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Where the smart money is going in technology

RFP

Over the past few years in the UK, the funding landscape has continued to present a challenging environment for businesses looking to grow. However, technology has remained an active market for investment, outperforming other sectors.

Grant Thornton UK LLP engaged IE Consulting to canvas the opinions of 40 private equity and venture capital practitioners with experience in investing in the UK technology sector. 

Private equity professionals experienced high levels of deal activity between 2007 and 2008, but since 2009 activity declined sharply, wiith many going on hold. A number of those deals have gone on to be completed, but the downturn forced the market to adapt to a significant lack of bank finance, a situation that has persisted and given rise to an increase in alternative funding solutions. In today’s market the mathematics of investment have changed. Private equity houses are still completing  transactions but with much lower levels of external debt and a much more conservative approach in terms of  which lenders they are comfortable dealing with. Many  funds have flexed their deal structures to ease the lack of  bank debt in the market and this increasing flexibility has  allowed a number of deals to complete which would not  have seemed possible back in 2009. The market has settled down sufficiently now to yield  a persistent, though lower level of deal activity. With deal  volumes oscillating around 60%–70% of the 2008 peak,  the technology sector has fared better than most. According to unquote” data, the combined technology  and telecommunications sector has consistently ranked  within the top two most popular sectors for early stage  and expansion investment and within the top three for buyouts. Overall, for all types of private equity  investment, the sector is second only to the broad  industrials category

Key findings

  • Over half of the respondents (57.5%) expect the level of private equity investment in the UK technology sector to increase over the next two years, with 10% of those expecting it to increase greatly.
  • Cloud and Managed Services are the top two subsectors for investment.
  • Many see the financing environment and Eurozone uncertainty as being significant obstacles for UK technology businesses over the next two years.
  • Competition for the right technology deals is intense, with a balanced universe of trade and financial buyers, both domestic and international.
  • Two thirds say they expect the major competition for deals to come from other UK private equity firms with a quarter citing UK trade buyers. Perhaps surprisingly only 23% saw overseas buyers as the prime competitors.
  • 93% of respondents believe the main exit strategy for private equity backed investments in the UK technology sector will be a trade sale over the next year; only 23% expect to see a sale to other financial investors as an option.
  • Any recovery in the IPO markets for private equity exits still seems more of a hope than an expectation, with only 8% seeing this as a credible option over the next 12 months.

The rate of change in the underlying technology market shows no sign of slowing. The opportunities this creates to disrupt markets and develop new business models will continue to feed the pipeline of potential deals for private equity houses and venture capitalists.

 

In general, there is a real wariness amongst private equity in investing prematurely, with one explaining: “We tracked some of our companies for more than two years before investing. We are looking at good companies with a good price.”
Generalist PE Investment Professional

 
     

Prospects for investment in technology over the next two years look good. 57.5% of respondents expect the leve of private equity investment in the UK technology sector to increase over the period. Breaking these figures down, VCs are the most positive about the sector, with 70% of VC respondents saying that investment will increase versus 52% of PE respondents saying the same.

 

“For every Facebook, there are so many in the graveyard. The social media game is really popular right now, but you can do very badly at it. It’s important to check opportunities carefully and not invest solely based on trend.”
Specialist PE Investment Manager

 
     

When asked which sub-sectors they expected to present the most attractive investment opportunities 92.5% of respondents said Cloud was an attractive sector with 50% planning to make an investment within the next
two years.

Whilst private equity sees numerous opportunities in technology, they also have some reservations about the
sector, emerging technologies and the quality of the companies involved in the sector. Some investors are wary of what they perceive to be a new social networking bubble. One private equity professional explains:

Another says: “Social media is now something of the past, as IPOs such as Groupon or Zynga are one of a kind. I’m really confused about how these businesses can be valued at such a high price. Could there be a pricing bubble for social media companies?”
Generalist PE Investment Director

Social media aside, one investor comments: “Because Cloud is attractive, competition is tough and prices can
be unrealistic or towards the higher end of the spectrum.”
Specialist PE Investment Manager


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