Trends to look out for when PE and VC respond to recession conditions
- What are your thoughts on the current market environment for PE firms as they look to go to market with new funds? What about other types of fund strategies?
Based on conversations with GPs over the last several months, we aren’t seeing a slowdown in fundraising. We are seeing the impact of the “denominator effect,” which is causing LPs to revisit and be more prescriptive with allocations. In an effort to navigate these conversations, GPs can no longer get away with a very general investment thesis or one that is not validated objectively with data. For most GPs, telling the right story is increasingly a function of internal operational rigor, wherein they can easily associate investors with funds, funds with portfolio assets, and so on. The GPs that can move quickly and effectively are rewarded with more capital.
We’ve also noticed a big jump in the variation of fund types offered by GPs to accommodate changing LP demands and expectations. For instance, providing open-ended funds to accommodate liquidity needs and co-invest for direct access to attractive investments. Strategies and vehicles like this are now essentially table stakes.
- Of the most recent concerns your clients have brought to you, which surprised you the most?
There hasn’t been a pattern in new client concerns, though we’ve sensed an acute shift in GP sentiment. Most GPs are now explicitly acknowledging that if they do not modernize their approach, they will fall behind. It’s been long and widely accepted that private markets participants are roughly five years behind the general technology curve of business at large. As long as returns were strong and fund sizes grew fund over fund, there was little incentive for GPs to rethink the way they do business.
As competitive conditions continue to mount, economic cycles decline, and emerging fund managers gain notoriety for operating like a data-driven tech firm, the broader sentiment is notably shifting, and archetype GPs feel like they are behind the times.
With that said, the appetite for modernization also comes with concerns regarding change management and adoption from their team. Chief technology officer is a rare role in privates, so most firms don’t necessarily have a technology visionary or someone to own the strategy and execution. A lot of our work involves informing a “crawl, walk, run” approach and instilling rigor around maintaining a sense of priority to create impactful outcomes in the near term, without being short-sighted to the extent that a decision now might hold them back in the future.
- As volatility remains heightened, where do you see the biggest gaps with regard to portfolio monitoring that have become critical for PE firms to address? What about firms focused on other asset classes?
Real-time visibility into portfolio performance is, again, typically a function of a GP’s internal operational rigor, as it relates to data collection, normalization, and visualization. In a bull market, some GPs might accept a quarterly lag in performance KPIs or condone redundant, time-intensive, administrative work to wrangle and consume this information. When times are more challenging, we all hold the wheel a bit more tightly for obvious reasons, and this requires many firms to modernize this aspect of the business via automation, systems, and data strategy.
Today, GPs are lucky if more than 75% of their portfolio companies provide operational or financial data in a timely manner. In addition, there is typically much variation in the format of the information they receive—from PDF documents to Excel spreadsheets to screenshots of general ledgers. This makes it tough to aggregate the information across the portfolio and ultimately turn it into something an internal or external audience can quickly comprehend.
This can all be solved with widely available technology. For example, an automated email with a link to a form so that portfolio companies can submit their financials on a monthly basis in a standardized format, which is aggregated and then translated to standardize analytics dashboards. Investment teams now look at on-demand dashboards to validate performance or spot follow-on investment candidates rather than sift through scattered material and struggle to reach confident conclusions. Furthermore, this type of analytics-driven experience can be provided directly to LPs to answer questions before they are asked. This is the experience LPs are used to in public markets and in their daily lives as consumers, so elite GPs are simply closing the gap. Lastly, LPs take note of the speed and accuracy with which this information and experience can be provided. Analytics are the tip of the iceberg everyone sees, but there’s a lot happening underwater. A GP’s ability to deliver here is a signal that their house is in order behind the scenes.
- Moving on to private fund strategies as a whole, where do you anticipate any shifts in allocation trends by LPs, given recent dealmaking and macroeconomic trends? Or do you think recent volatility and economic pressures are still too new to really exert any meaningful impact in the near term?
Most recently, we’ve all witnessed leading VC firms become much more active in public markets, as valuations and multiples have sharply corrected in the last month or so, thus creating a lot of perceived upside for investors at large. Crossover funds and investing are certainly not new concepts, especially from venture groups that do not want to end the ride at IPO. Though we believe the line between public and private investing will continue to blur as LPs index heavier to sector expertise and track record instead of public versus private exposure, and so on.
To build on the above theme of convergence, GPs that traditionally played in early-stage VC now invest in growth-stage or buyouts, so it seems the line between stage-specific investing is also blurring. In the simplest sense, LPs make decisions based on risk/reward profiles, diversification, and liquidity. The mechanisms that lead to these results are not nearly as relevant, especially when many are bloated or unnecessarily complex.
It seems like the frameworks and assumptions that the industry has operated under for many years are being challenged, causing swim lines and methods to converge. The macro environment is certainly a consideration, but I think all we can say at this point that it’s putting additional stress on the system. Stress on any system forces evolution, which is a good outcome, though there will of course be a cohort of firms that do not live on to the next generation.