Q3 Private Equity Industry Update

Sean Mooney:
[00:06] Welcome to the Karma School of Business podcast. Today's episode is brought to you by BluWave. BluWave is the business builder’s network for private-equity-grade service needs. BluWave's platform combines concierge-like advisors with technology, data, and AI to expertly connect businesses with proven operators across due diligence, value creation, and preparing for sale. The BluWave vetted network is an invite-only ecosystem of top-tier individuals and firms. Based in Nashville, Tennessee, BluWave ranks as one of America's fastest-growing companies, and today serves more than 500 leading private equity firms and thousands of proactive businesses. Visit www.bluwave.net to learn more.

[00:46] I'm Sean Mooney, the founder and CEO of BluWave. During this episode, we're going to talk about the latest trends in PE activity and lessons every business builder can learn as derived via BluWave's proprietary internal data. Enjoy.

[1:03] Today, we're going to talk about how and why the best business builders in the world are taking action, turning a perceived time of risk into opportunity. As we look at our data, the first thing we've been seeing is the PE industry has been getting their portfolio companies as liquid as possible. The private equity industry knows more than anyone that companies don't go out of business because they're necessarily bad companies. They go out of business because they run out of money. Every business today should be getting as liquid as possible. Do as the private equity industry is doing, and get as much capital and cash available to thrive and survive during the days ahead.

[1:42] Now, if you look at it, PE isn't just squirreling away cash to sit on it. They're gathering it in preparation for action. We saw this absolutely occur during the COVID recession of 2020, and we're seeing it again now. By the way, I'm calling this economy a transitionary economy. No one can argue whether we're in a recession or not if you call it a transitionary economy; all I know is things are changing. Another quick aside: The one thing I do know is the Federal Reserve will never admit that we're in a recession. They're only going to admit after the fact that we're coming out of recession. “We're out of it. Oh, yeah, by the way, we were in one. We didn't want to tell you about it."

[2:21] And that makes sense, right? Why would the Federal Reserve want to cause further strife and panic by saying we're in a recession? Because it just causes everyone to go into savings mode and stop spending and makes the recession worse. So keep that in mind as we think about the current times. Whether we're in a recession or not, we're obviously transitioning into something that's not great, but there are ways to navigate through this to make it as best it can be for your companies.

[2:44] We recently released our Q3 Insights Report that highlights what PE is doing right now and should serve as an example for what every business should be similarly doing as the private equity industry does. First, we'll look at and discuss the BluWave Value Creation Index that breaks down all of the projects that BluWave supports across the private equity industry, by due diligence projects and value creation projects. During Q3 2022, value creation accounted for approximately 69% of the BluWave projects in the BluWave Value Creation Index. This compares to 62% during Q3 2021. That's a massive increase year over year.

[3:34] So what's happening when we look at that data? One, value creation's up, due diligence is down, in part because there are fewer deals in the market right now. There was an all-time deal market last year. The economy was booming. People were trying to get companies sold in advance of potential massive tax increases, so a lot of the deals were pulled forward. Part of the reason why value creation is up is because due diligence is down, because there are fewer deals in the market. But that only really tells part of the story. A big part of the story is because private equity firms have to now transform their companies. When I spent my earlier days in private equity, it was really about optimizing companies. It was about doing the kitchens and bathrooms.

[4:16] Today, the economic competition for deals is such that private equity firms are paying more, and with paying more, they risk having lower returns. The private equity firms don't just fall victim to that. They're going to take action so they can maintain the returns that they've historically enjoyed. So now, what they're doing is completely transforming these companies. Whereas they used to do kitchens and bathrooms, today they're doing the entire house. What we're seeing is so much more activity around value creation, and this has increased period over period, year over year, as a categorical trend in private equity.

[4:51] The other thing that we're seeing that explains why we're seeing so much value creation industry is that the private equity industry runs towards the storm when a storm comes towards shore. Many people, when they see bad weather approaching, metaphorically anyways, they circle their wagons, they try to wait it out. The private equity industry does its best when times are worse. The data shows this clearly. So what they do when bad economic times come, they load up their wagon, they put on a slicker, they head towards the storm, they have stakes, they start grabbing land, and they turn perceived periods of risk into opportunity. We're 100% seeing this now. This is a mindset that every business owner should have.

[5:33] Next, as we look at our projects by functional area, we have an index that we call the BluWave Activity Index, and really what this does is look at all the different projects that we're supporting across private equity, across all the different functional areas in the company. When we look at this index, there are three clear trends that are emerging that every business should benchmark. The first one is that human capital activity, human resource activity, is still very active, but it's moderating. The private equity industry is starting to tap the brakes on hiring activity, but still very, very active. Human capital accounted for 36% of the projects in the BluWave Activity Index as of Q3 2022. This compares to 39% of projects during Q3 2021, so we're seeing a moderation occur. As we discuss this, it’s still very active, but it's starting to slow down a little bit.

[6:32] We're still seeing all sorts of hiring at the C-suite. We're seeing hiring actually occur in droves all the way down into lower levels of the organization. One of the big trends that the private equity industry is doing is thinking much more thoughtfully about not just C-suite hires, but hiring deeply in verticals that are most aligned where they expect the most value creation to occur, as part of their value creation plans. It's very important for business owners today to think not only in a uniform allocation of resources across your C-suite, but think about, through your entire stack, where should you be allocating your fixed resources for human resources, throughout your organization, that are most aligned with where you think you’re going to see the most growth, in your own company's valuations and businesses overall in general.

[7:17] The other area within human capital where we're seeing lots of activity is a trend towards the private equity industry bringing in wartime generals in place of peacetime ministers. During fluid times, there's often very different people who thrive during these periods in time. The private equity industry, when they see some of their leaders or high-key players having trouble, they're going to bring in very specialized people who are great during choppier weather, more difficult times. They'll bring them in to make sure that their companies thrive during these periods of overall risk. So we're seeing lots of activity bringing in people with these skillsets.

[7:56] The next top trend that we're seeing within our data and our Activity Index is technology. Tech activity is surging across private equity. Technology projects accounted for 15% of all the initiatives in Q3 2022 within BluWave. This compares to 8% in Q3 2021. That's a nearly 100% increase. What are the private equity firms doing, and what should you take lessons from as it relates to your own businesses, your portfolio companies, your firms, et cetera? We're seeing three areas of focus.

[8:32] Number one is digital transformation. Prior to COVID, digital transformation was always the next best thing, always had been and always would be, but it never really got momentum. It was always more of a buzzword versus a megatrend that actually happened. What we've seen during COVID is we were all thrust into this digital realm. Companies started becoming comfortable with being digital. They started seeing the benefits of it. They realized that you could automate process and procedures that people didn't like doing, and then they realized, "You know what? We can't even hire people to do these things because of the Great Resignation. So why not take advantage of all these tools that exist and are now democratized and affordable for virtually every business?” So we've seen a tremendous amount of activity all the way down to the lower middle market around digital transformation.

[9:22] The next thing that we're seeing, almost part and parcel with digital transformation, is a surge in cybersecurity-related activity. With all of us becoming increasingly more digital, bad actors across the globe are realizing tremendous opportunities are availing in ways that they haven't before. This includes industrial companies, technology-based companies, services, businesses. Everything related to a business is now accessible via the internet. As digital transformation picks up, these risks grow and grow. The private equity industry, like always, is trying to stay two to three steps ahead, so we're seeing them take tremendous effort to raise the gates in a multifactor way that includes a combination of using technology, third-party services, and training to make sure that their companies are as resilient as possible to people who are looking to take advantage of this new digital era that's evolving.

[10:20] The third trend within technology that is happening in a massive way is embracement of data and analytics. The private equity industry fully appreciates that those that can make the most informed and agile decisions, particularly during times of higher risk, are going to thrive and accelerate and surpass and outmaneuver their competition. We're seeing private equity firms themselves, as well as their portfolio companies, adopt massive amounts of things like Snowflake, Power BI, Tableau. Once they get their data clean and they're visualizing it, we're now starting to see them use some of these evolving and newly available tools related to machine learning and AI that help take their decision-making to wholly new levels. These tools, historically, were only available to the likes of Facebook and Apple and Google. They've now gotten to the point that mere mortals can use them.

[11:15] At BluWave, we have all sorts of AI engines that are turning our human beings that ordinarily support our projects into superhuman beings. So these are things that every company should start thinking about. They're addressable not only for the large companies, but also the lower-middle-market companies. Every business should be thinking about these tools and doing as the private equity industry is doing right now.

[11:36] The third top trend that we're seeing in our data, as of the third quarter of 2022, is sales and marketing. We're seeing the private equity industry do everything they can for their portfolio companies to resist the gravity of declining GDP. The private equity industry understands that the number-one correlate to valuation is growth. As the world economy declines, they're not just going to sit there and watch their numbers decline. They're saying, "Whatever the size of the pie is, we're going to get as much of it as possible." So we've been seeing surging demand for things like growth strategy, digital marketing, and sales force effectiveness.

[12:13] Sales and marketing projects within BluWave accounted for 9% of all the projects in Q3 2022. That's up from 7% in Q3 2021. It may not sound like a big surge, but it's a quite meaningful increase in activity in a year-over-year review.

[12:30] In addition to these three trends, we're still seeing significant activity by PE in both diligence and value creation across every functional area you can think of. But the foregoing three trends should give you a sense for the big movements that are occurring that every business builder should be thinking about within their own businesses, as evidenced by what the private equity industry is doing, which generally thinks about and acts on things multiple steps ahead of the rest of the economy.

[12:55] In summary, I encourage every business builder to view the current now through the lens of safety and success. You need to stabilize your foundation with liquidity, fuel up your tank to go through this storm or go around it, then start gathering information to inform your strategies that are going to help you succeed and make very agile decisions while others are paralyzed in fear. Great companies are made during recessions. Three things you can do now include being opportunistic on people, using technology to drive insights and efficiency, and using sales and marketing resources to help get every bit of the pie that can be obtained during this transitionary economy.

[13:35] So those are the big trends that are happening right now. If you'd like to get the full report that's going to go into more detail around these big megatrends that are happening right now, or if you'd like to get access to the actual PE-grade resources that are being used in real time by the PE industry, please contact your BluWave account manager or visit our website, and we'll hook you up.

[13:56] Thank you for joining the Karma School of Business. For further information about BluWave and this podcast, please go to bluwave.net/podcast. Please continue to look for us anywhere you find your favorite podcasts, including Apple, Google, and Spotify. We truly appreciate your support. If you like what you hear, please subscribe, review, and share. In the meantime, let us know if there's anything we can do to support your success. Onward.

Private equity insights for and with top business builders, including investors, operators, executives and industry thought leaders. The Karma School of Business Podcast goes behind the scenes of PE, talking about business best practices and real-time industry trends. You'll learn from leading professionals and visionary business executives who will help you take action and enhance your life, whether you’re at a PE firm, a portco or a private or public company.

BluWave Founder & CEO Sean Mooney hosts the Private Equity Karma School of Business Podcast. BluWave is the business builders’ network for private equity grade due diligence and value creation needs.