Q&A: Private equity investment and emerging technologies
September 2022 | SPECIAL REPORT: PRIVATE EQUITY
Financier Worldwide Magazine
September 2022 Issue
FW discusses private equity investment and emerging technologies with Erich Bergen, Dave DuVarney and Brian Francese at Baker Tilly US, LLP.
FW: Could you provide an overview of key themes in the emerging tech sector in 2022? How important is emerging tech in driving forward both the physical and virtual worlds?
Bergen: If we look at what is impacting the technology sector broadly, the issues faced are similar to what many industries are facing, in terms of topics like environmental, social and governance (ESG) initiatives, workforce shortages, and technology advances as they relate to the building of products, for example artificial intelligence (AI) and edge computing. The list goes on. Emerging tech companies looking to raise capital may want to keep their finger on the pulse when considering prevailing trends relating to edge computing, cyber security, ESG, talent acquisition and retention, M&A transactions and supply chain risk mitigation.
DuVarney: Some of the core challenges include cost pressures from inflation, as well as labour shortages. So what are technology firms doing to solve these challenges? Three key strategies are robotics, which can help automate the factory floor or distribution, business process automation, which can create efficiencies and reduce costs, especially with repetitive functions, and AI.
“PE firms will always be interested in introducing the right tools or technology to businesses that might not have considered them before. This will unleash untapped value.”
FW: What specific areas of emerging tech are capturing the attention of private equity (PE) investors? How would you describe recent activity levels in this area?
Bergen: One area capturing PE firms’ interest is companies involved with AI, either those in the application development process or those that are selling AI solutions in the marketplace, for example voice applications. Consumers are used to experiential shopping and engagement through AI applications – think Alexa and Siri – and I would not be surprised if that is going to drive the marketplace in the future. There are many different types of technologies based around AI, and everyone is trying to land as much market share as they can. The challenge is how to vet what solutions are viable in the marketplace, and how to place a valuation on those solutions.
DuVarney: Even though determining valuations for AI companies is difficult, opportunities are vast, especially those that create innovation but also drive out costs. Imagine a virtual staging AI platform for property listings. Prospective homebuyers could view the image of a room and make requests such as, ‘show me this kitchen with white granite countertops and stainless steel appliances’. Amazon’s ‘view in room’ feature allows you to see how a particular product would fit in a space in your house before you buy it. So, the technology exists, but it needs investment to develop.
Bergen: In terms of the industries most affected by the use of AI, the one that comes to mind immediately is manufacturing, bringing more automation into a plant. There is potential for AI technology that has more connectivity to the consumer, shaping the way people buy and consume goods and services.
FW: What impact has the COVID-19 pandemic had in the emerging tech space?
Bergen: The pandemic drove improvements in workforce technology in terms of automation, connectivity and collaboration, supporting the shift to work-from-home, which also had a direct impact on the bottom line for organisations by reducing travel expenses. A bigger impact is the way coronavirus (COVID-19) accelerated the omnichannel experience for consumers, creating a similar buying experience across different channels: in-store, virtual or otherwise. Omnichannel creates consistency for the consumer. According to our analysis, US direct-to-consumer (D2C) e-commerce sales are expected to reach $151.2bn in 2022, an increase of 16.9 percent compared to 2021. While D2C purchasing is expected to account for roughly 2.5 percent of total retail sales in 2022, the movement toward D2C has already challenged and successfully disrupted the retail industry by diversifying customer experiences, which is leading analysts to believe that future state will likely continue to grow beyond the current predictions. The lack of clean, accurate data for manufacturers, however, is highlighting additional issues for firms as they work to implement D2C initiatives. On the negative side, the pandemic likely stifled R&D investment in infrastructure or capital outlays, at least initially. One place it did not stifle investment was in the automotive industry, which reacted to a large drop in sales at the beginning of the pandemic by accelerating a shift from internal combustion engine vehicles to electric vehicles.
DuVarney: As more people buy things virtually, traditional brick-and-mortar stores are being forced to pivot. Now, different retail brands are creating both a virtual and a brick-and-mortar buying experience for the consumer’s convenience. A product can be bought online, but if it does not fit or meet the consumer’s expectations, they can return the product at that brand’s store. We will see more D2C sales, both from brands creating their own physical locations or providing delivery direct to the consumer’s door. The disruption here is that this new way of shopping bypasses both the big box stores of the world as well as independent retailers, like bike shops.
Francese: From the consumer experience side, COVID-19 accelerated where the market was likely headed anyway, from brick-and-mortar to online shopping. Companies had to be nimble to survive and one result is that whereas companies, pre-pandemic, might have considered themselves exclusively a manufacturer, a distributor or a retail store, now, because of the way they have had to adapt, are heavy in technology and may also be considered a tech business.
“Companies offering technologies that address labour shortage and cost inflation problems may be attractive to PE firms.”
FW: Have any high-profile PE deals in this space caught your attention in recent months? What trends do these investments reflect?
Francese: Looking at Q2 2022 deal activity within the broader technology sector, we have seen healthy activity from PE investors closing 256 deals for a combined total of $24.7bn, according to PitchBook’s ‘Q2 2022 US PE Breakdown’. While there is some overarching market uncertainty and volatility in the current environment – which the technology sector was not immune from, as the 256 deals closed during Q2 2022 was a quarter-over-quarter drop – technology nevertheless continues to be an attractive sector for capital investment and to PE investors.
DuVarney: It is possible that because of labour shortages in so many industries, and the decision by companies to deal with that talent gap by outsourcing certain functions like payroll, accounting and human resources, PE investors may become more interested in professional services firms that could provide these services.
Bergen: There is roughly $300m worth of technology consulting opportunities out of a $7.3bn consulting sector. This may be a large enough opportunity to support the notion that PE firms might be looking to invest in one of the many professional service providers with products that will help companies implement platforms that support AI technology.
FW: What advice would you offer to PE firms on target identification and early evaluation in the emerging technology space?
Francese: Early evaluation depends on each individual PE firm’s investment thesis. When PE investors are evaluating an emerging technology, they may be assessing whether that technology is too focused on solving a specific market issue or business disruptor. If conditions change in the market, will the emerging technology suddenly be irrelevant, or can the technology be adapted to address a different type of business or different problem?
DuVarney: Companies offering technologies that address labour shortage and cost inflation problems may be attractive to PE firms.
Bergen: It is important to be aware of anything that is related to experiential change within an industry, for example e-commerce or retail change disruption in the retail industry. There are many aggregator companies in the start-up world focused on D2C sales.
“PE firms should continue to be aggressive in creatively structuring and financing emerging technology deals.”
FW: What considerations do PE firms need to make when structuring and negotiating an emerging technology deal? What particular due diligence and risk management issues should be part of the process?
Bergen: PE firms should continue to be aggressive in creatively structuring and financing emerging technology deals. Maybe that will include more gainsharing-type deals. Deals involving professional services firms, for example, have to be structured differently because people may come and go. If you buy a company that has top talent, you have to figure out incentives so these people stay with the company, because that is where the value resides.
Francese: PE firms continue to be interested in the currency of the technology of portfolio companies. Existing data is an important component of being able to leverage technology and emerging technology successfully. Do they have AI in place? What is the condition of their data? Has it been scrubbed? Can you trust it? Can the business leverage its data to streamline processes and procedures? Understanding where the company is in its data journey is a very important part of the diligence process. Also, how is a company positioned to monetise its data? There may be untapped value within a company’s data.
FW: What are your predictions for the emerging technology space in the months and years ahead? Do you expect PE investors to play a meaningful role in pushing novel innovations forward?
DuVarney: AI will be embedded in everything. Augmented reality features also will continue to expand as people are more comfortable doing things virtually.
Francese: PE firms want to bring in value, creating strategies and tools that will help capture market share. AI, along with other novel methods to create better ways to interact with a customer base, will certainly attract the attention of investors. PE firms will always be interested in introducing the right tools or technology to businesses that might not have considered them before. This will unleash untapped value.
Erich Bergen is a director with 20 years of management, strategy and technology consulting experience across a wide range of industries, including a specialisation in the mobility and transportation sector. As a business and technology leader, he works side by side with executives to solve enterprise transformation related programmes. He specialises in corporate strategy, supply chain and manufacturing, customer experience, customer and field service-related functions, shared service design and program management. He can be contacted on +1 (248) 368 8741 or by email: erich.bergen@bakertilly.com.
Dave DuVarney is passionate about helping businesses drive sustainable growth through digital transformation and data analytics solutions. He brings a rare, well-rounded background that combines business and technical acumen to lead consulting projects. With nearly two decades of experience as a business intelligence (BI) expert, he has helped organisations design and implement data-driven business strategies, from full BI programmes to innovative solutions. He can be contacted on +1 (608) 665 9379 or by email: dave.duvarney@bakertilly.com.
Brian Francese is the PE practice leader and takes pride in helping drive fund and portfolio company growth, leveraging his experiences along with the advisory, tax and assurance services Baker Tilly has to offer. His clients have come to rely on his guidance and recommendations as they assess business and accounting issues experienced throughout the PE transaction lifecycle. He can be contacted on +1 (646) 776 6386 or by email: brian.francese@bakertilly.com.
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