Education Deal Diligence Outlook for 2023

Whether or not the U.S. economy enters a recession in 2023, shallow or otherwise, evidence suggests we are in the later stages of an investment cycle in the education market. As an asset class, EdTech has become well known to financial sponsors over the past three years, catalyzed for many by the critical role distance learning played during the pandemic. The surge in enthusiasm that began in 2020 and accelerated into a white-hot seller’s market in 2021 has diminished over the last 12 months, in price multiples if not volume. Most professional investors have well-baked strategies already at work and the nature of deals has begun to reflect this state of maturity.

For this reason, we expect to see several recent trends continue to develop in 2023:

• International buyers and strategics have become more ascendant in deal processes as prices have come down
• Large strategics have begun to look hard at rationalizing their businesses and a growing number of divestitures are headed to market
• Tuck-in deals are increasing as many venture-backed companies run out of capital and sponsor-backed platforms look increasingly for product and market adjacencies
• Value-oriented investors that have stayed away during boom times are looking for platforms at more reasonable prices
• Search funds and entrepreneurs-in-residence are looking for fixer-uppers

Of course, high-quality assets are still capable of commanding premium prices, but we expect to see fewer record-setting multiples over the next 12 months.

In this article, we highlight some emergent issues that investors might wish to consider when evaluating assets in the education market.

K-12 Funding Cliff Looms

Federal COVID funding – specifically the Elementary and Secondary School Emergency Relief Fund (ESSER) – has fueled much of the enthusiasm for K-12 edtech investments over the past two years. The $189.5 billion in funding has been so sufficiently large and flexible that market size has not been viewed as the challenge that it had been in past years for K-12 investments. That said, by statute funds related to instructional materials and professional development must be spent by September 2024. And while many still hope that the U.S. Department of Education may extend the timeline for expenditures, as it has for infrastructure spending, this effectively means that there are only 1.5 more selling cycles before the available funding outlook changes significantly, creating a meaningful divide between winners and losers.

For both existing portfolio companies and prospective investments, understanding where companies are in their development and selling effort relative to this funding cliff is a critical data point in assessing revenue forecasts. Understanding what local, state, and federal budgets products can access and whether there is a viable consumer strategy will be more urgent questions for dealmakers in 2023.

Higher Education Counter-Cyclicality May Be Tested

The tight labor markets of the past several years have added to enrollment challenges for higher education institutions, particularly those serving working adult students who generally have felt less pressure to pursue additional credentials during a record period of peak employment. These institutions include graduate schools, online degree completion programs, and community colleges; all of which have historically experienced counter-cyclical demand. If and as the employment market softens over the next 12-18 months, this working adult audience may turn back to higher education, providing tailwinds to suppliers and partners that are part of this ecosystem.

On the other hand, if the employment market softens and these students do not return, it might suggest a more fundamental issue with the value proposition among programs serving this audience. Implications for investment are various but suggest paying close attention to end-market exposure for any operators in the space and perhaps favoring those with some exposure to the emergent non-degree credential market.

Human Capital Management Could Shift Emphasis

Any change in the labor market is likely to have a big effect on the dynamics among companies serving the upskilling and reskilling markets. Entire business models in this ecosystem have been built on labor market shortages over the past 3-5 years in health care and technology. While historically corporate training has been notoriously cyclical, there is some reason to believe that the hiring challenges experienced by employers over the past several years may have changed attitudes toward the benefits of training and may lead them to lean into retraining workers rather than turning immediately to layoffs.

However, if corporate-facing training models do begin to weaken, consumer-facing revenue may pick up the slack as lower cost, alternative credentials could experience some of the counter-cyclical strength that has historically benefited higher education institutions. The rapid development of bootcamps and other alternative credentials since the last recession may create a new dynamic to the historical paradigm. For investors, balancing exposure between models supporting workers that are both gainfully employed and those that would like to be may prove critical over the next 12-18 months.

If you are a buyer thinking of a platform or a tuck-in and trying to evaluate attractiveness and viability at the intersection of price and value, we stand ready to support your efforts.