The Specialist #3 : Building The Case For Private Equity Upskilling

A fledgling startup called Foodiebay was doing just okay. It had a menu card of restaurants and it caught the eye of an investor. The investor saw some potential in the startup, cold-emailed the founder and appreciated the clarity of thought, the customer insight and the natural traction that the site was getting. The investor also seemed to understand the potential of the tech in front of them, seemed to understand it had a lot of prospects and that's why they went solo in the first four rounds of investment.?

No one else caught it. It was only the lone investor and the founder of Info Edge Sanjeev Bikhchandani who saw the potential of Zomato, which has compounded its success by leaps and bounds. Last year, Zomato hit a valuation of ?1 lakh crore, surpassing that of many established and legendary companies and giving Bikhchandani an internal rate of return of 60%. With Zomato mopping up about ?9300 crores from the public markets, Sanjeev's Info Edge clocked a return of 1050 times on its investment. What made Zomato such a trump card?

As Nassim Nicholas Taleb asks, "Why do we, scientists or non-scientists, hotshots or regular Joes, tend to see the pennies instead of the dollars? Why do we keep focusing on the minutiae, not the possible significant large events, in spite of the obvious evidence of their huge influence?"

Venture capital investments seem to be different that way. There's a disproportionate payoff from the unknown because, seemingly, there's little to lose and plenty to gain. At the heart of these investments is the power of disruptive technology. It can be argued with merit that the core philosophy of VC is to back ventures of the "unknown", with the principle of "higher the risk, higher the return" greatly validating the grandiose power of tech, which could sway either way, but understanding the tech make the tips scale towards high returns.?

Compare that with private equity, which is construed as a more segregated asset class relying on a steady and predictable stream of returns. It's fair to say you're going to find scores of financial geniuses in the world of private equity: people who could be like the Eye of Saurus when it comes to the aura of finance and private markets, the best at what they do. It's deemed to be stringently conservative, relying on intuition, human rationality and the ability to be shockingly prescient. And yet, there's a key element missing that ought to be ensconced in the fundamental DNA of private equity: tech expertise.?

Technology is rapidly forming a ubiquitous feature of our economy and the turbulent and disruptive wave of digitization is strapped to a rocket. It's clear that digitization is an irreversible trend embedded in the fabric of business operations. Everyone wants to back these unicorns. With 2021 being the year of tech unicorns for India, having the third-largest base for tech startups, the third-highest number of new tech startup unicorns in the world, the second-highest growth rate of funding and fintech startups outpacing the world in the form of digital payment adoption in India, tech is clearly a key piece of the pie.?

But PE doesn't seem to have it ingrained within its organization. We're not talking about external investments. In the first six months of 2021, private equity firms poured about $16 billion over 105 deals in the SaaS sector, according to PitchBook. We're also not talking about using technology as a service. The approach to investing is becoming digitized and operating models are becoming modernized, with technology being adopted to dissipate margin erosion, workflow processes being automated and due diligence being streamlined.?

We're specifically talking about people. We're specifically talking about talent. We're talking about PE firms having serious tech expertise and using it to ascertain which companies have the potential to grow and which would burn. How many key figures in any PE firm come from a tech background, be it, partners or consultants? If tech startups are the next big thing, doesn't it follow that they model themselves after the very same tech in the form of their stakeholders? If a private equity firm has to put billions of dollars at work and its underlying moats for investment are tech, why hasn't it modelled itself that way?

Now, I'm no greenhorn when it comes to the private markets; I've been tracking the space for more than a decade. I recall when the first wave of FOMO hit the PE fund managers. I've asked PE investors about BYJU'S making the rounds, early on, and the responses I've got have been dismissive, ranging from "it's too techy" to "it's the same old-fashioned ideas, but with technology." Then came an investor like the Canada Pension Plan Investment Board (CPPIB), which was a large pension fund taking a stake in tech ventures like McAfee and Viasat and this changed the game, becoming an eye-opener for a lot of PE firms.?

There are some pretty deep homegrown private equity firms, that are maestros at financial engineering. That being said, they need to develop the tech expertise to predict the future winners from those that may lose in the long run. The same can be said about investment banks who leverage tech runs and yet, don't really have any degree of tech expertise, save for one or two.?

The Internet has made great strides and we're now flirting with Web 3.0. By the end of the decade, we'll probably encounter Web 5.0. And yet, with such astronomical steps in tech, how come private equity is still in its infancy, when it comes to its evolution? Where's the upgrade? When is private equity going to embrace its antifragility to reinvent and reimagine itself from scratch for the businesses it invests in?

The bottom line is this: private equity has to emulate some of the traits of venture capital in terms of their capabilities or else, it'll be death by a thousand paper cuts. The business DNA of knowing technology makes it worth it and has the capacity to accelerate success for these PE firms. That's why Sanjeev Bikhchandani was able to savour the returns of Zomato: because he understood the technology. He knew it was going places. And that brought him the ideal position to win at the card table. So what's the answer? It's blowing in the mind. Look around you, CTOs are becoming CEOs! Parag Agrawal (no relation) becoming the CEO of Twitter is more notable in recent times. Tech is now at the epicentre of organizations being built.

It's about building in-house tech expertise such that the head of the PE firm can distinguish what makes one company different from the other. They all look very similar from the outside. A notch higher than just having fluency in tech is needed to understand that customer experience and employee experience go hand in hand. And PE firms are best poised to do this because they have this immense repository of knowledge on the nuts and bolts of building a sustainable business. Now, they just need to upgrade that with a tech lens.

Building tech mastery will also help them to provide the needed value add to their portfolios, especially at a time when private equity and venture capital business is so competitive, with everyone trying to establish differentiation. When there's an overabundance of capital available, the question needs to be posed: how will future founders pick and choose the funders? Furthermore, the basic premise of private equity is that it's intelligent capital and provides valuable insights in the growth of the business. If?businesses of the future are going to be centred around tech, it's about time that PE masters the tools of the trade itself.

Even CTOs need their own upskilling. According to experts CTOs seldom make CEOs, because their skill sets are radically different and it's “more siloed than anything else in the C-suite". Tech expertise can guide sales, but CTOs still need to know what to market. That's why CEOs generally come from an operations or sales background. So what's the upskilling required? In order for CTOs to become great CEOs, their financial skills must be honed, perceived levels of businesses acumen must be challenged and one's legal education must be brushed up on.?

Just because someone's proficient on the tech side, it doesn't automatically translate to being a terrific leader. P&L experience is important for this kind of job, for it shows financial acumen to churn profits and lead the way.?

Sure, a Parag Agrawal-esque CEO may be able to hire tech talent, but are they skilled enough to spot smart finance or marketing hires? So, there needs to be upskilling from the very start for these potential CTO-turned-CEOs. They must be groomed not just to be tech leaders, but also finance leaders to navigate the turbulent waters, in the face of any Black Swan event.

In addition to the upskilling required for PE firms to grasp the tech and double down on its know-how, they need Chief Digital Officers (CDOs). These CDOs need to oversee digital strategy and evaluate investments in data-driven tech in order for PE enterprises to reinvent their portfolio for the new age of digitization.

PE and VC investments hit $49 billion in 2021. They're poised to, soon, become a $100 billion market. $100 billion. Let that number really sink in. And with tech playing such a vital role, this is a no-brainer. No more outsourcing your tech intelligence, PE firms. It's about time you be future-ready today.