This article is sponsored by HPE Growth.
What are the challenges to identifying the right tech companies for acquisition in the current market environment?
Frederic Huynen: It all starts with having a very well-defined investment focus. We concentrate on four industry verticals that we are strong in, which are software, fintech, consumer internet and digital health. Those provide us with a defined investment space and allow us to be proactive in building relationships early with targets in our core sectors and markets. We get to know companies long before we expect them to look for funding, so we are on their radar and they can experience the value-add we provide. Often companies will call us ahead of others when they are preparing for a funding round to see if we can make a proposal.
One of the key criteria that we look at is efficient growth, which is different to maximum growth at all costs. We zoom in on profitability and capital efficiency, which means looking at the consolidation of a company’s revenue growth rate plus profitability margin, alongside a profitability assessment based on unit economics.
We also practise what we preach – HPE Growth invests in data-driven companies and we have created a proprietary data-driven system that monitors and flags a broad range of KPIs in potential targets, from press announcements to changes in the tech stack.
This approach helps us avoid the winner’s curse typically associated with formal processes and enforces the focus on a partnership approach to value creation post-investment, which is especially relevant in a high-growth environment.
Finally, while the market overall is very active and certain segments are seeing much higher valuations than several years ago, that is not the same across the whole market. We operate in a space that is often too early for the mega-growth funds, which tend to compete for larger rounds in later-stage growth companies, creating high valuations in that segment. We fit perfectly with early to mid-stage growth companies, where we see a better dynamic in terms of demand and supply and where we can make a difference in taking those companies to the next level.
We continue to maintain a certain price discipline and consider it OK to lose a deal where there is a significant difference on valuation, subject to having sufficient information symmetry and good understanding of the value-creation strategy.
How important is your value-creation approach in helping you win deals?
Manfred Krikke: We are not majority investors, so everything we do is in partnership with management teams and other shareholders. Our approach is partnership oriented. We believe founders have a special mandate from their organisations to be decisive and fast-moving; they are looking for partners that can help them achieve market leadership more quickly and build world-class teams to take their company to the next phase.
Our team is diverse, with some of us from a finance background and others that have gone through the entrepreneurial process. As an entrepreneur, I’ve walked a mile in the shoes of these entrepreneurs, having previously started an online software distribution company, backed by Kleiner Perkins and TCV and taken that company public on the Nasdaq. We can help others avoid some of the pitfalls of their own successful growth journey.
We see a real opportunity right now for European entrepreneurs to build long-term successful businesses and remain independent, taking companies public through an IPO rather than preparing them for a strategic sale. That is a path that was not necessarily there in Europe a few years ago, and one we know well, having been involved with more than 16 IPOs in both the US and Europe.
Today’s founders are undoubtedly more sophisticated about taking external capital and really know how to differentiate, especially when it comes to minority investing. It is not about selling the business but taking the best partner into the shareholder base. An emphasis on value creation provides strong network effects, with successful partnerships validating our reputation as a value-added, founder-friendly investor in the ecosystem and supporting our positioning for new investment opportunities.
What are your priorities when it comes to optimising performance in your portfolio companies?
MK: Our value-creation approach is based on a systematic framework that is repeatable, combined with ad-hoc support in areas that we know well. The way we provide that input is initially through a concentrated 100-day plan, identifying some easy wins and then working with the board to develop a clear strategy that ties company priorities to key shareholder value growth.
We put a lot of emphasis on helping founders think through the organisational change that comes with growth and recruit the world-class people they need to successfully navigate the challenges of that next stage. We know how to promote a highly functional team culture based on the founders’ values, and build a strong supportive board that includes independent industry-leading expertise. International expansion is another key element of our value-creation framework.
As an example, we also often do an in-depth review of the pricing strategy, the product road map, go to market strategies and, of course, an analysis of the ESG impact as part of our value-creation roadmap.
We help make sure the company has the right priorities and the right team to execute, with a “speed-as-a-habit” culture. We do not get into the operational or tactical execution of the business strategy, that is management’s job.
Where do you tend to find the most powerful levers to drive growth?
Tim van Delden: It is important that when we invest in a company there is a clear strategy and a functional business model already in place, and we then look at how we can improve on that and accelerate existing growth. We are focused on improving a functional business model and maintaining growth rates, which becomes more challenging as a company scales.
During due diligence, we tend to concentrate our thinking on identifying multiple layers of growth, analysing the company against various KPIs to see which layers we can combine and where we can provide capital to be a catalyst for enhanced growth.
The layers of growth that we look at and hope to run in parallel include a strongly growing industry, and then opportunities for growth in existing activities and with existing customers, expanding geographically, expanding the product offering and then looking at the channel mix, potentially considering direct sales versus an indirect ecosystem as a route to market.
Another layer is pricing optimisation, where companies can often benefit from keeping their pricing strategy under constant review, and then there are buy-and-build opportunities to consider.
Ideally, the outcome of due diligence should identify three or four layers of growth that we can actively influence. It may be that one of those will be impacted during the term of our investment by regulatory change, for example, which is why we like to have multiple layers running together to achieve a well-performing investment. If we can achieve that with a capital efficient cashflow we have done a good job.
What challenges and opportunities do you see in the exit markets for tech companies right now, and how might that environment change going into 2022?
MK: One of the most exciting things happening in Europe at the moment is the appetite in the capital markets to invest in high-growth IPOs. Europe has long been an interesting market for technology but there has always been a question around how to monetise that opportunity, and LPs were acutely aware of that.
That has changed quite dramatically in recent years with some high-profile success stories of companies that have built strong market leadership positions, often globally. At the same time, large asset managers are looking for places to gain returns, which is not easy in the current market environment, and so it makes sense for them to look at companies transitioning from private to public ownership. First, we saw successful exits of European companies selling to global tech companies, and now increasingly there is also a path to public exit.
We are seeing the European IPO ecosystem forming a bit of a bottleneck currently, with capital interested for the right reasons but the community not yet fully staffed to deal with the potential volume of IPOs. However, with further successes, people will increasingly focus on this and the markets will adjust and staff up to address the opportunity.
We are optimistic this will take off, because it is a very healthy part of the market and will allow capital to flow back to LPs, which can then reinvest into younger companies and recreate the cycle of innovation that has worked so well in the US. At the same time, in addition to traditional pathways to IPO there are also special purpose acquisition companies. We are somewhat sceptical about many of those but there are certainly some credible teams with a sound approach for using SPACs to transition companies to public ownership.
Just as we have a selective approach to investing, we are also selective about our approach to exit. We want to be known for bringing very high-quality companies to the market, delivering great management teams with sound strategies, predictable performance and processes that can be trusted, so that the next owners can also make a strong return.
Tim van Delden and Manfred Krikke are managing partners at HPE Growth, and Frederic Huynen is a partner at the European private equity firm