For investors looking to invest in technology, there have never been more options or more opportunities. No longer an industry sector but rather a feature of every single investment proposition, LPs are targeting tech through mid-market and large buyouts, venture capital and growth equity, and they are getting increasingly sophisticated in their analysis of market segments.
Miguel Luina oversees global venture, growth equity and technology strategy for consultant Hamilton Lane. He has seen interest in the sector explode.
“Every single investor is interested in tech and has increased their focus on it. We are seeing a lot of tech disrupting existing companies in addition to the emerging start-up opportunities, so how to invest in technology and protect your portfolio from technological change is front of mind for almost every investor right now,” says Luina.
Historically, the route into tech investing was via traditional venture capital funds, doing series A, B and C fundraisings. Today, there are large buyout funds that have a technology focus, as well as generalist private equity firms where the value-creation strategy is concentrated on technology. In between are growth capital funds, taking minority investments in later stage companies that are too mature for venture.
In Europe, both venture capital and growth capital investments stood at record highs in 2018, according to Invest Europe. There was €8.2 billion going into venture investments in European companies and €11.9 billion into growth.
The information, communications and technology sector was the largest beneficiary of investments in both segments. Alex Chaplin, director at placement agent FIRSTavenue, notes that venture capital is playing a much greater role.
He says: “There is certainly an increase in investors looking at both venture capital and growth. The average venture capital fund size is now such that the investors who avoided venture capital because they needed to write $20 million-plus cheques but could not be more than 10 percent of a fund now have enough options at sufficient scale.
“Furthermore, the trailing 10-year median IRRs on venture funds are getting closer to private equity, so the gap is closing. If investors are able to get access to the brand names or best performers then fantastic, but now they can get good performance beyond the top decile so a venture capital programme is more viable. The problem historically has been unrealised track records, so it is only by fund three that most of these GPs are talking to institutions and have track records that stand up to analysis.”
There are so many subsectors within technology that the list of attractive areas is hard to narrow down. Luina points to cloud, software as a service, cybersecurity, consumer fintech and consumer healthcare as particularly hot spaces.
“Every single investor is interested in tech and has increased their focus on it”
Miguel Luina, Hamilton Lane
Salim Nathoo is a partner in the tech and telco team at buyout firm Apax Partners, with a seat on the investment committees of Apax Buyout Funds, Apax Digital Fund and Apax Global Alpha, the firm’s listed vehicle. Everywhere he looks, technological change is rife.
“The technology world is undergoing seismic shifts given the advent of cloud, artificial intelligence, evolving interfaces, ubiquitous high bandwidth, security and data privacy and evolutionary architecture, among other forces,” says Nathoo.
“Technology is now core to pretty much every business, many of whom now have to compete against digital natives such as Amazon.”
Apax has taken the approach of focusing in depth on three sub-sectors that benefit from those trends, he explains: IT services, enterprise software and telecoms. Some of the firm’s portfolio companies in the technology area include software development company ThoughtWorks, Nordic IT business Evry, insurance software firm Duck Creek Technologies and Texas-headquartered ECi Software.
Apax also recently paid $3.4 billion to acquire global satellites business Inmarsat alongside Warburg Pincus, Canada Pension Plan Investment Board and Ontario Teachers’ Pension Plan Board.
Nathoo says: “Our approach is to find businesses that have very good long-term potential, but may not be fully polished, and then to work with these companies to enhance their market position and accelerate growth.”
A taste for growth
As well as favouring large buyout funds like Apax that have a technology specialism, investors are also getting more sophisticated about accessing tech investments by carefully selecting GPs.
“LPs generally are not saying to us that they want to target a particular sector within technology – they are putting that down to the fund manager. What they may look at and differentiate by is whether a manager is focused on B2B or B2C – B2C has seen some great growth and opportunities recently,” says Chaplin.
“We are seeing LPs looking at the structure behind those investments and whether the GPs are bringing just cash to the table or adding value in some other way, perhaps by making introductions to entrepreneurs or sales opportunities, having a track record in commercialising ideas, or something like that.”
One theme is the increasing appetite for growth equity, where traditional private equity investors who have historically demanded control positions are having to get comfortable with minority investing in order to increase their technology exposure. One driver for that is the fact companies are staying private longer, with some of the most successful ‘unicorn’ businesses reaching billion-dollar valuations before accessing the public markets.
Chaplin says: “That means investors that were getting exposure to technology through the public markets and want to see that stage of growth are needing to switch to either hybrid investors who can do both public and private or start looking at later stage growth funds.”
“The definitions of venture and growth equity are getting more complex and nuanced”
Brijesh Jeevarathnam, Adams Street Partners
For the more sophisticated LPs, and particularly those operating out of northern California, the market is getting even more fragmented.
Brijesh Jeevarathnam, the Silicon Valley-based partner and co-head of global venture fund investments at fund of funds Adams Street Partners, says: “The definitions of venture and growth equity are getting more complex and nuanced over time. There was a time when there was venture, growth equity and then companies went public or got acquired.
“Now there is seed capital, early stage venture, early stage growth, late growth, pre-IPO rounds and so on. Clients’ appetites for those different areas have become more sophisticated, and while there are some who just want the whole spectrum, most investors are much more targeted.”
Jeevarathnam adds venture and growth equity have different risk-return profiles.
“We like to invest across the spectrum, with the exception of pre-IPO, super late-stage investing, which is most prone to valuation risk,” he says.
There are fast-moving dynamics at both ends of the spectrum. Luina points to an explosion in the number of seed managers providing very early injections of capital.
“One of the shifts is that series A, B and C rounds are now coming later in a company’s life cycle, because companies need less capital to start,” he says.
“There are a lot more services available to them, like the public cloud, for example, which used to require upfront capital investment. They can now get to revenue stage without requiring venture investment.”
While the centre of tech investing, particularly in venture capital, has long been in northern California, the universe of opportunities is becoming increasingly global. Europe is generating a growing number of tech businesses, but activity is springing up all over.
New hubs are emerging in places such as Canada, with Toronto for artificial intelligence and machine learning and Quebec for life sciences, while Israel has always been a strong venture capital market. There are also now strong companies coming out of South-East Asia, Latin America and elsewhere.
“I expect to see more LPs making an active allocation to technology in the coming years. That has certainly been the trend and I would like to see that continue,” says Chaplin.
“I suspect most activity will be in the growth capital space and all those buyout funds that do not currently have a technology team will need to go out and get one.”