Private equity needs to embrace data

Gut feelings are great, but data is better. It’s time for private equity to get in the game.

By Randy Koch

No one would accuse private equity of being a particularly data-driven industry.

While their colleagues over at the hedge funds and quant funds are dealing with mountains of data on a daily basis, looking for insights that will give them an investing edge, private equity rarely hikes those hills.

In some respects, this is perfectly understandable. Private equity firms generally only do a handful of deals each year, and their need for data pops up at a few distinct moments in the investment life cycle.

Need to validate a thesis about whether a particular industry sector might make an attractive investment? Time to look at some data. Need to figure out how much to pay for a company once you’ve identified a target acquisition? Data can help with the due diligence. Need to analyze the competition for comparables? Nothing better than data. Need to see how different generations are spending, pre- and post-COVID-19?  It’s in the data.

Private equity firms have historically turned to the large consulting firms to help out in these areas. So, it’s not so much that private equity firms aren’t using data at all. It’s more that they could be using it much more frequently and much more advantageously.

What if private equity firms were able to tap into real-time data instead of static snapshots? Doing so would allow private equity firms to make better, smarter decisions at every stage of the investment lifecycle, and generate superior returns to boot.

Consider a private equity firm that was interested in buying up independent salons and barber shops to create a new national chain. Their thesis might be that there’s a segment of the population who can’t afford the high-end salons, but want something a step up from the “regular” hair-cutting places.

There are data sets out there that would allow the firms to establish how often those people are getting their hair cut, and what kind of potential market exists.

Just as importantly, this type of data, especially around consumer spending behaviors, could take into account curve balls like the covid-19 pandemic and the ensuing lockdowns and changes in behavior.

Likewise, data could assist with the due diligence aspect of a deal. Let’s say that rather than putting together a new hair-cutting chain, a private equity firm wants to buy an existing one and fix it up. They’ve narrowed the field down to two national players.

Real-time consumer spend data would give the firm a wealth of information to guide which of the two players to make an offer to and how much to sweeten the pot. They could see how much the customers at each brand spend, whether the customers switch brands on a regular basis or display strict brand loyalty, and so on.

The data might even reveal that one chain’s physical locations are clustered in parts of the country where more lucrative or higher-value clients are located. Being armed with all of this data provides a competitive advantage, where a firm can comfortably bid for a company at a level that other firms might not (or conversely that others are overbidding), secure in the knowledge that the bid can be backed up by more than just a “gut feeling.”

Since a typical due diligence period for a deal is 30 to 60 days, better use of real-time data can help inform these decisions all the way up to the final stroke of midnight. That stands in stark contrast to current due diligence processes, where data gathering typically takes up a few days, and then the remaining weeks are spent building a report off of that frozen-in-amber information.

Embracing data more often could also enable private equity firms to better monitor the performance of companies within their portfolio. How is the company doing relative to competitors at any given time? What tweaks could the company be making to its pricing based on the amount of spend competitors are capturing? Is the company on track to receive an attractive multiple based on current financial performance, and if not, what needs to change?  Are they capturing a higher percentage of Millennials, and how loyal are these customers?

It’d be easy for private equity to say, “If it ain’t broke, don’t fix it.” But one way or another, data will become a more prominent part of the private equity landscape. Giants like Blackstone Group and Kohlberg Kravis Roberts are already talking up their use of data for competitive advantage. Other firms would be wise to follow suit if they don’t want to be left behind.

Randy Koch is CEO of Facteus, a leading provider of actionable insights from financial data.