This article is sponsored by KPMG.
How has the pandemic accelerated digital trends and what has that meant for the role of technology as a value-creation lever?
Luke Anderson: As 2020 drew to a close, the world was looking forward to the end of the covid-19 pandemic, while still grappling with the disruptive changes that the virus has caused to all facets of society. Over the past 18 months, businesses have been forced to accelerate their digital transformation plans to maintain operations, reflected in the extraordinary share price jumps some technology companies experienced. Meanwhile, restrictive lockdown measures meant that digital channels were often the only customer touchpoints available.
Organisations that could not adapt either put operations on pause or shut their doors permanently. Driven by these extreme circumstances, existing technology trends were accelerated; infrastructure needs shifted quickly; and the speed at which we were forced to respond to the pandemic showed that assembling data-driven solutions could be done quickly when we focused on the outcome we were trying to achieve. A decade of digital and data-driven transformation has been condensed into just 18 months, meaning tech innovation has shot to the top of private equity’s to-do list, far more quickly than anyone might have expected pre-covid.
Where in the life cycle of an investment is that value created?
LA: We believe that technology needs to be part of the whole deal cycle, from origination, through due diligence, the portfolio hold period and then into exit planning. Gaining an understanding of the tech value creation angle early in the process can give deal partners and the investment committee the conviction required to underwrite a tech-led investment thesis and then give operating partners and the management teams the resources and support to deliver on it. Technology was something of a diligence or value-creation plan footnote five or six years ago and it has now become a top priority.
Dan Reinhold: Technology is the golden thread that runs through the life cycle of an investment, which is why it is so important to start early. You need to have a clear understanding of how technology is going to impact a business’s customer and supplier relationships. You need to understand the nature of disruption and the threat of substitution. You also need to understand the potential opportunities technology creates but also be realistic about the ROI from complex projects.
What types of opportunity are available and what scale of transformation should firms be targeting?
LA: There is a whole spectrum of opportunity. Table stakes for tech value creation is often around using ‘adviser defined best practice operating models’ to transform core functions such as finance, procurement, HR, supply chain. Another is to look at where robotic process automation can be used to drive efficiencies, reduce cost or redirect resources towards more value-added activities. We also see most PE firms taking a cloud-first approach with their portfolio and looking to folk like us to understand which, when and how those business applications move to the cloud.
At the other end of the spectrum, a firm may decide on a more fundamental transformation, for example replacing the whole enterprise resourcing plan to achieve the growth plans the general partner, board and management team have in mind for the business. Or even an entire business model change driven by new technology where the investment thesis is predicated on a shift into new products and new markets enabled by these digital changes.
First then, a firm has to decide where on that scale of transformation they should be playing by building a model to understand, in broad terms, the relative merits and value cases of each option. If you are playing offence, you must then identify the gap between the company’s current operations and where it could be in the new scenario, making a plan to improve capabilities to achieve that vision. If you are playing defence, you need to consider the capabilities and structures that could help the company absorb the impact of disruptive market change.
DR: Technology value creation can drive change at the front and back-end of a business simultaneously. For example, we are currently working with a B2B client where customer interactions were, until very recently, carried out on an entirely analogue basis. We are now exploring an e-commerce strategy, working with that business and its PE owner to digitise manual processes and create a platform to facilitate interaction with customers more easily, potentially increasing revenue potential at the front-end and reducing costs at the back-end.
Data is clearly fundamental to value creation today. How can data best be leveraged?
DR: For me, data is the most valuable commodity in private equity. It underpins the market scanning phase, and then remains crucial as you go into initial diligence, with web scrapes and data analytics, and then into deeper due diligence, identifying tech risk, as well as tech opportunity. Data is then fundamental throughout the hold period, when it can be used to support the board’s decision-making, and then into the pre-sale phase.
LA: As shareholders of multiple businesses, private equity funds have a privileged opportunity to access large amounts of insightful and timely data from the collective pool of companies in their portfolio. GPs should be using data models and analytics and combining those with data externalities to make them insightful, smarter (even prescient) shareholders of the businesses they invest in.
DR: What we are also starting to see is a data race, where the most sophisticated investors, with the deepest pockets and greatest expertise, are able to pay higher multiples than their competitors because they have been able to collect, model and interrogate data to spot potential and then deliver on it. That expertise primarily resides in the large-cap market right now, but I do think it will cascade down into the mid-market and when private equity goes head-to-head with trade, I think that will become an important differentiator.
With data comes cyber-risk. What role is cybersecurity playing in value creation?
DR: Cybersecurity is about both value preservation and value creation. A high-profile breach is the fastest route to value destruction that there is, destroying confidence in an entire organisation. Cybersecurity is therefore an area that we are seeing increasingly addressed in due diligence by private equity clients. We are also working with firms on cross-portfolio reviews.
LA: Taking cybersecurity seriously is no longer optional. It is vital firms hire a cyber lead internally, or else have relationships with best-in-class cyber advisers.
How should private equity firms leverage their cross-portfolio buying power when it comes to technology?
LA: The biggest funds represent hundreds of billions in assets under management, making them significant customers (or to be clear ‘aggregate shareholders’ of customers) for the large software vendors, advisers and system integrators. Private equity firms should be leveraging that buying power for the benefit of their portfolio companies by exploring Master Service or Master Licensing Agreements with the software giants or from an advisory or system integrator perspective to have fixed-time/fixed-price implementation agreements with folk who can (as much as is possible) de-risk the all-important implementation phase of any tech value-creation work.
One practical example and something we are increasingly doing is providing GPs a ‘bat phone’ – a single point of contact around tech-enabled value creation who can curate the right people both in our organisation and with our alliances (software, infrastructure, etc.) to work alongside deal teams, operating partners and portfolio management to get answers and solve problems quickly – where speed and alignment is key.
DR: Another quick win is to build CIO, CTO, CSO networks within your portfolio and get portfolio executives talking among themselves through virtual and in-person networks. There is a real benefit to having management teams sharing their experiences and best practice. As an example, an investor may face the situation where one of its portfolio companies is considering investing $2 million in a cloud upgrade when another of its portfolio businesses has just completed the same exercise, going three times overbudget. It’s important to ensure these experiences are shared and leveraged. The ability for portfolio companies to learn from one another is often an under-utilised resource.
Implemented effectively, what value do these tech-enabled levers create?
LA: Alongside ESG, technology is one of the most important value-creation levers for private equity from origination through to exit. Why? Because there is a clear correlation between businesses that are tech enabled and the prices paid when the private equity owner comes to sell.
Private equity, strategic buyers and the public markets will attribute higher multiples for companies that are (or are perceived to be) in that top right-hand quadrant when it comes to how they are leveraging technology, digital and data; which is why we are spending so much time with our private equity clients ensuring that they have the right support around making these important decisions.
What role should ESG considerations play in technology decision-making?
DR: At a headline level, tech-enablement has a positive environmental impact, as we have all seen with the prominence of video conferencing and a resulting reduction in business travel through the pandemic. Beyond this, many tech programmes drive greater transparency (important for both the S and G factors), hence why we now see this as an important consideration as well.
LA: Tech can be an important part of driving an ESG agenda. The right combination of data and insight solutions can help chart a path to the most effective changes portfolio companies can make to improve ESG status in the eyes of investors and consumers. One win where tech and ESG overlap is for private equity firms to be able to demonstrate that they are using green cloud data centres when migrating their portfolio to the cloud. In aggregate, across the portfolio this will have an impact on the ESG performance of the fund and fits within the regulatory drivers such as the Sustainable Finance Disclosure Regulation. Running your business on the cloud, or better a ‘green cloud’, also has an upwards value impact to the next owners.