Industry boom forces private equity firms to embrace new ways of working
It’s a golden age for private equity firms, amid soaring valuations and a frenzy of takeover deals over the past year.
That same pace of growth and success is also acting as a powerful agent of change for the industry in how it views and uses technology.
For Rich Itri, SVP, Professional Service, at ECI, a provider of managed IT services, cybersecurity and business transformation solutions, it’s a trend that is long overdue.
While other areas of financial services have eagerly adopted new systems to keep pace with their competitors, private equity firms have traditionally taken a different approach.
“It’s an exciting time on the private equity side because they finally see the value in investing in technology,” says Itri, an industry veteran with over 20 years of experience in the sector.
Itri believes private equity firms now accept that the sheer size of the industry – with thousands of funds and firms scrambling to compete against each other for deals – means they need to use technology in a more innovative way to compete more effectively.
“In private equity, it’s always been a challenge to get firms to think a little more strategically because of the lifecycle of their deals, and because things are so stretched out,” he says, contrasting the sector with asset management, where the time-critical nature of trading and investment decisions has acted as a powerful driver for the implementation of cutting-edge software and other systems.
“Now that urgency has changed, and the need to become more extensible as an organisation is driving them to be more strategic from an IT perspective.”
Increasingly, Itri believes private equity firms are trying to automate processes and standardise the data they use to streamline their overall operations and analyse potential opportunities more efficiently.
“These companies now have to scale,” he says.
“They’ve got bigger, in terms of their organisations, and they need to process more data as they grow. And they realise that the model they have in place just isn’t going to work. Their costs will continue to grow, and they’re going to have to continue to rely on people. And they’re seeing the value now in leveraging technology.”
Itri continues: “They don’t want to have to keep hiring people to shuffle papers around. They want to leverage technology to be able to streamline things.”
Itri says one example is how firms are sourcing deals in new ways – by automating the processes involved in analysing potential target companies and using advanced algorithms to do so.
“Taking those very manual processes that were so time-consuming, and being able to streamline them into really automated processes, is how a lot of these private equity companies are going to be able to scale going forward,” he says.
Private equity firms see the value of pulling in information from multiple sources and developing algorithms to find companies that they want to invest in or bolt on to existing companies.
Being able to do that at scale, and do it faster than a rival company, is becoming a competitive advantage.
Portfolio companies in focus
It’s not just the process of originating and analysing potential deals where the industry is evolving. Itri also believes private equity firms are becoming more directive in using new technology and software in their portfolio companies.
“Traditionally, firms would invest in a company, but they wouldn’t be super aggressive in dictating a lot of the operational aspects in and around their technology.
“Now, a lot of the private equity firms have groups that just focus on enabling their portfolio companies to leverage technology better: to do group purchasing, things that help generate value in the organisation and drive value creation.”
Cybersecurity is one area where private equity firms have been focused, especially recently.
The cyber-attack on the Colonial Pipeline, an oil project 23 per cent owned by KKR, offers an illustrative example of how such incidents can seriously damage the profitability of a portfolio company, with serious and immediate implications for investors.
Colonial was forced to pay hackers an estimated USD5 million ransom to restore the pipeline to service and lost several days of income when its flows were suspended.
“The investors now are keen on making sure that the PE firms are holding their portfolio companies accountable,” he says.
“So, they’ll bring in firms like us to standardise their security platform, to do assessments and audits and make sure they’re following industry standards.”
Other areas are coming into focus, too, as firms seek other ways in which technology can bolster the performance of companies in their portfolio.
“They see technology as a competitive advantage inside these portfolio companies and want to make sure that they’re leveraging it to its fullest, whether that be creating a better customer experience for an app that the portfolio companies might have or automating some of their processes internally and allowing that portfolio companies to scale. At the end of the day, the private equity firm is investing because they want them to grow.”
Another key theme which Itri believes is reshaping the industry is the increasing proliferation and ease of access to third party data used to conduct due diligence ahead of a deal.
The availability of those alternative data sets, often hosted in the public cloud, is changing the way deals are negotiated and the types of conversations private equity firms are having with their investors.
“Data is now becoming more accessible,” he says. “Even three years ago, it was very costly, and you needed a specific skill set, in-house, to be able to bring that data and be able to query it and make sense of it all. Now, with some of the advanced tools out there, like Snowflake, for example, you can just subscribe to these data sources and run queries directly against them.”
That means private equity firms are starting to realise they can leverage the accessibility of third-party data in new ways.
“It really gives them the opportunity to find bolt on acquisitions or companies they didn’t have before. Or it allows them to better value the company that they want to buy. “
Itri says this new ease of access is changing the industry in different ways.
“If a company is saying: ‘We see revenue growing from this to that, and we think the total addressable market is X’, then the PE shop will go out and get third party data to verify that. They’ll come back and say: ‘Well, I don’t think your total addressable market is this, and your valuation is not 200 million; it’s 165 million – and here’s why.’”
Investors are benefiting from the trend, too, by being able to form their own views about the way businesses are valued, Itri says. “Everyone feels more comfortable with data to back up a thesis.”