As seen in: PE Hub

— By Amy Newlan, SVP, Maestro & Ben Harrison, President, DealCloud

2019 was the year private equity yielded to technology adoption. It was the year Private Techquity was born. Or so we thought. Turns out the birth announcement was premature.

Covid has done many things to PE (misalignment of valuation expectations, slowing of deal activity, downward trajectory of fund performance), but most critically, it has exposed the industry’s digital façade.

Covid laid bare PE’s technological inadequacies – and how those inadequacies threaten sponsors’ fiduciary responsibilities during this new normal. Because, that new normal will demand digital adoption beyond Excel and Zoom. Yes, PE will need technology to replace the face-to-face rhythm of how deals get done, but it will need more sophisticated systems to meet LPs’ heightened bar. It will need tech that can:

• Digitally articulate firms’ unique value creation plans (VCPs) and track them;
• Analyze the ‘middle’ of the portfolio (given a post-covid world in which that middle has an outsized impact on fund performance); and
• Enable team alignment/accountability (rather than just rugged partner individualism).

The bad news is that covid exposed Private Techquity’s “emperor has no clothes” moment. The good news is that the demands of this new normal will (finally) force technology adoption across the investment lifecycle in the following areas:

Deal Sourcing and Due Diligence

An uncertain marketplace means more scrutinized, team-aligned sourcing – and that requires technology to give remote partners a real-time view into firm-wide pipeline. But covid will not only change the deal-sourcing process, it will also accelerate the number of deals done. The post-virus suspension of activity (to assess new market realities and adapt to remote deal-making) has created an urgency to put sidelined dry powder to work.

Partners will not only do multiple deals simultaneously, they’ll do them differently, (looking at more down-cycle risk scenarios). The combination of deal volume and diligence complexity will create a perfect storm requiring sophisticated systems to effectively navigate it.

Value Creation

Rarely a codified process, VCPs have typically been distinct to the portfolio companies executing them and the specific partners managing them. The fact that firms don’t leverage their bench of expertise, and that they lack alignment and accountability around value creation, has always been inefficient and concerning. Post-covid, it’s simply untenable. Why? Three reasons:

First, while market disruption has made select companies greener (telemedicine, at-home fitness), it’s created sharply depressed performance for many more. As a result, middle/yellow companies have an outsized impact on fund performance such that when a couple of yellows go dark, they diminish carry and returns. Post-covid VCPs will need to focus on the yellow.

That focus requires data centralization, and benefits from institutionalization: a firm-wide perspective on which liquidity management and EBITDA enhancement levers to pull, and when to pull them. That approach requires a tech-enabled, collaborative workspace centralizing everything needed to evaluate, plan, manage, and assess the portfolio.

Second, a competitive post-covid market (for dollars and deals) means operational improvement will become more paramount – requiring technology that not only codifies firms’ approach toward value creation, but can measure the outcome of those initiatives. Tracking VCP success will lead to an easier fundraising lift, but it will also lead to better portfolio performance. It will provide immediate insight into how VCPs are tracking, enabling early course correction where necessary, and the application of findings across the portfolio.

Third, PE must not only do, it must also “capture.” It must digitally capture firm-wide (not partner-specific) expertise to facilitate decision-making now. And, it must capture playbooks and findings to prepare for the next wave of crisis, later.

Reporting

In the post-covid world, management should be focused on only those operational activities that keep the business afloat. That focus can’t, however, come at the cost of reporting. The application of technology here is not only essential, it’s relatively easy, via the installation of purpose-built software that can automate the measurement of what’s actuallyimportant. (And what’s actually important now isn’t just the quarterly numbers, it’s the leading indicators of performance).

Fundraising

Fool me once, shame on you. Fool me twice, shame on me. For years, sponsors have mollified LP demands for tech-enabled processes with assurances they’ve digitized. The truth is: Excel still abounds. And, while Excel may allow for ad-hoc reporting for most investments, (and a few specific performance driver stories for others), post-covid LPs will expect sponsors to address the levers that were pulled in all portfolio companies. LPs will no longer tolerate scripted value creation stories during a fundraise – they will expect to learn the VCP impact on each company and the custom playbooks of each sponsor. And how technology is used to drive that value.

This new fundraising paradigm will require that sponsors not only deploy portfolio operations software, but that they “show their work” to LPs who will no longer be fooled by digital promises.

Hindsight is 2020, and 2020 will be the year for PE hindsight; the year PE’s digital façade came tumbling down. But, it will also be the year when technology changes from being an enhancement to the PE process to being an inseparable part of it.