The Tech Train Keeps Rolling as Private Equity Investment in Technology Continues to Soar

While private equity investment in technology has been a powerful theme for a number of years — representing anywhere from one-quarter to one-third of private equity investment activity — the pandemic has accelerated interest in the space. In the second half of 2020, private equity investment in technology companies represented roughly 40% of total deal value, according to a report released by Ernst and Young.

2021 should see a continuation of the trend, as firms invest at both ends of the size spectrum. At the larger end of the scale, they will continue to seek out opportunities in the SaaS and enterprise software spaces, often with more mature companies that value the opportunity to effect large-scale transformation away from the quarterly pressures of the public markets. At the smaller end of the scale, they likely will continue to invest in high-growth companies in emerging verticals such as Fintech, HealthTech, and mobile.

And across companies of all sizes, they will continue to seek out companies that are poised to gain from the long-term behavioral changes that have been observed as a result of the pandemic.

Potential allocators to alternatives may find the terms “private equity” and “venture capital” to be synonymous or use them interchangeably. However, while both focus on investing in private companies, the investment strategies focus on different stages of a company’s lifecycle.

Venture Capital (“VC”)

Conversely, venture capital will typically target early-stage startups, where one or all the following can be missing or lacking: product, audience, and/or operations. Early-stage startups often need seed capital to grow to the next stage of their development. VC firms will provide that seed capital, often without control interests, and build out a portfolio of startup investments with the hopes of select breakouts with outsized returns to compensate for less successful ventures.

Partnership between PE and VC → Benefits for LP Investors

The distinctions between PE and VC have started to blur over the last 5 years or so, as VC firms have found a new exit option for their investments – PE buyout funds. According to data provider PitchBook, nearly 20% of all VC-backed businesses exited to private equity buyout funds in 2017, vs. traditional exit options (i.e., IPO, M&A, and secondary market), bridging the two strategies together for a symbiotic relationship. VC firms have found a way to exit their seeded startup ventures and to provide PE firms access to more established high-growth companies. Breaking down the partnership between PE and VC firms and the value they are seeking:

The increased partnership between VC and PE strategies has led to more fundraising for Specialist Funds (including tech), as opposed to traditional PE funds, evidenced in the graph below from Bain & Company:

Buyout fund capital raised, by year closed and type of focus

Enter the COVID-19 Pandemic, which created an environment of the “haves” and “have-nots”, resulting in a polarizing experience between innovative companies flourishing under the new circumstances, while companies with aging technology struggled to adapt. According to a study released in early 2021 by Gartner Inc., global enterprise IT spending will increase 6.2 percent this year to $3.9 trillion. Enterprise software is expected to lead spending growth in 2021, with an estimated increase of 8.8% to $505 billion.

Notable PE Spending

As corporations increased their IT spending to adjust for the growing need to be digital, private equity investment in technology followed suit to meet the demand for tech innovation. According to market research company S&P Global Market Intelligence, investors committed $65.17 billion on 2,138 private-equity deals with US-based information technology firms in 2020, surpassing investments in any other industry. 2020 finished the year with the year’s largest deal by Thoma Bravo in December, acquiring information and data analytics firm RealPage Inc for $9.6 billion.

Pitchbook reports IT investments comprising 20.2% of all PE deals in the US, detailed in the graph below.

IT investments as a percentage of all PE deals in the US

As of March 2021, private equity firms spent $80 billion acquiring companies in the global technology sector this year, according to data compiled by Bloomberg. That's an all-time high for a quarter and already up 141% on this point in 2020, which went on to be a record year for such deals.

Buyout firms are flush with investor cash and are being drawn to startups helping companies to reinforce their businesses following the impact of the COVID-19 pandemic, according to Chris Sahota, Chief Executive Officer at tech-focused advisory boutique Ciesco.

"2021 will be a time of reinvention for many companies and digital technology is driving that, so the private tech market is booming," he said. "After last year's turbulence, businesses want to be agile and they have started to future-proof their operations."

Buyout firms have been increasingly active in tech in recent years, primarily snapping up companies that have experienced slowing growth and stock market underperformance. Deal-making has picked up since the early days of the coronavirus pandemic as more organizations have come to rely on digital tools to operate their business and stay connected with employees.

Of the 12 largest tech acquisitions this year in the U.S., excluding special purpose acquisition companies, seven of them have been orchestrated by private equity firms, according to data from FactSet.

The biggest this year so far was Thoma Bravo’s purchase of security software vendor Proofpoint in April in a deal valued at $12.3 billion. In February, Stone Point Capital and Insight Partners agreed to buy tech-powered real estate company CoreLogic for close to $6 billion.

Cloudera’s agreement on June 1 of this year to sell to a group of buyout firms in a transaction valued at $5.3 billion continues a 2021 trend: most of the big-dollar deals in tech are going to private equity.

Result of Private Equity Presence

Private equity has been a consistently rising force in the tech merger-and-acquisition industry for the last decade, according to Scott Denne, senior research analyst at 451 Research, a research division of S&P. According to him, private equity now accounts for about one out of every three tech acquisitions, up from less than 10% a decade ago. “More capital has flooded into the room as many tech- and software-focused private equity firms have rung up huge returns,” Mr. Denne said.

In January 2020, Cambridge Associates research reported top-performing institutional investors have raised their venture capital allocations in their investment portfolio to an average of 15%.

Digitalized Due Diligence → Faster Deal Execution

The digital transformation of many businesses accelerated because of the pandemic, which resulted in simplifying laborious practices in private equity and venture capital firms, and helped fuel the following trends:

Yet it is still too early to tell if these trends will continue long term as the economy transitions to post-pandemic life and businesses return to the office.

New Key Performance Indicators

As private equity investments in VC-backed startups increase, PE firms are rethinking their traditional Key Performance Indicators (KPIs):

Emerging Sectors

2021 is expected to continue funding many under-invested sectors, highlighted in the pandemic:

Technology continues to evolve with the aim to enhance people’s lives. As technology continues to innovate, private equity firms will look to partner with these startups and deliver effective products to more consumers, driving growth for the overall society and returns for investors backing those investments.