For those yet to understand the full Tech hype, can someone educate us on why PE is so obsessed with technology LBO
1) Why are firms raising bigger than ever amounts of funds to invest in tech
2) How many of these investments will actually be successful or it just a hype rn
3) Why is Tech 'the sector' to invest in rn vs say industrials or healthcare
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For a long time, tech was avoided because investors didn't understand it and shunned it post ~2000. Slowly built into what it is today, and the private markets are a reflection/trickle down of the public markets.
I think most of the low hanging fruit is gone.
Because the tech industry is still incredibly nascent (~20-30 years of scaled tech businesses) vs. 100 year old industrial and healthcare industries.
As the above poster mentioned, most did not understand tech (still do not) or the business opportunity underlying it (specifically software) until very recently. Now that the business model has proven to be incredibly sticky / sustainable - everyone wants a piece of the pie.
Robert smith described the rise of the tech industry as the fourth Industrial Revolution or major point in time where there is an opportunity for many to create significant generational (new) wealth. Think steam engine > science and mass production (dawn of capitalism) > mass production (scale of capitalism) > rise of digital technology (iteration and improvement of mass production - where the heart of B2B SaaS lies)
Well put, but unlike other eras of innovation we must account for the how tech revolution is much faster in all ways, including maturing. We’ve now gone through two cycles of what I consider digital innovation (post 01 and post 08) and it appears most of the juice from the lemon has been squeezed. Recall the companies who were hyped and highly valued in 21 were not 1-2 years old like in 99 but rather many had been around for almost a decade or half decade, which should have been ample time to develop solid unit economics, yet it appears many did not. Even many of the famous winners from post 08 cycle (Uber, AirBnB etc) are not great cash flowing businesses.
All that being said there is still juice to squeeze and even if a quarter of the lemon is juicy, that is a lot of potential $s. There will always be innovation, I’m a believer in human (and now non-human creativity) but one should consider that we have potentially entered a new era. Post 08 monetary policy played a large part in the growth of VC/GE and tech economy because you could be patient to return capital at low rates, but once dollars have real cost and investors demand profitability earlier, we will see less experimentation.
Relatively low barriers to entry across many applications compared to say starting a big industrial, healthcare, or financial services company. New technology generally speaking is superior to anything else that's available, if it wasn't it wouldn't be getting created. I'm generalizing here but: it's easier to scale, easier to realize ROIs for your end customers, generally more profitable than other sectors, and easier to maintain/update. Software is the perfect example of all my generalizations, you're almost never going to see a hospital/clinic, industrial manufacturing, food production, or pure services business scale from $0 to $100m revenue in the span of a few years. Even if you did achieve that, it would have vastly worse margins, be a much more fragile business, have many more moving parts you have to worry about, in many cases are also substantially more regulated, and much lower quality 1x/re-occurring revenue vs what a subscription model delivers.
Tech is just better that other business models and when your focus is on returning multiples of invested capital over a set timeframe to earn fees you will want to take the easiest, lowest risk path to achieve that. It's that simple.
Except that the majority of tech companies are not FCF positive and early stage investors have been fine funneling money into companies that likely have a CAC > (LTV/discount rate). As you mentioned, the barrier to entry is low so tech companies must continue to innovate and spend on S&M and R&D, whereas the industrial business is super hard to set up so one else tries to get a piece of the pie.
In short the asset light, low capex model of tech is a double edged sword.
You're generalizing about startups/VC, not all of tech. That is not at all analogous to the tech sector as a whole and does not come even close to making up a majority of tech-based revenues. I've spoken to dozens of software founders in the past year alone who have been profitable from year 1 and have been around for a decade or more. You're just wrong.
Are you implying that that asset heavy businesses don't have comparable problems? Not from a S&M/R&D angle necessarily, but higher working capital requirements, continual maintenance capex, and additional capex needed to drive capacity for growth vs just hiring a salesperson whose ROI in the short-to-mid-term is vastly superior is hardly an advantage. Plus if my software has a bug or there's a server problem causing an issue on the customer side, I can just debug and roll out a patch or reroute to a different server for deployment vs having to say, stop a production line, send in a repairman, etc. The whole point of OP's question was asking why PE/GE heavily favors tech vs other industries and none of what you said gives reasons for why that shouldn't be the case. Tech companies, particularly software, just grow faster and more profitably due to their inherent operating leverage compared to other sectors. Tech is inherently superior to non-tech, which is why when you bring it into traditional businesses like energy, industrials, healthcare, etc. the companies using better tech will vastly outperform the ones that are stuck using legacy or no tech.
Not really, but agree to disagree. Everything has tradeoffs but if you asked the vast majority of GPs whether they'd like to see higher velocity returns from an asset-light, capital efficient biz model vs an asset-heavy, person-intensive business 9/10 are going to choose the former. The ones who choose the latter are those who have specific operating expertise they can bring to the table which gives them an edge and lets them generate unique growth compared to peers which, unsurprisingly, often includes integrating new technology into the business to achieve greater efficiencies/leverage insights into operations. Technology isn't just a sector, it's everything that drives growth and human development as a whole. The business is just deciding which industry/application you want to classify it under.
(1) Because of perception. Perception is the driver of this type of activity
I see someone doesn’t like the reality of fundraising being a function of how people perceive the business
Thanks so much for the input everyone!
Some follow ups:
1) It would be helpful to find data on actual returns for Tech/ Software LBO Investments vs other Industries - does anyone have any useful links/ published reports/ advice where I can find this data to really understand the degree of differences in returns
2) As the barriers to entry in building a tech business are lower, surely this also means that its a highly competitive industry as other tech companies catering to the same client base can launch and scale rapidly with the right talent & funding. So is it possible that an increasing supply of PE-backed Tech firms competing within the same client markets actually generate lower returns than expected for the PE firm? I understand the software industry still has a long way to go but am thinking with a 10 year investment period
1) wouldn’t index too heavily on tech PE returns here — the businesses that large cap PE tends to buy will inevitably price in where returns need to be so these deals might not perform that much better. Where you’d probably find what you’re looking for is a comparison between how fast companies get to $XXXm in revenue. Software businesses get there faster, so growth/vc investors get improved IRR
2) Yes i definitely think so. Competition for quality assets is increasing in intensity due to the amount of dry powder (+ early stage investors moving later and vice versa), which drives up the market clearing price in competitive processes
Because of AI. It is the new hot thing in town. Everyone can’t wait to pour money into it.
Yeah maaaaaaaan good take! AI totes drove the entire tech rally for the last 20+ years.
Tech essentially is a bunch of distributed systems. AI is one level above it. It’s distributed system + statistics + neural science. AI is gonna revolutionize tech
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