Bracing for disruption
How are investors viewing the risks and opportunities in AI?
Not that long ago, the use of artificial intelligence in everyday business functions looked a fair way off as tools were either clunky or required a lot of time and effort to train. The arrival - and subsequent rapid advancements – of ChatGPT, however, have demonstrated how powerful AI has the potential to be in a relatively short space of time. So what does all this mean for LPs, private markets firms and their portfolios? Here’s a snapshot of what the industry is thinking today. Firms are actively considering how and where they can deploy AI, although many are treading carefully for now. “We debate using AI,” says a senior portfolio manager at an investment management firm. “The implications of doing so are very real, but it’s in its infancy and in a hype phase now. We are studying what the pragmatic use cases are that business owners could implement and figuring out when we could do this appropriately.”
GPs and LPs are looking closely at the disruptive potential of AI across a range of activity. “We think of AI as disruption,” says Nick Jansa, Executive Managing Director, EMEA, Ontario Teachers’ Pension Plan. “It is one element of a broader technology disruption question. We have approached this in a number of ways, including creating an incubator a few years ago, to both help drive investment returns and to work out how we are going to be disrupted ourselves.
We are sharing information across the organisation on what could happen with regards to the impact from AI.”
“We debate using AI,” says a senior portfolio manager at an investment management firm. “The implications of doing so are very real, but it’s in its infancy and in a hype phase now. We are studying what the pragmatic use cases are that business owners could implement and figuring out when we could do this appropriately.”
Even those with a history of investing in AI-type technologies are asking new questions.
“AI and ML are not new; we have been implementing them in solutions for over 15 years,” says Robert F Smith, Founder, Chairman and CEO of Vista Equity Partners. “But the arrival of generative AI means we have to look at how we engage with this.
The first question is whether it poses an existential risk to each of our portfolio companies and if it does, what is the extent of the risk and over what timeframe? The second question is: How can we, as a private equity firm, use it as an enablement tool to offer products and services we don’t have and to become more productive. And how will our portfolio companies benefit from AI? We don’t look at this company-by-company. Instead, we have a generative AI council that is consciously and continuously focused on these questions, and we are developing frameworks that will apply to companies we are looking to invest in.”
AI is increasingly included in target company risk assessments.
“Just as we might assess climate risks, investment committees will increasingly need to look at how AI will affect a business from a risk point of view,” says Michael Bruun, Global Co-Head of Private Equity, Goldman Sachs Asset Management. “Over the past six months, we’ve had a lot more engineers giving their view on this because it could disrupt some of the largest businesses we might think about acquiring.”
For those investing in SaaS businesses, the step change we’ve seen over recent times will make some categories and models less attractive. “AI will naturally put pressure on some areas of software,” says Orlando Bravo, Founder and Managing Partner, Thoma Bravo. “You don’t necessarily want to be a software vendor that automates reporting, in the mid layers of the software stack or in selling by the seat because there will be fewer seats – these are areas where you need to be careful.”
AI will become a tool for improving portfolio company performance and the benefits will come in stages. “The first use cases will be margin-enhancing as some labour is taken out,” says Matt Cwiertnia Partner and Co-Head of Private Equity at Ares Management. “Over the long term, this will move on to the question of: Can I use AI to generate growth?”
And in some categories of software, the potential for improvement is significant, say some. “AI can make software companies more efficient and profitable,” says Bravo. “Today, SaaS average EBITDA margins in our portfolio are 37%. If we can automate development, marketing and customer support, we expect to drive about another 10 points, so 47% average margins. We are going through portfolio companies and their customers to work through the effect of AI and we are seeing that for every threat, there’s up to ten times the opportunity to implement AI tools and increase value to customers.”
“The first use cases will be margin-enhancing as some labour is taken out. Over the long term, this will move on to the question of: Can I use AI to generate growth?”
