Tech-led Value Creation to Spur Company Growth

Private equity firms and their portfolio companies need to go beyond simply employing technology for reducing costs and increasing efficiencies. PE firms and their portco technology operators need to rethink their operating models to implement an innovative digital mindset and culture.

According to EY survey, the pivotal role of technology in shaping the value of PE firms’ portfolio companies has become undeniably paramount. It has evolved from a mere cog in the wheel that drives operational efficiencies to a powerful engine that propels revenue growth.

In this tumultuous scenario, harnessing technology and innovation is not just a choice for PE firms, but an urgent imperative. It is the lifeblood that can bolster their portfolio companies’ value against the gales of change.

Beinsure Media has studied the EY research and offers you an overview 3 tech pillars driving value creation for PE portfolio companies, according to Ernst & Young.

The key to unlocking this value lies in three vital technology driven pillars: fueling top-line growth, optimizing costs, and maximizing capital efficiencies. Each pillar individually and collectively fortifies the foundation, amplifying exit multiples and paving the way for heightened returns.

1. Key considerations throughout the investment lifecycle

PE firms and their PTOs need to embed these pillars throughout the investment lifecycle — from the establishment of the initial investment thesis during due diligence, to transformation during holding period, and finally to exit optimization.

Due diligence and strategy alignment

At the outset, PE firms must clearly define an investment thesis for a new acquisition; be it to keep the acquired entity as a standalone, utilize it as a platform play for additional acquisitions, or expand into other markets. It is essential that the technology strategy is closely aligned with this investment thesis at the PE fund level and the business objectives of the portfolio company.

The importance of thorough technology due diligence cannot be overstated, particularly at the outset, to gauge the viability of aligning the investment thesis with the technology strategy.

It also aids in identifying potential risks, opportunities, and synergies within the target company’s technology landscape. PE firm deal teams and PTOs need to consider factors such as IT infrastructure, data security and cyber assessment, AI strategy, supplier landscape, back-office standardization, cloud readiness, as well as the target company’s technology maturity.

Transformation during holding period

The holding period transformation phase is where timing becomes super critical. Given the typical three- to seven-year investment horizon, along with a mid-cycle review (where the PE firm decides whether to exit or wait and evaluates opportunities to improve EBITDA), the holding period is the transformation window to pursue value creating opportunities. Such opportunities are unlikely to happen toward the exit, as there is no payback runway.

Therefore, it is crucial to focus on top-line, bottom-line, and capital efficiencies across sales, marketing, operations, and finance. Additionally, throughout the investment lifecycle, PTOs in collaboration with the PE fund should adopt a continuous improvement mindset, a periodic sprint, constantly evaluating the technology landscape and identifying opportunities for further optimization and innovation.

Exit optimization

PE firms start formulating their exit strategy from the diligence phase (if not sooner) and this should dictate its overall technology strategy. PTOs must keep the end goal in mind whether to sell to a strategic buyer, sell to another PE firm, or a public listing.

2. Technology value creation pillars for portcos

The three primary technology value creation pillars for portfolio companies include driving top-line growth, having a laser focus on cost improvement (which includes tech cost takeout and tech investment), and establishing a comprehensive approach for optimal capital utilization.

Top-line growth is a key objective

PE firms are constantly seeking innovative ways to enhance their top-line growth, including using technology to create seamless customer experiences, provide virtual servicing, optimize data facilitation, and increase artificial intelligence adoption.

Through technology-led e-commerce and marketing strategies, businesses leverage their digital channels and targeted marketing to penetrate new customer segments leading to increased customer engagement.

Businesses can expand their servicing capabilities by helping customers directly through remote delivery and indirectly with the use of virtual chatbots. Both provide a scalable platform to expand service capacity, significantly reduce overhead and labor costs, improve customer satisfaction, and accelerate the sales conversion process. Additionally, data collected on these platforms provides greater customer insights, which can further enhance revenue generation capabilities.

Effectively utilizing and analyzing data can allow businesses to create new products and services for potential and existing customers. Additionally, businesses can use the information to efficiently deliver their most in-demand products and services. The primary objective of client data-and-analytics activities is to generate higher margins.

As such, data analytics activities are prompting more significant and fundamental changes to business practices in areas such as supply chain, research and development, capital-asset management, and workforce management (see how AI & Data Analytics Will Help Insurers).

By leveraging AI, businesses can extract greater value from their proprietary data. For instance, it can drive anywhere from 10% to 45% of sales growth for consumer-packaged goods companies.

Right sizing the IT organization by considering outsourcing and leveraging offshoring resources up to the extent possible is another effective strategy. This begins with identifying areas such as evaluating the cost of in-house IT staff versus outsourcing or offshoring as well optimal vendor selection. This not only serves as a key lever for cost optimization but also enables the technology team to focus on its core capabilities.

Tech-enabled operational improvement involves using technology to decrease overhead tied to people and processes.

Capital efficiency is critical

Given their leveraged funding structure, capital efficiency should be a high priority for private equity firms. Optimizing the deployment of capital for technology can enhance asset management efficiency and generate opportunities for an “asset light” strategy across dimensions of the technology landscape.

While large technology transformations can help address significant technology deficiencies and/or support go-forward business strategies, they may not always be the optimal approach depending on the exit strategy.

Infrastructure is another critical area where technology can help improve capital efficiency. Cloud hosting offers many advantages over on-premises hosting, including lower upfront costs, scalability, and flexibility.

While technology can improve capital efficiency, there are also risks involved. Balancing long-term growth and technology development with PE needs is critical to ensure that technology investments align with the overall investment strategy.

3. Technology value creation risks and pitfalls

Private equity firms using technology to boost value creation should aim to avoid these five critical risks and pitfalls:

1. Inadequate due diligence: Insufficient technology due diligence can lead to unanticipated challenges during the integration phase, such as system incompatibilities, legacy technology issues and cybersecurity vulnerabilities.
2. Resistance and shock: Resistance from employees and stakeholders can hinder the successful implementation of new technology initiatives. Additionally, the speed at which PE firms demand results can create organizational culture shock, placing greater pressure on mid-to-junior level workers.
3. Unrealistic expectations: Overestimating the benefits of technology investments or underestimating the time and resources required for implementation can lead to disappointment and undermine value creation efforts.
4. Insufficient governance and monitoring: Inadequate oversight of technology initiatives can lead to misaligned priorities, inefficient use of resources, and the inability to track progress effectively. Additionally, regulatory and industry compliance is a critical component in fortifying exit valuation.
5. Neglecting cybersecurity: Underinvesting in cybersecurity measures can expose the portfolio company to significant risks, including data breaches, financial losses, and reputational damage.

Tempting terrain for technology-led value creation

By embracing technology, PE firms can drive top-line growth, identify and implement cost reduction strategies, roll out tech-enabled operation improvement and optimize capital efficiency.

As the market evolves, PE firms must consider technology-driven value creation opportunities, align their portco strategy with their investment thesis, and prioritize their efforts while investing in innovation and tech transformation to stay competitive and drive long-term value for their investors.

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