Private Equity in the Technology Space

EisnerAmper’s San Francisco office recently hosted a meeting of the minds among seventeen prominent Bay Area technology leaders. “Private Equity in the Technology Space” addressed some of the increasingly visible issues concerning the funding and valuation of what seems to be an endless wave of new technology companies. Moderated by EisnerAmper’s Mike Morris (SF), along with John Pennett (NJ), and special guest, Nick Ellis, founder of data-driven talent management company Hirabl, the group identified and analyzed current major shifts in venture capital and private equity investment in the technology sector.

The supply of venture capital and private equity in the technology space has increased tremendously in recent years as investors seek higher returns in a low interest rate environment. Additionally, the advent of new funding platforms such as Funding Circle has increased access to alternative sources of capital and made it easier for new companies to obtain vital infusions of working capital. As a result of this influx, valuations and acquisition prices for new ventures are at an all-time high, and investment funds have begun selling off some of their portfolio companies. However, inherent problems in the market such as arbitrary valuation multiples are troubling both potential buyers and sellers as fund managers try to answer the most important question: Is this a good deal for my investors?

The panel weighed in on the subject and talked about debunking the “unicorn theory,” a model in which one amazingly lucrative success in the portfolio more than makes up for a series of smaller failures. Both private equity and venture capital groups are trending away from trying to hit these figurative grand slams and instead are starting to concentrate on hitting a more frequent string of singles and doubles.

When asked how he identified these kinds of opportunities as an entrepreneur, Ellis cited the concept of “negative space” in art and explained that instead of simply jumping on board a trend, he looked for new openings forming in the market spaces surrounding the trend. (As an aside, my thoughts at this juncture were on the potential kinds of products and services which might arise if driverless cars ever become the norm.)

Despite all the excitement in the technology space, there remains much uncertainty in the world of start-ups. What will prevent valuations and the supply of capital from shrinking when higher interest rates make other forms of investment more attractive, and how can that risk be managed? The financial structure of emerging companies is becoming increasingly important as PE & VC groups turn their focus towards shared-risk models which are becoming popular for aligning investor and entrepreneur interests.

A growing trend in the issuance of convertibles over traditional equity stakes, for example, encourages entrepreneurs to be responsible in managing their funding and ultimately softens the blow to investors if and when a venture does go belly-up.  In addressing the question of profitability for their investors, fund managers are taking a more holistic approach by looking to other metrics and factors besides valuation multiples and projected cash flows when trying to make informed decisions.

To that extent there was unanimous agreement by the panel: Sound investment decisions often stem from backing the right person, as well as the right company.