Private equity firms spent a record $80 billion acquiring companies in the global technology sector in the first quarter of this year alone, an all-time high for a three-month period and up more than 141 percent on the same period in 2020.
Last year was also a record year for technology deals, according to Bloomberg data, as the covid-19 pandemic accelerated a swath of digitization that might otherwise have taken years to come to fruition.
With fundraising by tech investors also hitting record levels, limited partners are getting more and more sophisticated in their approach to a heated market. “Technology is not an industry vertical anymore; it’s a horizontal that cuts across all basic industries,” says Scott Voss, chair of HarbourVest’s primary investment committee. “At the same time, if you look at performance in private markets you will see tech funds, regardless of where in the company lifecycle they are investing, have dramatically outperformed. That outperformance is causing lots of capital to flow into the space.”
The opportunities on offer to LPs are getting more nuanced and more diverse. Traditional venture funds are now increasingly ‘full stack,’ meaning they can participate in the growth of a venture company from start-up until it becomes much larger, encroaching on a space previously occupied by growth and buyout managers.
Likewise, diversified buyout funds are recognizing the opportunity in tech and both forming technology practices and raising tech-focused funds to do buyouts, smaller deals or minority growth investments.
Other managers claim to be stage agnostic but focus on particular parts of the technology universe, be it enterprise software, artificial intelligence or cybersecurity, to name but a few.
“We see a proliferation of strategies that are all converging on each other,” says Voss. “There are lots of really attractive parts of the technology space, and you need to be allocating to it. To do that, you need to be asking yourself which firms are truly differentiated in how they do it, whether that is differentiation around sourcing, around value-add capability, around the operating resources they can deliver, or how long the managers have been investing in the space. Those are the things that allow the top firms to continue to be top performers.”
Miguel Luiña leads the efforts in venture, growth and technology investments at Conshohocken, PA-based Hamilton Lane. He says: “What’s happened in technology in the last year and a half is essentially an acceleration of global trends that we were already seeing, whether that’s in e-commerce, remote learning, companies transitioning to the cloud and the cybersecurity that surrounds that, or the move to tech-enabled financial services. That means companies are accelerating their growth rates, seeing their total addressable markets being larger sooner, and creating value much faster.”
Luiña says Hamilton Lane is a big believer in diversification and consistent portfolio approaches, leaning in and out of different areas.
“The venture and growth market has grown significantly. The opportunity set is significantly bigger, with companies staying private longer. We favor strategies that are highly differentiated from others. We have always had a focus within buyouts on operational value-add, and in the venture and growth space we are looking for something unique where we believe there’s going to be a long-lasting ability to generate returns over time,” he says.
“We are investing in strategies where managers have industry expertise, great brands and value-add they can bring to portfolio companies, whether that’s through management team augmentation, bringing customers to the table or some other unique angle.”
Year-on-year increase in first-quarter technology spend globally, 2020 vs 2021
New managers are differentiating themselves in a whole raft of ways, be it the type of technology they invest in, the stage at which they invest, or the way they seek to create value.
Bregal Milestone is a European technology growth investor focused on helping late-stage growth companies reach their potential, working across software, technology-enabled services, data infrastructure, healthcare IT and services, financial technology and consumer/internet.
Cyrus Shey, co-founder and managing partner, says: “Our origination is underpinned by technology; we have engaged a team of data scientists and software engineers to build our proprietary sourcing algorithms and IP called the Beehive. It is the quality of our origination that allows us to find value in technology and pay the right multiples for those businesses. It is a combination of technology-enabled sourcing and sustainable value creation that allows us to drive strong performance.”
Bregal Milestone also has a pan-European footprint and a network of 50-plus contracted technology advisers who are active senior management from leading technology firms such as Microsoft, Amazon, and Google and work exclusively with the firm.
“Leveraging senior talent in some of the world’s leading technology companies gives our portfolio companies unprecedented access to channels they would not otherwise have access to,” Shey says. “If I broadly categorize the investment landscape for technology as being venture, growth and buyouts, we operate in the late-stage growth segment. In Europe, the growth space is vastly underserved and European late-stage growth businesses have access to only about a third of the capital versus their US counterparts. Our investment strategy of being focused, value-add growth partners to European champions has been met enthusiastically by founder-led management teams.”
In July, Eurazeo announced it had exceeded its fundraising target on its latest growth fund, pulling in €1.6 billion from investors to back leading European tech companies. In France alone, the firm has backed 24 companies in the Next 40 list of the most promising start-ups identified by the government, including unicorns like Backmarket, Contentsquare, Doctolib, ManoMano and Vestiaire Collective.
Marc Frappier, a member of the Eurazeo executive board and head of mid-large buyouts, says: “No LPs are walking away from tech. Everyone is concerned about valuations, but everybody is fearful of missing out and the last few years have shown that fundamentally tech is what matters.”
The scale of Eurazeo’s platform makes it pretty unique in Europe, not least because it covers everything from venture, through growth, to mid and large buyouts. Frappier’s team invests across tech-enabled services, financial services, consumer and healthcare businesses: “Our tech efforts are coordinated across all of those spaces, which is super useful in terms of identifying opportunities and is an important distinctive factor,” he says.
“Part of my team is focused purely on the tech environment. A section of the playbook of the specialists has been replicated by what used to be generalists. We are not generalists anymore; we are multi-specialists,” says Frappier.
“Technology is not an industry vertical anymore; it’s a horizontal that cuts across all basic industries”
Scott Voss, HarbourVest
Elsewhere, Baird Capital, the global private equity and venture arm of Baird, also announced the final close of its second global fund in July with more than $340 million in commitments. That fund makes buyout and growth equity investments of $15 million to $40 million in technology and services and industrial tech in the US, UK and Asia.
Andrew Ferguson, London-based partner and head of the technology and services team, says: “We have operated in the lower mid-market space for all our private equity lives at Baird, and that is a pretty congested space. As a result, the ability to differentiate has been very important for us.
“Our big differentiation is the fact that we are part of a global platform, sitting here in London with team members in Chicago, Singapore, San Francisco, Hong Kong and Shanghai. So, when we talk to tech companies, we talk about our global platform and our ability to help those founders internationalize and scale their businesses.”
At a time when investors are piling into a market awash with opportunities, it is the managers that can stand out that are successfully raising funds. At Hamilton Lane, Luiña says: “Across the board, the tech strategies are getting more sophisticated and more nuanced, creating an investment landscape that is really exciting.”
The trend toward specialist technology funds is gathering momentum.
At Campbell Lutyens, partner Sarah Sandstrom is head of the firm’s North American private equity fund placement activities. She sees LPs keen to increase their allocations to technology through a variety of routes.
“Many LPs at this time, outside of a few core generalist holdings, are looking for specific strategies and teams that are custom-built to take advantage of the opportunity in this specific sector,” says Sandstrom.
“One challenge for LPs is that the generalists have also been very active in this space. So, you might say you want two out of the 10 funds that you invest in to be tech funds, but then if you look at your generalist funds, they are doing a lot of tech investing, too. The majority of LPs have embraced the digital revolution and are comfortable with that over-exposure, but it’s something investment committees have had to restrict a little bit, to see how comfortable they are leaning into that trend.”
Fragmentation, particularly in the venture and growth space, is leading to a flurry of new managers being created, many of them spinning out of much larger funds. That is forcing LPs to choose not only between specialists and generalists, but also between established names and newcomers.
Voss says: “We recognize that we have these core managers that have proven to be great performers in their competency and that we believe can execute and expand their scope. But we also recognize there is always a need for specialization. If you are allocating funding, you want to invest in those firms that have built the moat in a way that would take others years to replicate. Or you might want to invest in someone spinning out of the firm that built the moat. If you sit in on our investment committee meetings, you would see we get excited when we see something a bit contrarian.”