As you’ve probably realized from previous posts, this blog is neither about startup investment nor unicorn chasing. As explained here, I am rather aiming to share and document best practices as they relate to the strategic and fundamental analysis of later-stage, cash-flow positive companies with an already-established business model.
However, I believe the PE and VC worlds are increasingly converging (at least in the mindset and skillset they require from participants). Failing to recognize that you need to incorporate some VC-type thinking in your non-tech private equity transactions will wreak havoc on your returns. Indeed, even if you are not seeking to invest in the next great disruptor and would rather comfort yourself in the solace of stable, proven and profitable business models from the past, you now have to go through the mind-stretching task of envisioning new, unforeseen sources of competitive threats.
This is not new. Even the most basic of strategy tools (Porter’s 5 forces) reminds you to assess “new entrants” and “substitutes” when analyzing a specific company. But the general tendency I have seen in the industry is for PE investors to focus the analysis on the competitive positioning and capabilities of current competitors (as Porter puts it, “rivalry amongst existing firms”) and try to anticipate new players with a reasonably similar model. What often lacks in PE deal analysis is the harder, more speculative work of trying to envision future, un-existing, disruptive threats. The very threats that can kill a business. The threats that the VC investor is trained to detect and seeks to profit from…
As a PE investor, this is a part of your due diligence process where curiosity, expert consultations, a futuristic mindset and a healthy dose of paranoia are all warranted. The signals you are looking for at this stage are generally quite weak and can only be heard at the boundaries of the target’s current business model. You must also keep in mind that the seller 1) is either keeping these signals secret, hoping you won’t notice them or 2) is simply not perceiving them, as they are still too subtle for his level of attention. (An alternate explanation lies in denial. As per Upton sinclair’s famous quote, “It is difficult to get a man to understand something, when his salary depends on his not understanding it.“)
As a private equity investor, you should also keep in mind that a target company might not necessarily be threatened by one single disruptor, but rather by a series of innovative players that are each chipping away at a specific part of the target’s value proposition enablers. This is called unbundling, a concept which has been popularized by CBInsights. Unbundling basically spells death by a thousand cuts for the incumbent’s business model.
So if you’re working on traditional buyout deals, please resist the temptation to categorize yourself as a “private equity” investor rather than a “venture capital” investor, please resist the urge to label yourself as an “old economy” vs “new economy” investor, and please resist the urge to stay in your comfort zone by avoiding a deep analysis of the technology and innovation zones of the target’s competitive landscape. There is a stage of your due diligence process at which you’ll want drop the financial and strategist’s hat to wear the innovator’s hat. Not so you can pick the next big disruptor…but so you can avoid investing in the next big disrupted!