Three tech pillars driving value creation for PE portfolio companies

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.

1. 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.

2. 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.

Short, sharp opportunities must be identified through rapid diagnostics, and the filter narrowed down to opportunities that will drive EBITDA. 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.

3. 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. A strategic buyer, for instance, will most likely migrate core tech platforms and services to its own platform so investing in a new ERP platform, for example, may not add much value.

In selling to another PE firm, a good option would be to leave something on the table, making it a more attractive acquisition. A public listing requires greater scrutiny on disclosure, privacy, and security and building out the capabilities to address these issues. In cases of add-ons, CIOs and PTOs need to develop a robust integration plan to ensure the seamless merging of technology systems and processes. This plan should address key aspects such as data migration, system compatibility, and employee training.

In any case, PTOs should identify tech investments (e.g., proprietary capabilities) that provide the business with a competitive advantage and pursue optimization opportunities that meaningfully improve exit multiples.

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.

1. 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-and-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.

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. According to Pitchbook, 60% of CIOs plan for AI to gain widespread use across departments by 2025. With the explosion of funding in generative AI, businesses are now forced to determine how generative AI will impact their sector, or risk disruption.

2. Reducing IT costs and using technology to improve operational efficiency is imperative

Through application rationalization and infrastructure optimization, IT organization redesign, and tech-enabled operational improvement, organizations can achieve significant margin improvement. These initiatives require a strategic approach and a willingness to embrace technological innovation.

One of the most effective ways portcos can reduce IT costs is through right sizing the organization from people, systems and infrastructure perspectives. The goal is to reduce spend on high-cost, nonessential items. By eliminating applications that are redundant or no longer necessary, organizations can reduce costs significantly.

Additionally, infrastructure modernization can help reduce overhead and spend for portcos by investing in a cloud migration strategy and cloud-native spend management tools to create "rightsized" instances. This can achieve up to a 60% run-rate in cost savings.

For instance, an enterprise health records cloud implementation can provide an opportunity to rationalize a portfolio company’s infrastructure and applications portfolio, reduce costs, increase performance and agility, and enhance security and business continuity capabilities.

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.

For example, a portco with an IT organization heavily concentrated in high-cost locations could realize significant savings by leveraging offshore resources for IT roles that are either not strategic or do not require geographic proximity. To avoid potential pitfalls, portcos need to design the right internal operating structure, monitor key metrics to manage the performance of sourcing partners, and make the necessary adjustments along the way.

Tech-enabled operational improvement involves using technology to decrease overhead tied to people and processes. As an example, a consumer products portco implemented autonomous supply chain planning, leveraging digital technologies to reduce inventory levels, lower transportation costs, and improve service levels. This led to improved forecast accuracy and a 20% reduction in distressed inventory.

3. 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.

One of the most effective ways to improve capital efficiency is by managing technology spend on transformational initiatives. It is crucial to control costs, adhere to timetables, establish business case ROIs, ensure proper governance, and address cybersecurity risks. 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. PE firms can also consider "lease vs. buy" options for IT hardware such as printing and end-user computing.

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. For example, a massive, expensive tech transformation project that may not align with the PE firm’s investment strategy can be risky and jeopardize the targeted ROI.