• Revamped reporting systems

The complexity discount and the fund returner

As Peter put it, the market for challenged assets is “dead”: “low prices but huge flaws”. On the other hand, the valuations for high quality businesses remain “crazy”. 

This puts FLEX in a unique position given their operational and add-on M&A capabilities. Let’s look at another case study - a QR software solution called Egoditor:

• 1st investment out of Fund 1 

• Bought a business with €12M revenue and 40% churn rate

• According to this case study, during FLEX’s ownership Egoditor grew revenues by 250% and EBITDA by 340%, while reducing churn rate by half

• Result: exited to Bitly in 2021 for a reported €300M (10X sales)

Clearly, it remains to be seen whether FLEX can repeat that success with the other 5 platforms.

Here’s a snapshot of the entire portfolio:

What are the showstoppers?

As Devin put it, Parker Gale is a value investor that is comfortable with many things - but not high customer or vendor concentration. It prefers businesses that are “hard to hurt” as they tend to make quite a few changes post closing, including replacing CEOs. 

What about FLEX?

• Share Devin’s views on concentration

• Fixing high churn is difficult most of the time (that Egoditor deal must have been an eye-opener!)

• High levels of technical debt in the platform company complicate an add-on strategy

Competing with other funds

As Devin put it, “if we’re looking at a platform that could be someone else’s add-on, it’s not the right deal for us”. In other words, investment returns are inversely correlated with the degree of competition for deals with larger investors / aggregators. 

When it comes down to winning deals, FLEX’s has three key advantages:

• Understanding and leveraging the founder’s ego and positioning themselves as the founder’s partners, rather than paymasters, which is the impression that many larger funds give, who are often represented by junior investment team members

• The language advantage and the local brand

• Last, but not least, while FLEX’s mid market focused strategy isn’t unique (think LEA Partners, BID Equity etc.), according to Christoph no new funds have entered the German market in the last 24 months