Can a Computer Replace Private Equity Decision-Making?

By DirectorCorps

December 17, 2019 Private Equity Human Capital

Is the United States ready for “private techquity”? That’s the name a consulting company gave to the adoption of technology in private equity, including machine learning and data-heavy databases.

“It’s not a substitute for the relationships, reports and research that have typically governed PE deal sourcing,” write Nick Leopard and Jon Apter of Accordion. Although private equity firms know how to leverage data in decision-making, “private techquity” focuses on collecting, organizing and analyzing reams of data to make more informed decisions, they said.

By comparison, venture capital firms are better known for making strides in data science. One analytics-based firm founder recently said that before he co-founded his company in 2013, there had been no innovation in private equity since Microsoft’s Excel spreadsheet. An Ernst & Young survey from 2017 that found about 75% of private-equity firms struggled to see how data science could affect the value of portfolio companies.

For private equity, data analytics translates to projecting a company’s revenue with more accuracy, both in the due diligence stage and post-investment value creation. “Using large-scale, cloud-based engineering we can handle very, very large data sets in very, very short timeframes. Billions of rows of data,” Two Six Capital’s co-founder Ian Picache said at a conference of the Wharton School of the University of Pennsylvania earlier this year. Data reduces the typical four to six weeks of due diligence a firm conducts, and can more quickly come to a conclusion: Can this company produce adequate returns?

Data analysis also is much improved. The two cited work they did alongside private equity giant Bain & Co. to evaluate a possible purchase. They obtained a time stamp for every customer interaction at the prospective target. Bain believed there was a lot of competition for the company in a particular region that would challenge growth, but the data proved the opposite. The company was expanding its customer base in that region, according to the number of new transactions. The insight turned out to be correct. The business in that region experienced 100% growth last year.

The promise of big data has convinced big names like investment firm The Blackstone Group, which disclosed in February that it has its own data platform to help in decision-making. Falfurrias Capital Partners used data analytics in its decision to buy SixAxis in 2016, The Wall Street Journal reported.

Still, shifting from human judgement to more machine learning could take time. Many in the industry have decades of experience making decisions and don’t necessarily feel comfortable handing part of the analysis over to a computer.

“This is a journey that we’re just beginning, and while we’ve got a team, it’ll take more investment in the team,” Tony James, executive vice chairman of Blackstone, said during the company’s February earnings call. “It’ll take somewhat of a cultural change.”