Prioritizing Efforts in Private Equity as Gen AI Impacts Broaden
Navigating the Gen AI Era: Strategic Approaches for Private Equity Firms
By Marc Malott, Senior Manager
Private equity faced significant challenges in 2023 — interest rates and financial markets impacted deal activity, deal processes, and portfolio company decisions. While macro challenges appear likely to begin to normalize this year, Stax observes a growing impact and influence of Generative AI, presenting new challenges and opportunities for private equity to navigate.
This year will likely see more widespread Gen AI impact as distribution, technology, usability, and partner ecosystems all undergo significant improvements. Robust distribution of broad off-the-shelf productivity tools will support widespread business adoption. Gen AI capabilities are also increasing — it is highly probable that in 2024, we will witness the launch of new and powerful models with stronger capabilities (e.g., improved multi-modality such as image and video, reasoning power, “agent-like” automation) supporting improved efficacy. Barriers to less technical workforce adoption are also decreasing as new features such as GPTs (in their simplest form, a way to share structured prompts) improve usability. Lastly, a rapidly maturing partner ecosystem will help companies more quickly customize tools for high-value use cases. These drivers appear likely to lead to intensified competition across industries in 2024.
The most direct way to de-risk this trend and achieve positive outcomes is through proactive action. Yet, private equity faces no shortage of calls for action — optimizing deal workflows, uncovering Gen AI risks and opportunities in new investments and across the portfolio, and prioritizing and implementing PortCo Gen AI value creation opportunities. With so many vectors of risk and opportunity, it will be important to pick the battles worth fighting.
Optimizing Deal Workflows
The value of Generative AI extends beyond assets. Many private equity firms and corporate acquirers are rightly exploring how to improve deal workflows. Use cases today can help address acute problems such as deploying capital and reformulating PortCo strategies and hold timelines:
1. Trend and Asset Identification
Gen AI can be utilized to build more robust deal pipelines. The technology can parse through vast amounts of data and identify emerging themes as well as potentially well positioned assets. This provides an opportunity to diversify from sale processes that often come with elevated competition and pricing.
2. Early Pipeline Screening
Gen AI can help improve the number of “shots on goal” by leveraging extensive qualitative and quantitative data to accelerate and improve early pipeline screening decisions, allowing valuable time to be spent pursuing assets with a greater hit rate.
3. Developing Investment Hypotheses
Gen AI can assist in formulating investment hypotheses with clear rationale and attributable support, leveraging available information. Though as indicated in multiple studies, Gen AI can struggle to properly consider contradictory information. Thus, human experience and insight remain critical in high-stakes decisions such as due diligence.
4. Improved PortCo Reporting
Gen AI can enhance the speed and accuracy of decision-making at a time when adaptability is becoming critically important. This might include identifying meaningful KPIs grounded in available data, semi-automating data analysis, and streamlining reporting processes. The benefits appear most pronounced for firms that lack ops teams, and for smaller assets that lack reporting experience and bandwidth.
Stax’s data and digital teams have found that private equity firms are generally early in the adoption of these technologies. Good first steps include building data architecture, governance, and establishing specific business objectives to help orient efforts. These structural steps are critical as seeking advancements can place near-term pressure on people-heavy workflows, and a Gen AI use case for early pipeline screening will require different data consolidation than improved PortCo reporting.
Incorporating Gen AI Gating Questions in Diligence
Diligence-both buy and sell side-became a natural vehicle to address top of mind Gen AI concerns and opportunities in 2023. Our most acute questions fell across technology and business services (e.g., legal) verticals, where accelerated software development cycles driven by Gen AI’s coding enhancements improve efficiency but also compromise software moats. ICs now aim for even greater conviction in the multifaceted differentiation of targets. This includes factors such as entrenched customer relationships, advantaged distribution, strong brands, or valuable proprietary data that Gen AI can now craft into compelling and unique value propositions.
Stax integrated relevant Gen AI questions and objectives into our work for much of the past year, leveraging advanced perspectives and hypotheses on key risk vectors:
- Are a vendor’s core end markets at risk?
- Is its core value proposition durable enough to resist continued Gen AI improvements?
- Is it broadly differentiated to win as competition increases?
- Do customers have faith in management’s ability to execute a Gen AI strategy?
…in addition to identifiable opportunities:
- Are there new opportunities to reduce costs and address customer pain points or unmet needs via Gen AI?
As Gen AI’s impact continues to grow and expand across industries, the criticality of addressing these questions in diligence will also increase.
Addressing Pressing Gen AI PortCo Questions
As private equity anticipates stronger deal-making activity in 2024 and seeks clarity in PortCo strategies and hold periods, we are seeing more questions on how Gen AI might affect PortCos in the foreseeable future. It’s worth briefly revisiting a simplified yet directionally accurate triage that many funds performed in early 2023:
- Technology and Digital (especially AI) — Most affected.
- Business Services and Professional Services — Potentially affected.
- Physical Goods and Services — Least affected.
However, this triage is becoming stale as Gen AI’s increasing distribution, capabilities, usability, and partner ecosystem drive broader industry impacts. Said another way by Nvidia founder and CEO Jensen Huang at the J.P. Morgan Healthcare Conference, “this year, every industry will become a technology industry.” While aspirational, within many industries companies are viewing Gen AI as a lever to transform operations and solutions, and potentially leapfrog competitors.
A meaningful next step that builds on this early triage is to approximate the AI maturity of PortCos. This can help private equity allocate time and effort to where it will be most impactful.
While PortCos with high AI maturity can likely be left to their own devices, private equity should focus efforts on PortCos with low to moderate AI maturity in industries potentially susceptible to AI advancements. By creating a stronger foundation these assets will be able to react more quickly to continued Gen AI advances, better positioned for growth, and armed with a stronger story and nearer opportunities at exit. At a minimum, stakeholders within each PortCo should be tasked with thinking through Gen AI impacts to their industry, and potential use cases and opportunities worth pursuing.
Prioritizing and Implementing Value Creation Opportunities
There is clear consensus that Gen AI provides very real value creation opportunities.
At a minimum it can be used to enhance internal operations and de-linearize costs, improving scalability-improving process velocity, output quality, employee and customer satisfaction, and ultimately enhancing margins. When executed, valuable time is also freed up from low-value tasks and can be re-allocated toward higher value, revenue generating activities. This also creates opportunities and time to leverage Gen AI to develop new products and services, or even enter new markets. In some cases, forward-looking PE firms are formulating entirely new assets to complement their existing portfolio and address emerging needs unserved today.
While companies broadly agree that the opportunity is significant, a full implementation can be difficult. According to an October 2023 MIT report, only 5% of mid-market companies had fully deployed one or more Gen AI use cases, compared to 13% of SMBs and 14% of enterprises. Mid-market companies often lag enterprises given the lack of available resources and necessary skillsets, and lag SMBs given a comparative lack of nimbleness and greater change management requirements.
Usage will surely proliferate in 2024 as off-the-shelf tools from Microsoft (i.e., Copilot) and OpenAI (i.e., Enterprise and Team) are broadly integrated. However, pre-formulated tools may do more to moderately raise productivity than transform companies. In many cases transformation is dependent on significantly customized or tailored tools applied to the right use cases. This of course requires proper strategy, governance, time and development, and change management. Given the level of effort, which use cases are worth pursuing and who is the right partner? This is a question that Stax navigated in 2023, leveraging a combination of strong internal data science capabilities, enterprise tools, and startup partners to develop solutions to address critical use cases.
Where to Focus
Each set of opportunities is worth pursuing, though relative importance may differ by firm — there is no one-size-fits-all approach. Thankfully, the rapid pace of Gen AI advancements simplifies prioritization of efforts within each category. Efforts can be steered toward practical applications more likely to succeed. And a maturing partner ecosystem offers meaningful ways to scale effort across opportunities and assets.
About Stax
Stax’s expertise in the AI sector expands across the investment lifecycle — including buy-side, value creation, exit planning, and sell-side support. If you wish to learn more about Gen AI, are looking to start a dialogue, or want more information about Stax, our services, and our experience with AI, visit www.stax.com or click here to contact us.
Originally published at https://www.stax.com on January 25, 2024.
