PE and the 4th Industrial Revolution: Blurring the lines

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As private equity makes efforts to adopt the new economic reality brought on by the Fourth Industrial Revolution, the other half of the private equity family – venture capital – is at the forefront of the revolution and in many cases supporting the companies threatening to disrupt the established industries.

Though private equity's role is arguably not to be at the forefront of the Fourth Industrial Revolution given the typical risk profile of buyout houses, the lines between private equity and venture capital have blurred substantially in recent years.

Unicorns – startups valued in excess of $1bn – are no longer the rarity their moniker implies and have in some cases become established high-growth companies by disrupting their industry. Driven by the value that these companies are realising in the modern economy, they are raising hundred-million-dollar funding rounds at billion-dollar valuations, led by the VCs that have been around from the earliest stages and supported by corporate venture funds, institutions and large corporates.

It's just a question of staging. At the growth stage of a technology company you'd focus on venture capital, followed by growth capital, and as the business matures and becomes profitable, private equity is an attractive avenue" – Per Roman, GP Bullhound

While funding for these rounds come from multiple sources of capital, their size is at levels previously reserved for private equity, and are increasingly complex in their structures, which have been known to feature blends of debt and equity.

Some of the largest global private equity firms have also been seen participating in late-stage rounds for disruptive tech companies, including TPG Capital, TA Associates and KKR. Some firms are blurring the lines even further: buyout giant KKR is raising its first ever fund dedicated to growth equity investments in technology companies and EQT has been hinting at EQT Ventures for the past six months.

The details of EQT Ventures is still unclear and while EQT declined to comment on the new operation, the GP has hired a number of tech-industry and startup veterans to lead the division, while initial reports suggest a €500m stage-agnostic fund for investments in European startups.

PE: a new role, or diminishing demand?
Dawn Capital founder Haakon Overli believes the perceived narrowing of the gap between private equity and venture capital could lead to diminished demand for private equity: "Looking at the difference between private equity and VC, I think the big change is that venture capital will bypass private equity in a way that perhaps has not happened before, as the capital needed for disruption and improvement has fallen.

"Now we're seeing a number of private equity firms raising technology funds to invest in late-stage technology, which on one level is good, but they're taking the least risk in investing late in a business's development."

GP Bullhound co-founder and managing partner Per Roman takes the importance of this changing ecosystem with a pinch of salt: "It's just a question of staging. At the growth stage of a technology company you'd focus on venture capital, followed by growth capital, and as the business matures and becomes profitable, private equity is an attractive avenue.

The big change is that venture capital will bypass private equity in a way that perhaps has not happened before, as the capital needed for disruption and improvement has fallen" – Haakon Overli, Dawn Capital

"There are some companies that will raise these hundreds of millions in funding rounds and go straight to the stock exchange, but the bulk will not," says Roman, suggesting the current strength of venture capital will lead to plenty of opportunities for private equity SBOs of VC-backed companies down the line.

The first wave of private equity buyouts of VC-backed companies has already begun, including the acquisition of Photobox by Exponent, and Overli believes this is the start of a trend: "If we were a PE firm, we would definitely have a look at some of the bigger assets.

"There are venture-backed companies now with very large revenues and EBIT – and that is a change from earlier tech booms. I think we will soon start seeing similar deals to those that have gone on in private equity for a long time, meaning a VC will sell to a private equity house that will then continue to develop the company. I'm surprised there is not more of it happening already."

Reports of my death are greatly exaggerated
The advent of huge venture rounds may be changing the landscape of private capital investing, but private equity will not be made obsolete any time soon – provided it does not dismiss the Fourth Industrial Revolution as a passing trend.

While, as Overli puts it, "the way venture capital fits into the new economy is partially disrupting and partially enabling it," private equity's role is less clear. However, the toolset private equity possesses can and will still apply to a sizable chunk of the companies that emerge as children of the Fourth Industrial Revolution.

There have been examples of fast-growing tech darlings that – like a large swathe of the marquee venture-backed companies today – sacrificed profits for revenue growth and global expansion at blistering pace, but struggled when it came time to monetise the business. Private equity's ability to grow profitability and build strong organisations will be of value to businesses once they reach a certain size and their growth stabilises.

Any business is about business acumen and financial performance, and these are areas where private equity firms can add a lot of underlying value" – Per Roman, GP Bullhound

Likewise, the deal structuring expertise private equity has will unlock a mass of opportunities for those GPs that have developed a strong understanding of the new economic reality. The buyout industry's experience in sector consolidation will be a huge attribute for the disruptive companies of the new economy.

Industry disruption is often the result of barriers to entry being lowered and once one challenger has achieved success with a disruptive model, competitors will follow, creating sector fragmentation. The European food delivery vertical is a particularly good example of fragmentation resulting from disruption, where Food Panda, Deliveroo, Jinn, Just-Eat and Hungry House are just a few of the increasing food delivery services receiving VC funding.

"Even though investing in technology companies may be a bit new for private equity funds, it is important to recognise that many of the skills a private equity firm has are still as relevant," says Roman. "One shouldn't be too afraid just because a company's description has the word ‘technology' in it. Ultimately, any business is about business acumen and financial performance, and these are areas where private equity firms can add a lot of underlying value."

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