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Buying the bond
For two decades, private equity firms and traditional holding companies often treated a vertical software business as a bond. The subscription dynamics and margin profile made the cash flow steady, so buying one meant buying a coupon.
The stapled call option
Beacon buys the bond and a call option stapled onto it. The call option is the asymmetric upside of building more for the customers already there. The right to clip the bond coupon is earned by serving customers better every day, which means building new technology.
Customers asking for more
A software business that adds no more value next quarter than it did the last has no right to exist, and that holds for any business. So far every one of Beacon's businesses is growing faster than when Beacon bought it and is more profitable, and customers are going to those software businesses and asking them to build more.
A campground, a youth soccer club, a precast concrete design firm, or a K-12 private school needs AI too. When they call Microsoft, they sit on hold. The software company they have used for decades has a multi-decade relationship with them and can help with the transition.
Why is recurring revenue priced like a bond?
A bond pays a fixed coupon on a schedule, and its price reflects how reliably that cash arrives. Subscription software renews on a schedule too, and vertical products tied to daily operations often keep customers for years. Investors therefore value predictable renewals at a premium to one-time sales. The price of a bond equals the present value of its coupons and principal, discounted at a rate set by its risk.
How does an option create asymmetric upside?
The buyer of a call option pays a fixed premium for the right to buy an asset at a set price. If the asset's price rises well above that level, the gain has no ceiling, while the most the buyer can lose is the premium. Options like this were priced with a formula published by Fischer Black and Myron Scholes in 1973. Scholes shared the 1997 Nobel Memorial Prize in economics with Robert Merton for the work.
Why do customers stay with decades-old software?
Business software holds a company's records and daily workflows, so replacing it means moving data and retraining staff. Economists call the burden of leaving a switching cost. Carl Shapiro and Hal Varian described how such costs lock customers in, in their 1998 book Information Rules. They argued that the value of a customer base often rests on what it would cost those customers to leave.
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