Technology in private markets: A disruptor & a differentiator

Disruptive technology does not discriminate – it continues to transform industry after industry, even the most conservative and relationship-driven.

The pandemic marked something of a turning point for the private equity industry – traditionally fuelled by personal relationships and manual processes – giving General Partners the push they needed to step up their digital game. Many intensified their focus on technology to help portfolio companies better manage their supply chains, retain customers and ensure business continuity on the one hand, and to engage with new and existing investors on the other. Tech and data is becoming an increasingly important driver of value across the entire investment cycle and can be a real differentiator.

Here’s how technology is influencing four key areas:

1. Pre-deal

A nudge in the right direction

A heavy dose of wisdom-led judgement is key to assessing investment opportunities and the deal origination process is and will remain centred around developing human relationships. But the private equity industry is estimated to be sitting on $1.8 trillion of dry powder, according to Preqin, and with fundraising cycles becoming shorter, the pressure on GPs to source the right deals for investors and deploy their capital effectively is mounting.

Using data to find, value and price investments is one area of focus to help that process. Use cases for artificial intelligence range from funnelling through companies that are most likely to fit a GP’s investment thesis, as well as those that additionally exhibit signs of growth – for example through geospatial analyses to forecast sales performance – to helping with competitor mapping by identifying similarities between companies. Furthermore, automation of inputs can accelerate data gathering for due diligence, while alternative data – such as patent data to assess the innovation strength of companies – can provide differentiated insights ahead of any access to management information.

Digital leaders in the space are going one step further to uncover “hidden-gem” deals. For example, Swedish investment firm EQT is using its AI-based deal sourcing tool, Motherbrain, to sift through millions of data points every day, scanning deals, people and companies to find the unexpected. Driven by Big Data and Machine Learning, the tool is being used to find more diverse start-up teams, unveiling, for example, promising female founders that may otherwise be overlooked.

2. Post-deal

Data: an asset; Information: a competitive advantage

The global alternative data market size is projected to expand at a compound annual growth rate (CAGR) of 54.4% to reach $143.3 billion by 2030, according to Grand View Research. And the use cases in private markets are growing. More firms are looking to leverage data as an asset through emerging technologies that can help not only effectively manage and monitor portfolio performance, but also push these companies to the next stage of growth.

AI capabilities like machine learning and natural language processing (NLP) can ingest and analyse written documents like financial and management statements, and help to resolve human language ambiguity to make sense of complex, unstructured data from the web. Applications in portfolio company management include customer behaviour analysis to help predict future demand; market and competitive intelligence; supply chain optimisation (e.g. using shipping data to detect disruptions) and risk mitigation – a particularly important one given rising investor pressure for GPs to enforce a structured ESG policy.

The next frontier of alt-data applications will be in the demystification of the fast-growing universe of digital assets. Although discourse around crypto has soured given the recent dramatic drop in valuations, institutional adoption of digital assets is projected to grow and therefore the asset class may hold yet-to-be-discovered opportunity sets.

3. Enhancing internal operations

Going digital in the day-to-day

Creating value through digital transformation extends well beyond the role of a CTO or a few “analytics champions”. It requires the help of cloud-based technology platforms and often third-party suppliers and consultants to enable the rewiring of entire investment and operational processes, from tax reporting and regulatory compliance through to investor communications.

This spans everything from investor onboarding, to due diligence, to cyber security, to treasury and liquidity management. GPs can benefit from operational efficiencies and controls, reduced risk, improved performance and can even improve LP relationships.

4. Exiting investments

Building and telling a compelling exit story

With a robust data-driven approach in place, PE firms can more easily and quickly demonstrate the value created at a portfolio company during their holding period, including any digitisation-driven streamlined processes, reduced costs, and operational and ESG-related efficiencies. When packaging their value creation story, GPs can seamlessly integrate insights from predictive analytics to project how the company is likely to perform under future ownership and beyond, further instilling confidence in potential bidders.

A trend worth noting too is that holding periods in private equity have increased over the past decade. As GPs deepen their technology expertise, they are realising they can tap into the networks they have built thus far, as well as into their proprietary insights and pattern recognition capabilities that they have honed to add greater value to portfolio companies. Increasingly, firms are choosing to hold onto an interest in a promising company post-exit or turn a minority stake into a control one so as to maximise value creation and ‘ride their winners’.

Evolving into digital maturity

Operational complexity in the private markets will only continue to rise, as more asset classes, geographies, fund vehicles and regulation come into the equation. Add new groups of investors, each with their own investment goals and reporting demands, into the mix and it’s not surprising that a 2022 KPMG survey reveals tech investments and digital transformation are set to double in importance over the next three years for private equity firms.

There is a growing acknowledgement that digitally driven investment strategies can give GPs the agility, efficiency and insights they need to stand out in today's crowded market. The problem however is that firms’ perception of how sophisticated they are in using technology does not quite match up with reality. Over three quarters of PE leaders recently surveyed in an Accenture Strategy described their digital capabilities as advanced, yet only one in three technology/digitization programs are successfully executed.

There is still some way to go, and bridging this gap will rest heavily upon improvements in data collection, which will in turn enable the standardisation of metrics – the fundamental ingredient for the use of AI adoption. That, underpinned by a consistent focus on the technology levers available throughout the deal cycle for business efficiencies and top-line growth. Lastly, regulators will need to adopt a pro-innovation approach – one that is light-touch and forward-looking to keep up with the fast pace of innovation.

With thanks to BackBay Communications for their contribution to this article.