Just 10 years ago, digitalisation was seen as a concern for IT teams within private equity portfolio companies. Today, digitalisation has become a priority, with portfolio managers, boards and C-suite executives required to engage in outlining and enacting digital strategies.

Digitalisation can be defined as using digital technologies to change a business model and provide new revenue and value-producing opportunities. It includes every activity and process that’s made possible by digital technologies.

Digitalisation has reshaped the diligence process for private equity firms, as they evaluate the potential of investment opportunities.

According to a Preqin survey of 300 private equity fund managers, approximately 70% of respondents said the degree of digitalisation of a company would influence their investment decision.

“[Digitalisation] has gone from being a hygiene factor in technology for a lot of businesses to something that's critical to compete,” says Mark Richards, managing director at BC Partners. “For example, if you are a consumer or retail business that doesn't have an e-commerce proposition, then that would be seen as a risk to your business – this is different to how it would have been 10 years ago.”

GPs understand that having an effective digital strategy could be the difference between success and failure, therefore thinking about digitalisation begins during the diligence process. If a business is found to have a weak digital proposition, then some GPs may be turned off from investing in it.

“We would question if it's something we should invest in, whether it is a technology business or not,” says Richards. “However, this won’t necessarily prevent us from investing because, as part of the investment thesis, we will explore whether we can make the business more tech-enabled, or more digitalised, and in turn, create value.”

Richards highlights BC Partners’ investment in global white-collar insurance services business Davies Group, which the GP acquired in 2021. The business historically focused on outsourcing insurance claims processing.

“Part of our investment thesis, which management agreed with, was that driving automation would be a critical component of being efficient in a people-heavy business,” Richards says. “So once we acquired the business, we significantly increased capex investment to accelerate the adoption of digital technology. The goal in this and similar instances when we come to realise our investment is to ensure that we're leaving behind a more tech-enabled business than the one we bought.”

Dearth of talent

While the benefits of digitalisation are undeniable, challenges exist in implementing and executing digital strategies effectively. Being aware of in-house capabilities and understanding that digitalisation is not innate for all businesses, especially among executives that are not primarily focused on technology, is crucial.

“One of the main challenges to overcome when embedding digitalisation is the cultural mindshift of the businesses themselves,” says Ben Hollowood, portfolio director at Bowmark. “Part of the cultural change involves bringing new people in with a different mindset but, most importantly, the whole organisation needs to embrace digitalisation and be able to move at pace.”

Bringing in the right people is not as easy as it seems. Recruiting tech professionals that are keen to work in non-tech-focused portfolio companies is a massive challenge.

Fortunately, an entire ecosystem of service businesses has grown rapidly during the last decade to support companies on their digital transformation journey. These service providers offer specialised expertise and support, enabling businesses to overcome hurdles and fully embrace digitalisation.

Stephen Delaney, partner at Bowmark, says: “The recruitment and retention of great technology talent into companies, especially of the sizes of businesses that we are investing in, is tough. And, therefore, we see a number of our companies using outsourcing providers as well as insourcing.”

Another aspect to consider is that implementing digital systems is not solely about the technology itself. It necessitates a change in how businesses operate and approach their processes. Merely implementing technological changes does not guarantee a company will immediately enjoy the benefits of digitalisation.

“Just implementing the technology change doesn't get you the full benefit,” Richards warns. “What some of these systems do is allow your business to be much more agile and react more quickly to market change. You therefore need to change how you actually go about doing business.”

Legacy vs modernisation

PE firms are now a lot more aware of the operational dangers of taking legacy tech risks. If the company hasn’t done a good enough digitalisation job, then the GP’s deal team and investors are aware that this will directly affect the value of the business. Upgrading or modernising a company’s digital systems is usually one of the main priorities for a GP after acquiring a company.

However, implementing your initial digital strategy is sometimes not possible. What do you do then? Bowmark’s Delaney says it is vital to be flexible with your digital strategy to cater for your customers’ needs. That is what the GP did when it acquired fintech company WSD last year. The business's clients include tier-one investment banks, among others. Some clients were not ready to move away from the legacy technology that existed before the acquisition. 

Delaney says: “When we bought the business, it was physically hosted with a data centre in Canary Wharf. It was clear that the business needed to move to the cloud during our investment period or the next one. But not all of its customers were comfortable with that move. So we adapted and the business today is a hybrid model, with some clients hosted in a physical data centre and others on the cloud.”

But in other instances, changing digital systems is not necessary, particularly for companies that already have their own robust systems in place.

Changes to come

The constant evolution of technology and the emergence of cutting-edge solutions present private equity firms with both opportunities and challenges. When considering the implementation of new technologies, it is essential to strike a balance between being at the cutting edge and adopting proven, road-tested solutions.

“We're certainly seeing AI have an impact on our portfolio companies,” Delaney says. “We have examples where, in early-stage AI trials, some of our services businesses are seeing reductions in costs because of how efficient some of that technology is, including things like ChatGPT.”

However, the practical application and impact of generative AI, for instance, is still being explored, and its potential disruption to different business types and markets remains uncertain, according to Richards.

“There's a lot of hype around it as a technology. And I think it will be disruptive to several different business types and markets, but it is difficult to know how and when,” he says.

At the same time, business models have also undergone significant transformations in the digital era. The traditional approach of purchasing software licences and paying maintenance fees has shifted towards ‘as a service’ models. Businesses now opt for monthly payments, often based on consumption, which impacts cost profiles and the profit and loss statements of both customers and software providers.

Richards adds: “The old way that you used to pay for software is to buy a licence, typically treated as capex. All of these business models have changed. This impacts both the cost/capex profile for the customer, but also the profit and loss profile of the software provider.”

A digital world

Whether or not a company needs a complete uprooting of its digital systems or something that requires a light touch, PE firms now understand that the potential benefits of digital transformation are undeniable.

GPs actively seek opportunities to make businesses more tech-enabled and digitalised, leveraging data, AI and cutting-edge technologies. The journey towards digitalisation requires careful evaluation, collaboration with specialised service providers, talent acquisition and a deep understanding of evolving business models. By embracing digitalisation and nurturing a digital-first culture, businesses can position themselves for long-term success in an increasingly digital world.

Bowmark’s Hollowood concludes: “The whole process of digitalisation can sound quite daunting. The reality is that it is a continuous process and the important thing is to get moving on the journey. You'll definitely see management teams that were initially unsure about digitalisation embracing it once they see the benefits.”