Private equity steps up its technology adoption

“What is now proved was once only imagined” – William Blake, Auguries of Innocence, 1803

The private equity industry remains a staunchly conservative, relationship-driven industry, fuelled by the operational and financial expertise of deal teams to identify the right companies to invest with and transform. 

It relies on human rationality, and a strong dose of intuition to spot an opportunity in the market; not to mention that rare human ability to look years ahead into the future. This is not something current technology (including AI-based analytics) is predisposed to do, from a deal making perspective, but there is no doubt the pace of technology innovation is beginning to play a more prominent role in how PE firms digitise their approach to investing. 

In short, technology is becoming an adjunct, an enabler to support GPs, as they steadily modernise their operating model. According to a study by Altvia last year, 39 per cent of firms said they had implemented technology to mitigate margin erosion in their management companies, closely followed by increased use of outsourcing (37 per cent). 

It is still early days, but as GPs start to discuss the potential of technology to automate workflow processes, improve fund accounting and reporting, streamline due diligence, and analyse huge data sets (both structured and unstructured), there is every chance PE firms of the next decade will look quite different. 

Assessing the digital curve 

The size and provenance of PE groups will influence the extent to which management teams are willing to embrace new technologies and commit capital. Multi-billion dollar managers like Hg, which specialise in technology investing, are, culturally speaking, more predisposed to embrace new digital solutions, for example, than a first-time consumer retail-focused fund. 

As such, it is difficult – nay, facile – to offer broad generalities on the pace of technology adoption, but there are a few key areas, including AI-based data analytics to improve deal sourcing and ongoing portfolio management, digitising the due diligence process, and using cloud technology for data management – providing a single version of the truth – that are beginning to make a tangible difference.

Eric Feldman is Chief Information Officer at The Riverside Company, a global PE group that has been investing in the lower end of the middle-market since 1988. Discussing the digitisation trend, Feldman says: “Gone are the days when you can manage relationships in a spreadsheet. You need the integrations between your deal tracking platform or CRM, your portfolio management platform and the regulatory considerations are a lot different now, so reporting is more complex. 

“Having sources of truth that you can trust, and having the ability to pull data from multiple systems to get an accurate report to the regulators and your investors, is increasingly important.”

Digitising relationships

Part of this comes down to PE firms partnering with the right service providers to do a lot of the heavy lifting, as part of the ongoing outsourcing trend within the asset class. The efficacy of how well a fund administrator can transport data and provide customised reporting has become an important selection criterion. 

“Data is so important when it comes to sharing information with investors, and telling a story in a way that’s meaningful,” says Jill Calton, Executive Director, Alternative Investments, UMB Fund Services. 

“I think it really comes down to having data available in a timely manner. Think about private equity in the past; investors would wait six months to get information. I think the reason technology is so important is because it improves efficiency, accuracy and dependability of data sharing.” 

There are myriad ways that PE firms might go about using technology to enhance data management. It starts with having a clear idea, as part of on ongoing data strategy, on what challenge the manager is looking to overcome. Only then can a proof of concept be rolled out to determine how technology might lead to incremental gains for the business. 

Global firms like Riverside have a complex web of relationships with companies they interact with and track in their CRMs. With approximately 350-plus employees and 30 years’ worth of investing experience, one can imagine the extent of these relationships.

“The way we communicate is through email and there is a treasure trove of data within our email system, specifically in regards to who knows who,” says Feldman.

“What we’ve been thinking about is how to tap into that treasure trove so that if I’m a deal team member looking at a pet food company, for example, who at Riverside might have expertise in that sector, or might know somebody? 

“We believe a platform that is able to analyse that kind of information and infer what a meaningful relationship is, could be a powerful connection valuation tool.” 

Feldman confirms that Riverside is engaged in a proof of concept discussion with a company, and test driving their platform. Then, he says, it is a case of determining how to operationalise it, should they move forward:

“How do we explain what the opportunity is? The hard work is the internal marketing – proving what the original thesis was behind a new technology tool and in this example, we know there are a few players testing the platform. The next step is to validate what we believe could be a very effective tool, not only for the deal origination team but potentially our investor relations team as well.”

Cloud technology enhances data automation

As the PE space begins to embrace digital transformation, one of the most important technology enablers in the last five or more years has been the incredible success of cloud-based infrastructure. By increasing the level of available computing power, PE firms are now exploring the myriad benefits of Big Data, and with it, find new ways to apply automation to data sets and associated workflow processes, which are inherently complex in private markets. 

Data automation within an organisation cannot happen at the click of a finger. For some PE firms with legacy technology and disparate IT systems, digital transformation should best be thought of as an iterative process, using the cloud as the focal point, like a raindrop that forms by coalescing around a grain of dirt. 

Using the cloud, each new system, be it in the front or the back-office, can be seamlessly integrated and help the GP move a step closer to achieving an enterprise-wide IT environment where data is ingested, managed and automated such that the firm increases its operational efficiency. 

As the fund administrator, Citco pointed out last year in its Outperformance at Scale white paper, pan-European manager Triton Partners had adopted SharePoint to streamline document management.

George Ralph, Managing Director of RFA in London confirms that many of its PE clients are increasingly asking for a single source of truth for automated reporting. “We’ve partnered with Snowflake to provide data warehouse services that allow clients to rationalise their disparate data in a central location, ready for transformation and analysis,” he says.

Snowflake is a SaaS enabled, multi-cloud data platform that allows users to create their own private data exchange to share and collaborate with business partners, suppliers, and employees in a centrally managed data hub. 

This type of cloud-enabled technology is moving things forward by allowing firms to focus on using data rather than get side-tracked by managing data. 

“I think within the last five years, the cloud has been a game changer,” says Riverside’s Feldman. “A lot of the work my team is able to do is directly connected to access and ease of use of complex systems on the cloud, that previously would have taken weeks or months to build. 

“We are able to create data points using a variety of cloud-based tools and this has made things faster, more reliable, more resilient, we can scale up and down on demand to manage the economics of it and so on. But you need a team of people to direct a line of questions so that those ecosystems are properly built, and the right information is gathered, to enable everything to fire on all cylinders. 

“It’s an orchestration across different departments that historically might have worked in isolation. All of the research and analysis being done within Riverside is now much more of a partnership, which I really enjoy.” 

Knowledge is power 

PE firms are looking at how new technology can facilitate the flywheel of gathering, sourcing, analysing and reporting data. It still feels like the industry is in the early innings as managers work out what data automation means to them, and where they feel they can make operational gains within the management company. 

Some firms are more predisposed to using AI-based tools to improve their analytics, such as PE secondary managers and FoF managers, who have to analyse potentially hundreds of Funds and thousands of underlying portfolio companies to monitor performance, and seek out the best investment opportunities. 

Jared Barlow is Partner at Kline Hill Partners, a PE secondaries house that focuses on deals in the lower middle-market. “For every technology we look at bringing on board, we need to think in terms of how it fits in with our existing cloud ecosystem and how easily it might integrate,” asserts Barlow. 

“We are invested in over 600 funds and the challenge can be that all of those funds have their own reporting styles and formats – how do you then take that information and feed it into a single source of truth? 

“We’re currently looking at a solution to best integrate all of our data in the cloud. We are evaluating various digital processing tools because if you can find a way to capture unstructured data, and structure it to be used in that single source of truth, it can be very valuable. 

“I think it is still relatively early days for how PE secondary funds and PE fund-of-funds might capture the power of data and automation in their businesses. Right now, we use a dynamic search function in the cloud that is quite effective.” 

Roger Woolman is Sales and Business Development Director, Fund Management & Alternative Investments at SS&C Advent. In his view, data consolidation has been one of the key technology trends in PE.

“PE firms want to produce reports, which look through into their investments to provide transparency to investors on underlying assets or holdings. Technology is great for that and is a requirement we see often,” states Woolman. 

Automating pre-deal due diligence 

That whole push towards data automation and aiming to achieve a single version of the truth to enhance reporting capabilities is clearly in train. 

What is also now undeniably gaining traction is how technology might be applied to support critical functions such as the ODD process. 

According to an Intertrust survey last year, 56 per cent of respondents felt digital innovation was currently having the biggest impact on the back office, by generating greater operational efficiencies. Moreover, 37 per cent said innovative technology was also being deployed to speed up the due diligence process when completing transactions.

At RFA, Ralph says that the way technology is evolving in terms of workflow automation and operational automation “means that there is greater scope for collaboration with employees and gathering data from third parties when doing due diligence”. 

This move towards digitising due diligence was discussed during Private Equity Wire’s US-focused COO/CFO digital summit last month, and is the latest sign of how the industry is evolving along the digital curve. 

Alex Lesch, Partner and member of the Investment Strategy and Risk Management team at Adams Street Partners, a prominent PE investor with USD41 billion in AUM, felt that virtual ODD signalled a fundamental shift but on-site meetings would remain a key element. 

“There are some benefits to virtual meetings: for example we are able to spend more time with managers and they can be more transparent, and it has facilitated our ability to have more conversations across the team,” said Lesch. “I think that element might prevail long-term, leaving the on-site meetings for more focused, high-level discussions to validate certain things and get to the real issues and risk concerns that an LP has when diligencing a manager.”

Digital communication

In many respects, it is not technology holding PE firms back, it’s a mindset; a cultural commitment to embrace technology with full buy-in from senior management downwards. 

The pace of adoption is a function of leadership. As more millennials become Founders and CEOs of their own PE firms, one can expect technology integration to move along at a far greater pace over the coming years. 

Covid-19 has arguably accelerated this, as PE firms have had to transition from the office to the home environment. The increased use of video conferencing to stay in communication with investors, and fellow work colleagues, has radically changed the way the industry operates. 

Speaking as a panellist during Private Equity Wire’s COO summit, Riverside Company’s Pamela Hendrickson, COO and Vice Chairman Strategic Initiatives, said: “We’ve been using Zoom for a long time. We have 40 operating partners on standby working all over the place so we were all very much used to this remote work environment and that helped us a lot.”

Cathay Capital, a Sino-French PE firm with approximately EUR3.5 billion in AUM, has 97 investment professionals working across four continents. Speaking alongside Hendrickson, Mark Woods, Partner and Head of North American Private Equity, said the firm had been integrated in its approach to working with teams in different time zones. 

“We were as well prepared as we could have been (for remote working),” Woods remarked. “We are power users of WeChat, a messaging platform similar to WhatsApp, which is incredibly efficient for video communications as well. 

“One of the lessons we’ve learned has been the frequency of team calls to keep people’s spirits up, as we’ve adapted to not being in a live office with our local teams. It took a while to get the dials correct on that but it’s been surprisingly effective and efficient.” 

Barlow believes that the pandemic has accelerated how investors are interfacing with GPs for their interim, annual and fundraising meetings.

“We are an LP in hundreds of funds,” says Barlow. “Given less need for travel, we can actually attend more digital meetings and webinars being hosted by GPs than we might otherwise be able to. Interestingly enough, the pandemic might increase the number of touch points that investors, who might be dispersed geographically, receive from their GPs. 

“Nothing can beat in-person meetings, but I think many GPs might opt to take a permanent hybrid approach using remote sophistication combined with in-person events. In the end, hopefully this gives LPs more options to interact with GPs.”

Digital transformation also extends to sourcing talent. Take, for example, one of The Carlyle Group’s investments in Carlyle Fund VII called HireVue, a video interviewing technology that helps companies to improve their hiring practices by finding the most qualified and diverse candidates. A number of Carlyle’s portfolio companies are now using HireVue to improve the way they build diverse teams. 

“What is interesting is this is helping remove unconscious bias in the hiring process,” says Megan Starr, Principal and Global Head of Impact at The Carlyle Group. “Companies have the imperative to build diverse teams but they don’t always have the tools to know how to do it. If they can use technology that is cheaper, more effective and far more impactful at creating diversity, that’s a great growth market.” 

It is not inconceivable that PE firms will themselves start to use tools like HireVue themselves, to improve their recruitment process in the back-office. 

Covid-19 scoring systems

Scraping an email system to mine data insights is just one example of how PE groups might introduce business intelligence tools into the operating models. Front office tools are far from prevalent, at the moment, but as suggested by Hackernoon, “sourcing and secondary liquidity platforms are two large and growing categories that look to solve a meaningful pain point for private equity funds”.

At Kline Hill Partners, Barlow explains that they’ve built a Covid scoring system “that we incorporate to our underwriting of a transaction. It starts with a scoring system on industries that we think are being more or less impacted by the pandemic, and then drills down to company-level Covid impact ratings. This informs our view on sourcing and elevating transactions in our deal pipeline. 

“Each transaction we’re looking at and elevating in the pipeline is assigned a Covid score. Our deal pipeline is very full, so if a deal opportunity shows negative impact by Covid based on this scoring, it gets filtered out and we save time for more attractive deal situations. It is a lens we’ve developed to look at transactions in real time in the current pandemic environment.” 

Could AI take a board seat?

Barlow’s example of a Covid scoring system demonstrates that PE firms are evolving their approach to deal sourcing. The concept of using AI-type tools is particularly relevant to an investor like a PE secondaries house, which might have exposure to hundreds of funds and thousands of underlying portfolio companies, because of the sheer breadth of data involved. But that’s not to say a typical PE buyout fund shouldn’t be looking at AI adoption to optimise the deal process. According to the Intertrust survey, 90 per cent of private equity firms expect AI to have a transformative impact on the industry within five years. 

“I’m optimistic about automation and the structuring of unstructured data in the private markets, especially for PE secondary fund investors who have such diverse portfolios. The technology is getting better and better all the time,” suggests Barlow.

He does, however, point out that most technology vendors who pitch to the firm are either a front-end CRM and deal-related solution, or a general ledger solution for the back office. There aren’t as many ‘soup to nuts’ solutions that cover the front-end all the way to back-end accounting, although there are some technology companies seeking to provide this, he says. 

“Our task thus far has been to use separate technology solutions for portfolio tracking, monitoring and sourcing on the one side, and a general ledger accounting system on the other side, and build effective “pipes” between them. This has worked fine for us as we feel we’ve found best of breed technology providers on both the front-end data collection and the back-end accounting.”

Riverside’s Feldman believes that now is the time to evaluate its systems (fund accounting, HR, deal-related CRMs, etc) and the connectivity between those systems, “with the idea being to create a platform where all of the data can be accessed and used by everybody within Riverside, from the front-office to the back-office, to do their jobs successfully”. 

“The pipedream of one of our CEOs is to have an AI system that is able to take in all of the different data from specific deal research, and become a voting member in the investment committee alongside the humans; it is potentially achievable,” states Feldman. 

That vision of AI is reflective of how data analytics is becoming a more integral part of PE investing. And whilst adding AI systems to investment committees is likely some way off, the central premise is that by building a data science capability, that leverages the power of the cloud and Big Data, could really empower the way PE firms operate from front to back. 

Feldman confirms that one of Riverside’s funds recently hired a data scientist. He explains: “My team has partnered with him to understand the project, the questions he’s trying to ask, where the data he’s using is coming from, and built an environment to do all the data ingestion, transformation and reporting for him. 

“I see this data science approach being applied to more of our funds over time.” 

AI-driven cybersecurity 

PE groups must increasingly pay heed to the increasing cybersecurity risks they face as they head down the path towards digitisation. As they ingest more data and seek out process automation within the cloud, they expose themselves to a new set of business risks; a natural consequence for anyone increasing their digital footprint. 

This requires COOs and CTOs to carefully evaluate the extent to which they embrace new technologies such that the cost benefits are not gained at the expense of operational vulnerability; which could lead to a serious data breach, impacting them financially and reputationally. 

Over at RFA, they have introduced a machine learning tool to enhance their clients’ cyber defences by analysing historical and applying behavioural analysis to monitor staff activity. It all sounds rather Orwellian but the purpose of using an AI sentinel is to guard against any human-related data breaches. 

“Its inevitable that as people have more access to technology and it becomes more available to them from an ease of use perspective, there will be more file sharing. Microsoft teams has a file sharing element built into it, for example. Our AI tool sits within the network and looks at the files people are downloading and what they are doing with them: not in terms of content but the behavioural use of it. Since the lockdown started, we haven’t had to change anything for our clients,” explains Ralph.

Conclusion

Cloud technology is re-shaping the way PE firms think about the way they run their business operations. By using integrated systems within the cloud that support many different tools – be they analytics, data automation, reporting – PE managers are starting to see how data automation could bring marginal gains. And improve the way they analyse unstructured data, build greater collaboration across teams, enhance LP communications, and make them more cyber secure. 

But there is still an awful long way to go before PE, as an asset class, gets comfortable relying on technology to support deal teams. This remains a very relationship-driven industry, and while Covid-19 has accelerated the pace of digitisation, we’ve barely scratched the surface from a front-office perspective. 

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James Williams
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