2 posts tagged with "investment"

AI is set to revolutionize nearly every aspect of our world, but the billion-dollar question remains: who will emerge the winners and losers in this AI-driven future? While much attention is focused on tech giants, an underrated winner is emerging: private equity firms.

Private equity is on the brink of a major transformation, and here’s why they’re poised to be the biggest winners in the AI race:

1. Cheap, Reliable, and Custom Software for Every Portfolio Company​

Software has immense potential to drive efficiency, particularly for the operationally heavy and technologically laggard businesses that private equity funds often acquire. The challenge has always been that existing software doesn't fit the unique needs of each business well enough. Customizing and maintaining software has traditionally been a costly nightmare, often causing more problems than it solves.

AI is turning the world of software engineering upside down. We've moved from simple code completion that drives 50% performance gains to full-blown AI software engineers, with reports suggesting that GPT-5 matches senior engineer levels of proficiency. We're entering an era where cheap, reliable, and bespoke software is available for any business. The barrier to creating tech-enabled businesses will no longer be cost but rather inertia and know-how. Private equity firms, being highly motivated and sophisticated owners, will rapidly adopt custom software that allows them to outcompete alternatives in the market.

2. AI-Enabled Employees Will Drive Up Profitability​

Contrary to the naysayers who believe AI will replace workers, AI as a companion to workers will make them exponentially more effective. Think of AI as a highly inexperienced but eager-to-learn intern. Without oversight, it's useless, but with proper supervision, it can accomplish serious work. Unlike a human intern, AI costs almost nothing and is infinitely scalable. Workers bolstered by an army of "AI interns" will be able to increase their output significantly.

Private equity firms, with their focus on operational excellence and the benefit of scale, are well-positioned to enable their portfolio's workforce to become AI-enhanced. These AI-enhanced workforces can not only scale to serve more customers with ease but also provide better, faster, and more personalized service. This combination leads to top-line growth with minimal change in operating costs, driving meaningful EBITDA margin expansion.

3. The AI-First Private Equity Firm Will Be a Powerhouse of Efficiency and Decision Making​

AI excels at finding, analyzing, and restructuring critical information among a sea of data. For private equity firms, 95% of the investment team's work is information curation—from digesting company data to conducting hours of expert or customer interviews. This painstaking process is slow, costly, and often biased. Most problematically, it’s impossible to conduct this process thoroughly for every opportunity, leading to missed hidden gems and wasted efforts on walking-dead deals.

Private equity firms that embrace AI as a core tool in their diligence process will become unstoppable winners. With AI, these firms can pick winners with complete information and move faster than the competition to secure key opportunities.

The Future of Private Equity in the AI Era​

Today, everyone has Nvidia on their list of AI winners, but private equity should be on that list too. While some firms may resist the winds of change, the elite and forward-thinking funds that reconfigure themselves to be AI-first will emerge as generational winners. By leveraging AI to enhance software, empower employees, and optimize decision-making, private equity firms can secure their place at the forefront of the investment world.

In a world where AI will change everything, private equity stands to gain immensely. The firms that adapt will not only survive but thrive, accruing the substantial benefits of this technological revolution.

What are your thoughts on the impact of AI on PE? Eager to hear from folks that disagree or think AI will impact PE even beyond the ways I’ve identified.

Focus Matters: An Untracked KPI for PE Firms​

In the world of private equity (PE), the prevailing belief is simple: as long as you pick the right opportunities to invest in, you will be a top-quartile fund with excellent returns. The logic behind this is straightforward—almost all deals, except a small handful of truly proprietary opportunities, are seen by every fund. The best funds bid the right price to win deals on the best companies.

The Hidden Challenge​

But here's the catch: not every fund truly "sees" every opportunity. Sure, you receive the data room, and an analyst performs at least a quick review of every deal—but how many diamonds in the rough with outsized return potential die well before they reach the Investment Committee (IC)?

It's not just that firms prematurely passed on deals that ended up driving returns for other funds. They also spent an enormous amount of mental energy focusing on deals that ultimately went nowhere. Most ICs pride themselves on being objective in their evaluations, but human bias forces everyone to think in relative terms. Did you really back the best if it's just better than the other options you saw?

The Investment Funnel​

Everyone knows that PE funds work through a funnel, with thousands of opportunities getting a cursory look and only a few dozen ever going to IC, backed by a massive amount of research. However, the nuanced point is that it matters how good your investment team is at deciding which opportunities get a glance versus a deep dive. There is a finite amount of focus any fund has. Yes, the investment team can always push harder and work more hours—but real focus and proper decision-making are finite resources. The best funds triage that focus effectively, only on what matters most.

Introducing the Deal Focus Score​

I propose a new KPI for PE: the Deal Focus Score.

Deal Focus Score = 1 - (premature passes + excess diligence) / total opportunities seen

Different funds have varying processes for evaluating opportunities and progressively digging deeper, but a general heuristic should be:

• Premature pass: Any deal that was eventually done by a well-respected competitor that did not reach an IC discussion.
• Excess diligence: Any deal that could have been passed on faster. A strong indicator is if the eventual pass reason was something known early on.

The Power of Focus​

Optimizing for the Deal Focus Score forces every member of the investment team to make a series of incremental judgment calls on what deals matter. You can think of the Deal Focus Score as a powerful proxy for investment judgment for associates, principals, and junior partners who "invest" with their focus. Given the difficulty of long time horizons and the low number of using fund return metrics like MoM or IRR to evaluate the effectiveness of an investment team, the Deal Focus Score is a highly compelling way to motivate and continually develop the proficiency of an investment team.

Tracking and Improvement​

By tracking and improving your Deal Focus Score, you ensure that your team is not just busy but effective—focusing their finite resources on the opportunities that truly matter and optimizing their decision-making process along the way.

Conclusion​

In conclusion, focusing on the right metrics can transform the way PE firms evaluate and capitalize on opportunities. The Deal Focus Score is a step towards refining this process, ensuring that valuable deals are not overlooked and that resources are allocated efficiently. By adopting this KPI, PE firms can enhance their investment strategies and achieve sustained success.