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Robert Smith's Billion-Dollar Software Investing Playbook
Muhammad Abedi
February 14, 2025
Image of Robert F. Smith, founder and Chairman at Vista Equity Partners.
Vista is a software focused private equity investment firm with over $100 billion in AUM.
Software is one of the most transformative technologies of our time. Few investors understand it like Robert F. Smith, Chairman and founder of Vista Equity Partners.
Vista is one of the world's top private equity firms that have a singular focus on enterprise software. They have over $100 billion in assets under management. Vista has acquired more than 500 software companies since its inception in the year 2000. If you combine Vista's portfolio, they rank among the top five largest enterprise software companies globally. Smith himself has an estimated net worth of over $10 billion.
Vista Equity Partners has demonstrated strong historical performance across its private equity strategies.
"As of 03/31/2023, Vista has generated a 37.4% gross IRR and 3.12x gross MOIC on the 51 investments fully realized across all private equity strategies since Flagship Fund II began investing in 2000."
Smith's (and Vista's) credentials warrant a deep dive into their manual for investing in software companies.
This article is Part 1 of a two-part series.
In this first part, I break down how Vista Equity Partners thinks about investing in software companies.
I use direct quotes from Smith to understand how he (and Vista) thinks about evaluating and creating value in software companies.
To provide additional context, I have also included my own insights (under 'Author's Comments'). I do this to highlight key takeaways and expand on Smith's perspectives.
Part 2 will explore how Vista built a world-class organization and Smith's views on technological trends like Generative AI (Gen A).
I've spent many hours listening to Smith speak across various interviews. I've read multiple articles about him. His insights into software investing, value creation, and business building are worth sharing.
This article distills the key lessons from his investment approach based on direct quotes from his interviews.
Most of the quotes I use come from the following podcasts:
· Capital Allocators
· Invest Like The Best
· Dry Powder
· The Money Maze Podcast
These interviews took place across multiple years, mainly between 2020-2023. This means that some performance figures and market statistics may vary slightly.
Let's dive in.
I break this post down into 5 sections.
Feel free to skip to the section that is most relevant to you.
1. Investment Philosophy & Strategy
Focus on Enterprise Software
"We're in enterprise software. I'm not investing in oil and gas one day and insurance accounting the next. We do one thing. So we're actually pretty good at it."
"… there's just still a massive consumption, because enterprise software continues to be the enabler for almost every industry. It underpins all the core banking systems in the world, enables all digital sales and e-commerce, supports logistics and supply chain management, and drives segments like healthcare. A lot of that's driven by software."
Author's Comment: Vista Equity Partners focuses solely on enterprise software. This specialization helps them gain deeper expertise than other firms. They also compound their knowledge of the industry faster than their non-specialized peers.
Disciplined Investment Approach
"We've always maintained a very disciplined approach to how we buy those businesses. In the last couple of years, we've been buying them at half the price of the overall market."
"…the public markets continue to hammer some of the enterprise software companies… that creates a great opportunity for folks like us to make investments in this dampened valuation environment."
"I had a good conversation with Mark Andreessen the other day... he's a fantastic investor. He's like, look at your loss ratio and look at mine. And he says, my loss ratio is designed that way. He's saying...[he] need[s] to be losing 50 percent, and he takes that sort of risk. And so there's a whole industry that does that. We manage a lot of pension fund capital, and I'm sure they don't want me just to go try it. They want me to invest and not place bets. And so that's why I think about and take very seriously this whole idea of being an investor, which means to me minimizing your losses and your loss ratios while maximizing your returns. So that's really how I think about it."
Author's Comment: Venture capitalists make calculated bets, expecting only a few investments to succeed and drive overall performance. Vista Equity Partners is a private equity firm that focuses on investing, not betting. Vista aims to maximize returns while minimizing risk. Every deal has to have a high probability of success. As a result, Vista has a strong discipline around underwriting deals—which can be seen in their low loss ratios.
Taking an Engineered Approach to Everything
"The most important thing to think about in our firm is we focus on building systemic solutions that can scale. The engineer mindset isn't an episodic fix but an engineered solution. An engineered solution can grow at scale."
“…as an engineered mindset…you think about continuous improvement. We all can continuously improve on what we do, but you have to have a system.”
Author's Comment: Robert Smith is an engineer by training. He regularly speaks about the 'engineer's mindset' and 'engineered solution'. Smith adopted the engineering mindset to build Vista into a vehicle that constantly learns through feedback and feedforward mechanisms. He has been successful in building a self-sustaining investing firm which constantly improves.
Value Creation Through Operational Improvements
"Vista Consulting Group, VCG, [is] our value creation group...And what they are focused on is identifying best practices, and this is one of the key things…that we do."
"…[we are] looking for companies, mission-critical, business-critical enterprise software companies that when you bring specific sets of operational improvements create massive amounts of value in those businesses."
"Can we build, buy, be a part of what is the ultimate winner in that space?"
"About 70% of the deals we do at Vista, believe it or not, are founder-managed businesses. And 90% of those founders are still with us some place in our ecosystem, either at those companies or sitting on other boards... But one of the things that we do is work with those managers to teach and train and inform and help them run their businesses more efficiently."
Author's Comment: A big part of Vista's success comes from improving the operations and strategic positioning of the businesses they acquire. By creating VCG, Smith built a system that constantly adds operational value to portfolio companies.
Vista ensures that knowledge stays within their ecosystem. They do this by keeping personnel at all levels (both within Vista and its portfolio companies) closely connected. This setup encourages the diffusion of information, habits, and best practices that drive continuous improvement.
Vista understands the importance of owning market leaders. They will take steps to ensure they control the winner in any given space. They leverage their resources and expertise within their ecosystem to strengthen and position their portfolio companies for dominance.
2. Software Economics
Superior Business Model of Enterprise Software
"It's a 95% gross margin business at the end of the day. OK, how many industries are 95% gross margin? You build it once, you can sell it as many times as you can."
"There's no inventory...You have negative working capital and you have no capex, now that we have this opex model for access to compute."
Author's Comment: Warren Buffett once said, 'When a manager with a reputation for brilliance tackles a business with a reputation for bad economics, the reputation of the business remains intact.'
Fortunately, enterprise software has one of the strongest economic profiles of any industry. Many underestimate how even small differences in gross margin can significantly impact a business. People also overlook the complexities and challenges that come with inventory management, which is something software companies don't have to deal with!
I’ve written about the significance of gross margins here.
Mission-Critical Nature and Customer Retention
"The nature of enterprise software lends itself to what we call these mission-critical, business-critical type of businesses. And if you run them well, you'll have high retention rates with your customers."
"So if you've got churn, you've got to look at it. Is it because the customers picked another solution or they went out of business? If they've gone out of business, is there some fundamental underlying element of that industry that you're serving that gives you some suggestion that this is not one that you want to necessarily invest in?"
"One of the interesting things...that also came out during this pandemic is people stopped paying their bills to pay their rent, but they paid their software bills. Now think about that. Our retention rates actually went up."
"Software contracts are better than first-lien debt. A company will not pay the interest on its first lien until after they pay its 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."
Author's Comment: B2B businesses are compelling because customers make rational, profit-driven decisions. So when software is valuable and is deeply embedded in daily workflows, businesses continue using it for the long term. Mission-critical software is needed to operate a business, so it is prioritized over other expenses. As a result, enterprise software companies enjoy strong and predictable cash flows. This makes software contracts among the most valuable in business!
Recurring Revenues
"I look at my portfolio today, 71 companies, I think we're 92% recurring revenue, over 90 plus percent in [gross] retention rates with our customer base, and the average customer you have for a decade or more, well, it creates a massive amount of certainty, especially if it's very little capex on those businesses around free cash flows."
Author's Comment: Contractual recurring revenue is the golden goose of revenue types. It enables businesses to maximize the value of each customer relative to the cost of acquiring those customers. (This is reflected in the high LTV/CAC ratios). Recurring revenue fuels compounding growth. New customers are regularly added while existing ones continue generating revenue. Recurring revenue provides predictability, making financial planning much easier.
Note: Vista's portfolio companies have a 104%+ net revenue retention rate. This means they generate more revenue from existing customers (through upsells and expansions) than they lose from churned customers.
Software's ROI for Its Customers
"The average ROI of the products that we sell to our average customer is 640% ROI. Now, think about it. There's very little business investment that you can make that gives you that level of ROI."
"One of the things we do…is we measure the ROI of the products that our companies sell to their customers. And we do that annually, plus or minus three months, as a matter of timing, what we have going on."
Author's Comment: I mentioned that business customers make rational purchases to maximize profit. Investing in software is one of the smartest decisions a business can make because it delivers high returns on investment (ROI). Vista evaluates how much value its companies' products provide to customers. The higher the customer ROI, the more valuable the software. This is such a key factor in Vista's assessments that they calculate it annually.
3. Vista's Investment Process
How Vista Assesses Software Companies
Assessing Product ROI to Customers
"…one of the first things we do to at that point is [ask] 'what is the actual value of the products we are selling to our customers'? Okay, so if I'm selling this product to a bank, what's the return that they get on it? You know, how much more efficient are they going to be in processing whatever it might be that they're processing...And then how do you characterize that value and how do you capture what I call your fair share of it? That's the first thing we do when we're evaluating. And if you're saying, 'well, gee, this actually isn't so productive for your customer', then why would they continue to buy it?"
"...the most important thing is really, does this provide a real sustainable value to the customers that they're serving? You got to look at the must have versus nice to have kind of rubric of decision making from the customer's perspective. So that's kind of point one."
"Point two, does the management team really understand not only the value that they are creating for their customers, but how their customers are actually using that product? And how in using that product, it actually enhances their relationship with their customers. So that's kind of point number two."
Author's Comment: Vista begins its investment assessment by evaluating how valuable a software product is to its customers. (Software can create value for customers by driving revenue growth, reducing costs, or increasing operational throughput). Vista focuses on the key purchase criteria (KPC) that influence customer decisions when buying software. By analyzing these KPCs, Vista determines the long-term sustainability of the product's value to the customer.
Vista then assesses whether the management team has strong customer relationships and truly understands their customers' needs. (The best companies in the world are customer-centric).
After evaluating these fundamentals, Vista examines the business' economics. They analyze the company's recurring revenue profile, retention rates, and sales funnel. They also assess the management team's capabilities.
Understanding the economics of the business
"Then we look at some of the other elements. Is it a recurring revenue business? Does it have high retention rates with its customers? Why does it have high retention rates with its customers? Is there an opportunity to upsell existing products to that customer base? And then you have to look at the management team."
"What level of recurring revenues do you have with your customer base? What's the retention rates of those customers? What's the length of the contracts with those customers? What's the ability of that in market? Are these companies and customers going to go have problems where they can't pay you?"
Author's Comment:
Vista analyzes the revenue profile of software companies in great detail.
Software has high gross margins. This means that even small changes in recurring revenue and retention rates have a disproportionate financial impact.
Vista does this by understanding the nature of recurring revenue contracts with customers. They know how to make these contracts more sticky, last longer and more appealing to customers. The result is higher and more stable annual recurring revenues (ARR).
Retention is key. A company with net revenue retention above 100% can grow revenue without adding new customers. This happens when existing customers spend more (through upsells, expansions, and price increases), which outweighs any revenue lost from churn.
Vista also evaluates a company's sales funnel to see if revenue is being lost when acquiring or expanding and ascending customers.
Vista analyzes the software company's customer base and industry dynamics. They do this to identify potential risks to achieving high retention rates. Churn can be caused by company-specific issues or because of industry structure. If a company's customers are primarily small businesses or restaurants, churn tends to be structurally higher due to the high failure rate in these markets.
Market Size and Go-To-Market (GTM)
"Then from that, you can roll up into your normal TAM… what's your total addressable market? How do you assess that addressable market, given the products that you're selling, relative to the competitive set, to the extent they are selling those sorts of products? And then do you have an efficient motion? Go to market sales motion. Do you have an efficient value capture motion in your contract? And do you have an efficient motion in your product development so that you can create sustainable, long-term relationships with these customers, what we characterize in the form of ARR, right?"
Author's Comment:
You have to understand a business's competitive environment to evaluate its performance and potential. This involves identifying all the alternatives a customer has when choosing a software solution. You then compare the different solutions based on their features.
You have to develop a deep understanding of the customer's market and how it is segmented. Different segments may have different key purchase criteria (KPCs), which impact how customers evaluate and adopt software. Breaking down a market by its various segments and product KPCs provides a good understanding of the total addressable market.
Vista takes this granular understanding of the market and evaluates a company's go-to-market (GTM) strategy. It assesses its GTM effectiveness and identifies areas for improvement. Is there a good fit between the company's target segment and its product? Is the company using the appropriate channels and message to acquire, retain and ascend those customers?
4. Valuation Based on Value Creation
"Then from there, you can now start to talk about valuation, okay? What is the value of this revenue stream that you have today in your ARRs and have the potential to capture in your projections? And to what extent can you capture that, you know, using your organic methods of expanding your sales force or expanding your pricing or expanding your product or your penetration into the existing customer base? And that forms the basis of our underwriting."
"Are we capturing our fair share? And then how can we capture more of our fair share? So, from there, then you can think about what is the price discipline that one needs to exercise in investing in those businesses? And then from there, what are the activities that we're now going to deploy with the management team to now capture more of the economic rent that this product is actually providing to the customer segment…? ...And that's why we maintain a very strict price discipline because we have a good sense for the value of what these products can offer."
"But we think about really focusing on underwriting to critical factors for success being under our control — under our control being things that we know that we've done in the past, done before with an enterprise software company."
"We used a thing called a growth adjusted multiple… So you've heard of PEG ratios, price-to-earnings ratio? Rather than earnings, for a fast-growing software company, use revenue."
Author's Comment: After developing a strong understanding of a business's fundamentals, Vista can now focus on valuation. Smith regularly talks about underwriting to 'critical factors for success being under our control.' This means Vista only includes operational improvements in its underwriting if VCG can confidently implement them. VCG must have successfully executed these types of improvements many times before factoring them into valuation.
Smith has also discussed using a growth-adjusted multiple similar to the PEG ratio but uses revenue instead of earnings. From 2020 to 2022, software companies traded at revenue-adjusted multiples as high as 0.93, with an average of 0.61. Meanwhile, Vista acquired businesses at 0.43, demonstrating strong price discipline.
4. Vista's Value Creation Playbook
Approach to Building Best Practices
"VCG engages with our management teams, our investment professionals, our operating professionals to really deliver and enhance the value creation best practices."
"But you will often learn things that they're doing that are particularly effective in the markets that they're in that have some applicability across the broader portfolio."
"We build a whole set of best practices. You think about it, it's an engineered approach to value creation in software businesses. And that's what has been our unique advantage in this marketplace."
"Being able to evolve not only our best practices, but evolve relative to the way that the technology industries continue to evolve using different tools and methodologies and platforms."
Author's Comment: Smith built a value creation system at Vista that provides a unique competitive advantage. With VCG and Vista's extensive knowledge base, the firm can:
· Underwrite deals with greater accuracy.
· Drive more value through operational improvements.
· Close higher-quality deals at lower prices.
· Attract top-tier talent.
Vista's advantages function like a flywheel, where each success reinforces the next. Their best practices constantly evolves and improves. This makes Vista an attractive partner for all stakeholders.
Approach to Implementing Best Practices
"We've got literally hundreds, I think it's over 400 executives who've been on their second, third, fourth, fifth, sixth tour of duty at a Vista company. One of the best things we do is now bring those new executives in contact with existing executives."
"We've done this now over 500 times. And each time it's proven out that product superiority is probably one of the most important things that you can focus on, which is very much a heart of our best practices methodologies."
"We have very effective feedback and feed forward loops and we actually have structured times when our senior management teams get together. They learn from each other. They have shared experiences. We'll take the data from that. We'll enrich that data within VCG and then redeliver it across portfolio companies that may need that sort of applicability. So the organizational design, the construct, the methods by which we engage with our management companies and our management teams, are quite unique in the industry."
"We've got over 100 of these best practices. And when we're underwriting a business, we'll end up with, 'Okay, here are the 8 to 10 that we really have to do right now. Here are the next 20 that it'd be great to do in the next couple of years. Here are the next 30, if we have this company long enough that we need to do after that.' Because like all things, as an engineered mindset, there's just this thing you think about continuous improvement."
Author's Comment: Vista has built a large and strong ecosystem of seasoned talent whose expertise lies solely in enterprise software. Vista has engineered a process to collect the knowledge and experiences that exist within this ecosystem. It then formalizes this 'practical wisdom' into best practices that can be used by VCG.
When it comes to implementing these best practices, Vista adopts an 80/20 approach. They first focus on the few things that will carry the largest results. They continue to focus on implementing the few best practices that yield the highest return at a given time until they exit the investment.
How Software Markets Evolve Over Time
"…enterprise software still is kind of winner-take-most type of markets. Sometimes, they're very attractive, very interesting, and you're not quite sure who's going to be the winner just yet. Sometimes it's a capital play that makes them a winner. Sometimes it can be the management team that makes them a winner. And sometimes it's a regulatory environment that might determine winners or losers."
Author's Comment: Technology is constantly evolving, and enterprise software is still a relatively young industry. Industries tend to consolidate over time. Smith talks about how some software companies come to dominate their segments, whether through capital, management, or regulation.
Smith gives a good example that people can relate to. When he first started working, multiple spreadsheet solutions existed. This created inefficiencies when working with firms using other spreadsheet solutions. Eventually, one spreadsheet solution came to dominate the market. The dominant spreadsheet solution had more capital, a better product, and better distribution.
Vista and its portfolio companies need to understand industry dynamics and how industries evolve. Who will consolidate the market? Who will be acquired? Smith again emphasizes the key to long-term success: deliver high ROI and drive massive productivity for customers. The companies that do this can become segment leaders for decades.
Importance of Being Agile
"If you think about creating true operating leverage…you then have the ability to dial up and dial down what we'll call your go-to-market resources and manage that relative to what sort of profitability you think you want or can capture in a company."
"What we look for is…[can they]…innovate their product sets…to actually move the code base along at a much more rapid pace, which gives you the ability to deliver additional sets of products, services and solutions to your existing customer base and for what we call newer customers that we want to capture"
Author's Comment: Software is agile in nature. Code can be changed relatively quickly, and different customers can have different experiences. Although flexibility is critical in software businesses, many software businesses don't know how to manage it.
Agility is needed when companies pivot or transition from a high-growth model to a profitability model. Many businesses struggle with this shift because they lack the infrastructure (people, systems, and processes) to manage their operating leverage well. Vista understands this and builds adaptability into its portfolio companies.
Smith mentions the example of a Vista portfolio, Cvent. Before COVID, Cvent relied on in-person events for 95% of its revenue. When the pandemic hit, live events stopped. VCG, along with software developers, quickly worked to launch a virtual event solution within five months. This solution brought in over $60 million in bookings at the time of launch. Vista built the right infrastructure that allowed Cvent to adapt and innovate. Cvent lost only 10-11% of revenue during this time, despite the massive disruption caused by COVID-19.
The Significance of Technical Debt in Software Companies
"...the enterprise software companies that have failed and gone bankrupt or had all sorts of financial challenges, it's because, typically, they have too much technical debt...When we take a pass on a company, it's often because they have too much technical debt relative to the pace of the market that they are in. We have a whole set of best practices around reducing and ultimately eliminating technical debt...when we take a pass on a company, it's often because they have too much technical debt relative to the pace of the market that they are in."
"… you'd be surprised at how many management teams I know that we spend time with in due diligence evaluating businesses that actually don't really have a sense for the amount of technical debt that they currently have and never thought of that. Yet they provide increasing levels of resources against managing their existing code base and not really realizing that they're losing ground every day because they actually haven't taken the right approach to eliminating technical debt."
Author's Comments: Technical debt occurs when developers take shortcuts in coding to save time. This leads to hidden issues that emerge when the system is under stress. Technical debt slows development, increases maintenance costs, and makes scaling harder. Companies with high technical debt struggle to adapt to market changes and may lose to competitors with cleaner code. Technical debt also lowers valuations in mergers and acquisitions due to the high cost and risk of fixing bad code.
The impact of technical debt is highly underestimated. Vista understands the risks around technical debt. Technical debt is especially problematic in fast-growing businesses. High growth will put a strain on systems, which will break down more often. Although Vista has best practices for reducing technical debt, it will decline to invest in companies with excessive debt relative to market growth.
Challenges of Operational Value Creation
"But you actually have to be able to [improve operations] where you're not breaking the business. And the way I like to characterize it, to accelerate the corporate maturity, it's not just as simple as cutting costs. It is actually building sustainable infrastructure in the core pillars of the business, which might be...product development...go to market strategies...[management of] your contract administration processes. How do you manage your human resources and human capital? Do you utilize centers of excellence? Do you go to places where you can get high-quality talent at lower cost, but still maintain high KPI productivity?"
"...[you need to ensure] that fundamental underpinnings ultimately give you the ability to scale and to pivot in some cases from higher growth to more profitable, but still not necessarily break the business. There's an art to it and the good news is we have 23 years of managing that process and have been fairly successful at it."
"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?"
Author's Comment: Improving a company's operations isn't easy; if it were, it would have already been done. Vista' accelerates corporate maturity' by strengthening the people, systems, and processes across key functions like product development, revenue operations, and human resources.
Many of the companies Vista acquires are led by management teams who have never operated at a larger scale. To bridge this gap, Vista provides them with the training, tools, experiences, and relationships needed to grow and evolve successfully.
Fostering Innovation
"... we'll have two hackathons a year, one in some place in the US and one place in Asia, and bring these top engineers together and we'll charge them with a task… Years ago, it was using machine learning to develop a new set of products and or it's artificial intelligence. Well, of course, now the topic is Gen AI.
So we just had two of this [hackathons] recently in the last couple of months, and we have over 250 participants from I think almost over 30 companies, multiple teams, and they compete and they come up with products.
Well, the good news is when you do that, we're actually generating ideas, workflows, infrastructure that can be leveraged. Oh, that's a great go-to-market product for this one company that can be leveraged across 18 others, right?"
Author's Comment: Smith applies a process-driven, engineered approach to innovation. One way Vista "engineers" innovation is by organizing hackathons. These hackathons bring together VCG employees, software developers, and other key stakeholders to collaborate and build solutions around specific technologies.
5. Exiting Investments
"…strategic buyers and financial buyers all looked and said...[that] these are actually very attractive businesses that you all have built...when they do their diligence they see...we haven't just kind of glossed over what...the important elements of maturing [the] corporate...infrastructure...which is what buyers really want."
"And so if you [strategic buyer] use your terrific sales force, to expand the sale of these products into your customer base, here's the economic benefit you get from a product that's already built, proven and used, into a customer that you already have. And now it's just a function of how long it takes to now go capture it."
Author's Comment: Most of Vista's investment exits occur through sales to strategic buyers. These buyers are typically very large technology companies. These buyers acquire Vista's best-in-class businesses because Vista develops them into high-value assets. By the time a strategic buyer steps in, the company is positioned for seamless growth. The buyer leverages its salesforce and large distribution network to scale further and easily.
Apptio was a Vista portfolio company before it was sold to IBM for $4.6 billion. According to Smith, IBM saw an opportunity to double or triple Apptio's value. IBM could do this by integrating Apptio's solutions into its sales infrastructure and extensive customer network.
Apptio had potential for additional value by embedding Generative AI capabilities. IBM could easy embed such technology into Apptio, which made it more attractive. The ability to 'plug-and-play' and scale easily justifies the sometimes multi-billion-dollar acquisition price paid by strategic acquirers.
This first part explored how Vista evaluates and invests in software companies.
In Part 2, I’ll:
Dive into how Vista builds a world-class organization
Share Robert F. Smith’s views on emerging technology trends
Explore how Vista is adapting to the evolving software landscape
I’ve also written more about why B2B software is such a powerful business model. You can check it out here.
Investing in high-quality software companies can be highly rewarding. Click below to learn why B2B software:
✔ Consistently experiences high margins
✔ Generates strong retention and predictable revenue
✔ Benefits from powerful competitive advantages
What are your thoughts on Vista’s investment approach?
Let me know!