Relentless technological advancement is the new normal of our times – no sector remains immune. Technology is responsible for upending long-standing business models and digitalising sectors ranging from accountancy to aviation. The world of investing is no exception.
The ongoing digital revolution in the world of finance is enabling Limited Partners (LPs) and General Partners (GPs) to explore new investment opportunities, enhancing their business practices by equipping them with smarter tools for better decision-making. This trend was highlighted by a panel of experts in a recent webinar co-hosted by TMF Group and SuperReturn, titled 'Raising Funds in an Era of Digitalisation - What do LPs and GPs Really Think?'
The ubiquity of digitalisation
The forces of digitalisation extend well beyond the technology industry, the panelists pointed out, percolating across sectors to improve existing processes, be it for delivering services, streamlining supply chains or strengthening customer feedback mechanisms.
"Digitalisation transforms industries in myriad ways," observed Jie Gong, Partner, Pantheon Ventures.
While its reach is extensive, the adoption and impact of digitalisation is seen to vary. The healthcare sector has been at the vanguard of digitalisation, noted Eric Marchand, Principal, Private Equity, Unigestion. Fintech and proptech companies, meanwhile, are "embracing technological change and changing the paradigm in typically archaic sectors" such as financial services and real estate, he added.
Gong agreed, citing the development of telemedicine and 3D bioprinting and the progress made by fintechs in upcoming fields such as mobile payments, instant loans and robot asset management. "It's a fast-moving space to watch," she said, predicting that the use of digital-enabled services in healthcare, e-commerce and real estate will continue to grow.
Marchand struck a note of caution, specifically about the growth potential of e-commerce companies and their ability to generate profits, especially under increasing regulatory scrutiny. "That might really change the paradigm for these companies ... Yes, it's a growing industry ... but, ultimately, it comes down to: 'When the going gets tough, are you actually generating profits?'"
The risk-return equation
Because investments in the rapidly evolving tech industry are inherently risky, investors should ideally have a good understanding of the business, although there are ample generalist funds considering investments in the tech sector, the panelists noted.
"Domain expertise is extremely important and the GP's ability to dig deep into a space and have a demonstrable track record of success in a particular sector is very important," Gong said. "In GP land, there are venture capital companies that focus on early-stage businesses and many of those have a pretty heavy innovation element. To be fluent in the subject of digitalisation is a must-have skill."
Marchand agreed, adding that, for generalist funds, having a specialisation in any given sector provides an edge from a sourcing perspective. Entrepreneurs typically feel more comfortable giving control of their company to investors who have the sector knowledge and a track record of delivering on that knowledge, he observed.
The expert panel also recognised the need to correctly assess the high valuations typical of technology firms and navigate through a crowded field towards the right investments. Gong noted that her firm has always had a preference for early-stage ventures, as they are regarded as a defensive play from a valuation perspective.
Because most technology investments happen in the venture stage when a company's business model is still evolving and revenues and profitability are absent, she added, investors expect a higher level of return commensurate to the risk they are taking.
High valuations are concentrated in the late-stage venture capital space, especially among those nearing unicorn status, and are driven less by hard details such as business models, competitiveness and profitability and more by market sentiment, explained Gong. "It's less a statement on technology than which part of the life cycle the business is in and how stable and how long their track record is."
While looking at established or mid-market technology companies it's crucial, according to Marchand, to consider two factors: whether the digitalisation efforts of such companies give them an edge over the competition and support revenue growth.
"It's really making sure that you're paying a high price for a high cash-generative and high-growth company. Otherwise, your value breaks somewhere," he said.
Embracing tech, being human
While an understanding of technology helps make the right investment calls, GPs are increasingly using that knowledge to digitalise their internal business processes.
These efforts include building online interfaces to help clients access research reports and slice and dice data to assess the performance of their funds. A growing number of GPs are using big data analytics to assist and vet their commercial due diligence process, while others are hiring experts to perform digitalisation for portfolio companies, according to Gong.
"Big data can help inform decisions in many ways. I think it's a very powerful tool ... to enhance underwriting and to add to the confidence of pricing on deals," she said.
GPs are also building capabilities to roll out digital strategies for their portfolio companies. Technologies such as blockchain have the potential to reduce the time and cost involved in forming a fund while making the whole process simple, secure and fair.
"Digital transformation has become central to most investment strategies," Marchand said.
Despite the onslaught of technology, the industry's digitalisation is still in its infancy, the panelists agreed, and the fund-raising process remains a "very person-to-person business," Marchand noted.
"We still have the use of placement agents. They're far from being replaced because the placement agent is not only someone who's trying to raise capital for you, it is someone who advises you, kind of a marketing consultant for your fund ... technology will always struggle to replace that."
Gong agreed, pointing out: "In the foreseeable future, the use of digital tools is really to speed up efficiency in the storage of information, exchange of information, due diligence and quantitative analysis. I don't see it replacing the role of a broker because private equity is a human business."
But, given the inevitability of digitalisation, Marchand emphasised the need to get the processes right as businesses move to adapt technology and build digital tools. Failing which, it matters little how good the technological solution is, he said. "Digital is great but if your processes are rubbish, it's not going to help."
Moderator Rajindar Singh, Sub Regional Director APAC, Fund Services, TMF Group, sounded an optimistic note about the impact of technology on fund-raising. "The webinar confirmed TMF Group's view that digital transformation is changing the way firms compete across sectors in ways that will benefit consumers and investors. Digitalisation promises to create exciting new business models and increase the speed and transparency of commercial information. This will support faster decision-making and more informed investment strategies. However, the human element remains critical. GPs will always need to leverage their fundraising track records and knowledge to present their fund offerings to LPs."
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Listen to the entire webinar here.
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