KKR on taking an active approach in a maturing asset class

Growth investing should be about forming deep relationships with a small number of great companies, says Dave Welsh, partner and global head of tech growth at KKR.

This article is sponsored by KKR.

Dave Welsh, KKR

How would you describe the current maturity of the growth equity asset class?

What developments have you seen in the past year or so? I have been doing this for 22 years and have witnessed the asset class evolve from a cottage industry to its own fully fledged category. The past year has been frenetic and, in some ways, hard to keep up with. The speed with which transactions occurred was incredible and, frankly, it began to feel almost dangerous.

We believe that making successful investments in high-growth companies requires significant time for due diligence and for getting to know the companies and their management teams. This is why we typically only do six to 10 transactions per year.

KKR plays in a part of the market where it takes real focus and concentration to make sure the right investments are being made. This requires thorough diligence up front and putting a lot of effort into supporting the company’s growth; it is not a passive strategy.

What does growth mean to KKR, and what do you find attractive about that part of the market?

We see growth as beyond product or market risk, where you are helping innovative businesses that have proven products to scale up and commercialise. These are businesses with very strong top-line growth – for us, most companies are growing at 50 percent or more year over year, and we aim for more than 30 percent compounded growth over our hold period.

These businesses still have room to grow and can leverage the right platform of resources to de-risk and potentially accelerate their growth trajectories. Having a platform that can navigate trickier waters, such as geopolitical uncertainty, is also a differentiator.

Growth equity for us means taking a concentrated long-term view on a small number of companies and spending a lot of time with them. These investments, if done right – with the right companies and the right collaborative partners – can de-risk a significant amount of the downside and generate great break-out upside by helping businesses reach the next level of success.

Where in the market do you see the most attractive opportunities?

We are a broad-based technology growth strategy, so we look at internet, cybersecurity, traditional software, fintech and beyond. What’s really important is finding great companies and building a robust pipeline of businesses that we cultivate long-term relationships with. We have a database of 20,000-plus companies that we are getting to know over a long period of time, and we typically start getting to know our businesses three or four years before we invest in them. That’s critical for making sure we are backing quality teams that can execute.

There are a few areas within the technology ecosystem that we are particularly excited about today. One is cybersecurity, where we have made a number of investments over the past several years, including ForgeRock, ReliaQuest and Darktrace. Disaggregated software development is another area that we find compelling and where we have seen a number of opportunities. Our investments here include Leapwork and OutSystems, both of which specialise in low-code software development and testing.

“Businesses that become too inward looking and forego international expansion because they are afraid of geopolitical turmoil may fall behind”
Dave Welsh, KKR

The last area I would mention is solutions that support the office of the chief financial officer, including supply chain logistics. Examples of investments in this area include OneStream Software, a corporate performance management business, and o9 Solutions, a next-generation cloud-based supply chain and operations planning software provider.

How does the current macro and geopolitical environment impact the space?

The key thing we’re focused on is working with mature management teams that are willing to collaborate and can use the resources that they have at their disposal to be successful. We find that our robust platform of resources is a real asset to these businesses and is something that differentiates us from other partners.

As we work through this tricky geopolitical and macroeconomic environment, organisations that can think deeply about scenario planning and can leverage the resources they have are going to be best placed to succeed.

As we look at new investment opportunities, we want to be very mindful of the impact of continued movement in the macroeconomic outlook and how those headwinds will affect the companies we invest in. We need to be effective in identifying those risks, understand what our resources and platform can do to help mitigate them, and make sure that the risks we take on are reflected in the prices we pay. We don’t want to avoid risks, but we do want to make sure we fully identify and mitigate them.

“Growth equity for us means taking a concentrated long-term view on a small number of companies”
Dave Welsh, KKR

Certainly, some companies in the growth equity segment are not as global, and therefore some of the recent global macroeconomic and geopolitical issues may not impact them. But just about every business we invest in can be global, so some of those challenges will impact them eventually. Businesses that become too inward looking and forego international expansion because they are afraid of geopolitical turmoil may fall behind. It is about doing that the right way and being cognisant of the risks that may be there.

What are companies looking for in a growth equity partner?

Over the last few years, certain players in the growth equity market have adopted something of a hedge fund mentality. Investors came in fast to get deals done fast. Companies are now realising that an investing partner at the growth equity stage should be a partner with a broad platform, a long-term mentality and a commitment to supporting growth over a number of years. Securing the highest price does not matter if you cannot turn that into a successful outcome.

How can a growth equity player add value to their portfolio, and what are the metrics that an investor should be focused on?

We add value in a lot of ways. We do not have the only platform of resources that can be helpful, but ours is possibly the broadest and deepest of any growth equity firm. We are very proud of that.

The key thing we do is clearly identify near-term areas where we can help. Just because you have significant resources does not mean you should apply all of them in a playbook style to every investment. We aim to identify areas where our resources and expertise can have the greatest possible impact and build from that. Depending on the situation, this might be introductions to our over 100 private equity portfolio companies, which collectively spend more than $15 billion a year on IT and marketing.

We also have a team of operations experts to help with optimising operational performance across a variety of areas, a deep bench of senior advisers to provide high-level counsel on anything from engineering to sales and marketing, a public affairs group to advise on ESG and stakeholder management, a capital markets group that helps with financing and capital structure improvement, and a dedicated team that provides expertise and analysis on trends in geopolitics, macroeconomics and demographics.

Finally, there is our global footprint, which we like to say puts us just one call away from any company in the world. The challenge is identifying, in collaboration with management, which of these resources can add the most value to any particular situation.

What do you see as typical paths to exit in your growth equity portfolio?

Given the stage and type of companies we invest in, we will not invest capital in any company unless we believe it is capable of being a strong, standalone public company.

That being said, we think a lot about exit optionality. Going in, we think about the three standard routes: IPOs, strategic M&A or financial buyer acquisitions, which are not necessarily mutually exclusive. We work towards taking many of our companies public, but we also often hold on to stakes in public companies that over time we might sell to a strategic or a financial buyer.

Of the 12 investments made in our first fund, four have already gone public, two or three will likely go down that route, two or three will sell to strategics, and two or three will go to financial buyers.

What should LPs be focused on when considering a commitment to a growth equity fund?

You want to look for somebody you would consider to be a good custodian of capital. That comes down to alignment with the way the manager is committing capital and the way they work with the business. We think that discipline and consistency of deployment is important. It has been proven across the growth equity asset class that consistent deployment across cycles tends to set you up for the best long-term returns across vintages. Focusing on managers that have shown consistency, were not hyperactive last year, and did not disappear during difficult, choppier periods, is a good start. Also, looking for managers that have a focus on long-term investing and partnering with businesses. This shouldn’t be considered a momentum play because the businesses you invest in are out of the woods from a pure technology risk standpoint. They still face execution and scaling risk, and managers need the right mentality to support that.

Dave Welsh is a partner and global head of tech growth at KKR.

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