Orlando Bravo: Our LPs ‘very comfortable’ without a hurdle

Thoma Bravo’s funds have satisfied their LPs to justify their streak of no preferred return going forward.

Chicago-based Thoma Bravo held a final close for its latest fund, Thoma Bravo Fund XII, on its $7.6 billion hard-cap last month. The fund easily surpassed its $7 billion target in a matter of nine months of fundraising, reaching more than double the size of its predecessor that closed on $3.65 billion in May 2014. As PEI previously reported, the latest fund is charging a 1.5 percent management fee, 20 percent carried interest, and no preferred return, otherwise known as the hurdle rate GPs have to reach in profits before earning their share of the carry.

Below, the firm’s managing partner Orlando Bravo discusses the fund in more detail with PEI and its investment pipeline and appetite in the current market.

Q. How did fundraising go for Fund XII?

A. The fund was spoken for way before the final closing; it was 90 percent closed by June, but there were a few institutions that needed to finalise their commitment processes. We didn’t want to announce anything until we were 100 percent closed, which is why we announced it in September.

There were no long-term investors that didn’t return [to Fund XII]. This is an industry that really rewards superior performance and penalises mediocre performance. There were no demands from our LPs for change on the 20 percent carried interest; it’s been the structure for a long time. There’s no activity of secondaries sales within our investor base, either. LPs want to get into very good funds, because they themselves need it for pension obligations, endowment growth, beating their peers or the index. There’s a huge amount of demand for best funds.

Q. Even without a hurdle rate in this fund?

A. We’ve historically never had a hurdle rate in any of our funds. And we aren’t likely to introduce it in our future funds. Our LPs, given our rate of return, are very comfortable. Hurdle is not an issue; they’re not investing in us with worries about it. We have a long history of very high net returns and it’s something our LP community sees.

Q. Fund XII is more than double the size of Fund XI. Has your strategy changed?

A. Our deal size for the last 16 years have been going up just because the software and technology companies that we follow have been growing. We are doing the same types of companies, but they’re just becoming bigger. So, every subsequent fund [managed by Thoma Bravo] is bigger. But we’re sticking to our same strategy. Given the numerous changes in technology, such as fast migration to the cloud, cybersecurity, changing customer behaviours, we try to maintain our focus and remain a specialist in this sector.

Fund XII is off to a very fast start for investments. Of the latest four transactions, three are take-privates. We bought [IT infrastructure software provider] SolarWinds in February for $4.5 billion [with Silver Lake]. We bought [self-service data visualisation company] Qlik for $3 billion in June, and we bought [healthcare IT security provider] Imprivata [for $544 million in July].

Q. Why is Thoma Bravo interested in take-privates in the software sector?

A. The first take-private transaction we did happened 15 years ago. We’ve always been in the take-private market since the beginning of Thoma Bravo. The general evolution of software businesses is that they pretty much all go public at some point because they need to finance themselves for growth by tapping the public equity markets.

Also, we find great operational opportunities in the public companies we find. When we buy a company, we have a process for improving its earnings and growth rates. Rather than a company being in the public hands, we find more opportunities to drive those improvements in the private hands. This is essential especially in a fast-moving space like software and technology. Sure, public companies are usually more transparent, but their governance is not meant to produce significant operational changes. And while the innovative industry undergoes dramatic changes itself, those operational changes are needed from time to time. The software sector is a bigger part of the US economy and pervasive in all businesses.

Q. How are you navigating through the peak valuations as you put capital to work?

A. Our Fund VIII [which closed on $765 million in 2005] has provided our LPs with a multiple that is almost 3x net, and it was invested just before the financial crisis, at another peak time. It’s not that different this time. The way we deal with that is: we just go back to not deviating from our strategy and process, so we can triple a company’s earnings in software by using our operational expertise and our ability to do add-on acquisitions. For example, one of the best deals we’ve ever done, if not the best, is [content management software provider] Hyland, which we first acquired in July 2007 and still hold in our portfolio. That deal was done at the peak of the stock indices just before the financial crisis, but the company more than tripled its earnings within the first four years of our ownership.

Because valuations are very high, everybody is in play for sale. You have so much to choose from as an investor. We are seeing three or four deals per year to strike on. The challenge in 2009 was creating the buying opportunity. Today, you just can’t be afraid to turn a lot of things down. You have to have the discipline to not invest in something that just doesn’t meet your return goals.