The Real Economy’s latest topical survey underlines how much of a priority investing in digital technologies is for the middle market. So, what part do the private capital markets play in the relationship between technological transformation and the middle market?
Venture Capital has acted as a key engine for growth in the technology sector. But the bigger brother in the private capital markets, private equity (‘PE’), has also played an important role in technological development.
When private equity meets digital technologies
From what PE invests in, to what it focuses on when supporting a business, and, looking internally, how PE organises itself, technology and digital transformation is an enabler and a clear source of value creation for the sector.
Here are five ways that PE is working with digital transformation:
1. Tech-related sectors receive significant PE investment
Software and IT services and products accounted for 21% of all PE related transactions between 2020 and 2022 in the UK. It was surpassed only by commercial services and financial services. What makes the sector so attractive to PE is the growth potential and assurance that recurring revenue streams provide.
2. The next generation of owners of technology businesses and digital transformers
While corporate acquirers have been the most common exit path for UK-based VC-backed businesses (taking an average of 86% of deals for 2022 to end September (118) according to data from PitchBook Data Inc), PE is the next most active route (12%), followed by IPOs, where there have only been three in London during that period.
PE is well suited to partnering with firms that have moved on from hyper-growth-at-all-costs, to the phase of rapid but profitable growth. They are experienced business builders and can provide the capital necessary to enable that growth.
LoopMe, an AI-driven adtech firm, is a recent example of this VC to PE journey. After having gone through a series of six funding rounds from VC investors, the business was acquired by Mayfair Equity Partners to help the firm expand internationally.
3. Helping businesses harness the power of technology
PE firms recognise the transformative power of technology in most, if not all sectors. This includes the more ‘traditional’ spaces such as manufacturing, business support services and logistics. While not a common approach, PE has helped many of these businesses transform by making acquisitions of smaller technology companies that leapfrog the acquiring business into becoming more technology enabled.
For example, Polygon, a property restoration services firm backed by AEA Investors recently acquired an Internet of Things (IOT) driven remote data monitoring platform. The acquisition allowed it to increase its responsiveness and automated the process of property damage control.
Similarly, Hydro International, a water treatment and services business has been backed by Agilitas since 2018. Hydro acquired sophisticated software modelling firm Oxford Scientific Software to help support its customers improve the management of their infrastructure.
4. Developing in-house tech transformation skills
A lack of available skills came out as one of the two top limiting factors from our topical survey (the second being cyber security). Digital skills are a rare commodity, hard to find and expensive when they can be sourced.
PE houses are moving to support their portfolio companies by providing them with these hard-to-find digital expertise. We are seeing increased hiring of specialists in this area by PE firms, forming part of what they call their Portfolio Operations Teams. These teams are geared to support the growth path of their portfolio companies. There are a range of skills in this area, from tech strategists to data scientists, right through to tech-related program managers, all there to help ensure that the digital interventions are a success, and that they rapidly and sustainably deliver value to the business.
Importantly, these capabilities are not the exclusive remit of the large capital PE houses and their larger portfolio companies. Rather, it is becoming increasingly relevant in mid-market centric PE houses too. Those advanced technologies have become more accessible to smaller businesses as the cost economies of technology are coming down. It should be mentioned however that there are skills shortages in these areas so companies’ ambitions might be delayed somewhat.
On top of the provision of digital skills, PE houses have also started orchestrating match making between the best advisers and their portfolio companies. There’s a lot to be said for PE managers having pre-defined best-of-breed provider lists to provide complimentary skills and extra capacity to help their portfolio companies get out of the blocks quickly.
5. Using AI to help them find investment opportunities
In a competitive world, with a near record amount of PE-centric capital looking to be deployed, what’s often referred to as dry powder, PE houses are deploying increasingly sophisticated approaches to finding the best opportunities for investment. Use of Artificial Intelligence (AI) to help find these opportunities is becoming an increasingly used tool.
Using AI-driven software solutions applied to vast and varied data sources allows PE houses to predict areas of growth, or find companies and interesting combinations of those that would otherwise have been missed. We have seen some of our clients starting to embrace this by using software tools from firms like SEALK and Syfter – both of which are VC backed. It’s an emerging area so a space to continue to watch.
Technology has been transformative across many facets, and PE is no exception. From investing in new technology businesses, to accelerating their more traditional businesses, right through to how PE firms operate themselves, technology is increasingly important in this space. Owner managed businesses considering private equity backing can expect digital transformation to be part of the value creation journey.
For more information on private equity and digital transformation, contact Jasper Van Heesch.