Tech startups finding few takers from private equity - for now

PRIVATE equity firms here don't seem ready to invest in the newfangled tech startups that their venture capital counterparts usually target, but this could change down the road as these startups mature.

At least, that seemed to be the consensus from a panel of private equity and asset management firms at a recent event organised by the Chartered Alternative Investment Analyst (CAIA) Association.

Their reasons were not surprising. While both private equity and venture capital are investors in private entities and seek eventual exits through trade sales and initial public offerings, at the heart of it, they buy very different types and sizes of companies, and invest different amounts of money each time.

Even the size of stake they choose to hold differs. Private equity tends to be control-oriented because it wants to have a hand in shaping the company's business to generate higher rates of return, whereas the traditional venture capital model entails minority stakes in 30 to 40 startups per fund, spreading its risks since it does not know which company will get its lucky break.

The question posed to the panel two Fridays ago was in view of the fact that increasingly, more private equity has started funding tech startups especially at the later stages.

But the response from the representatives of Blackstone, CDH Investments, EQT, PAG and Platinum Equities, all seemed to reverberate around the conclusion that private equity still prefers the traditional sectors of consumer, healthcare and education for now. As it is, these are also the sectors that are trading at cyclical highs currently.

In fact, all five companies do not focus on early-stage or mid-stage tech in particular. Most say that many of the investments in the new-economy sector get filtered out early in the deal-sourcing process on the grounds of deal size, fundamentals and valuations alone.

For instance, one speaker said his firm only does buyouts and structured minority deals such as convertible bonds. "Immediately, that funnels down to a much smaller space and when you have so many investment opportunities, you're not only an allocator of capital but also of time more than anything else."

There are also other aversions such as the fact that private equity requires a minimum level of Ebitda before investing, but many tech start-ups have not yet turned a profit. Another speaker said that in sectors that are changing rapidly, there is a higher chance of losing money, which is not palatable for private equity. Many early-stage tech firms are also generating negative cash flow, although admittedly, this is not uncommon for a growing company.

To be sure, both sources of funds have been very active in the deal market, with numbers from global advisor Duff & Phelps showing that Singapore achieved the highest yearly transacted volume of private equity and venture capital deals in 2018 at 154 investments made in Singapore companies, versus 125 investments in 2017.

The deals made up US$6.6 billion in value for 2018, below the record high of US$22.8 billion achieved in 2017 which was driven by sizeable private equity and venture capital buyouts, including the privatisation of Global Logistic Properties and the acquisition of Equis Energy.

But private equity investment in the tech space is not a lost cause altogether - the panellists signalled that perhaps over time, as tech companies mature, private equity may find more impetus to buy.

Indeed, the lines between the asset classes of private equity and venture capital are constantly being blurred. They may get even more so as more liquidity globally seeks out limited quality deals amid a low interest rate environment, with more institutional investors joining the fray.

Still, it is not likely that private equity will negotiate on the basic fundamentals of profitability and growth which they will require before they enter the space.