Ahmad Sheikh, a Partner at SFW Capital Partners, was invited to join an expert panel titled “Investing in Software & Technology: From Diligence to Value Creation.” The panel was organized by the New York Private Equity Network (NYPEN) and included leading technology-focused professionals from investment banks, corporate acquirers, and private equity firms.
Takeaways from the panel included:
An influx of generalist private equity firms investing in the technology sector has driven deal volumes and valuations up. “All private equity firms get lumped together, but in cases in which the ownership group cares about their legacy, the future prospects of the business, and the employees, we advise our clients to be extremely selective about who they partner with. There is no substitute for experience,” said one of the leading technology investment bankers on the panel.
Private equity firms that specialize in the technology sector generally have a clearer vision for growth, offer value-added resources to support the execution of a growth strategy, including a strong network of executives and advisors, and more realistic expectations for investment requirements and timeframe.
When generalist private equity firms try to bring their operating models to technology businesses, they often struggle to drive long-term value creation. Cost cutting, use of high levels of debt, and focus on “add-on acquisitions” generally don’t cut it for driving value-creation in technology businesses. To truly drive growth in the technology sector, investment firms need to be prepared to invest in talent, solution development, and business infrastructure.
“In most of our investments, we increase operating expenses [thereby reducing profitability] in the first few years after our investment. In the case of Spectro Scientific, one of our portfolio companies, we tripled product development expense in the first twelve months, enabling the company to develop some truly innovative solutions for its customers,” offered Ahmad Sheikh. “Value creation requires financial flexibility so we typically employ lower levels of debt than available in the market so that we can focus our management teams on the most important strategic growth initiatives without the short-term pressure on profitability.”
One key aspect to identifying the best investment opportunities is to start conversations and build relationships with founders and management teams in advance of a possible transaction. “Well-positioned businesses of scale receive hundreds of inquiries from investment banks, business brokers and private equity firms. We help our clients sift through the inquiries to separate the ones that are truly committed to the sector. The best private equity firms have established strong relationships with the teams or have common connections,” said one of the leading investment bankers.
In addition to making introductions and offering insights, founders want to develop relationships built on mutual trust and understanding. Ultimately, a founder wants to know that the person who is proposing an investment in their business appreciates and values the legacy that they have built with their employees and community. The best way to develop this type of relationship is through a long history of success in the sector.