September by D’Ornano + Co.: why growth is paramount in Tech buyouts, a deep-dive into Foundation Models and the economic opportunity of GenAI for the PE industry
This is our monthly newsletter dedicated to Tech x Investments.
Dear readers,
I hope you have had an excellent start to the year's second half. Although I am a profound optimist regarding Tech, as mentioned in last month's edition of this newsletter, the current environment is highly challenging across the spectrum of the Private Markets, and high-growth and disruptive assets are not immune to this.
Macroeconomic indicators point to a high probability of a recession in the next 18 months, contributing to the ongoing uncertainty we are facing in the Private Markets. Also, the platform shift brought by GenAI takes on greater significance each day, and the era in which it remained a field solely invested by VCs (and this was just a couple of months ago) is gone. The magnitude of start-up and incumbent revenues in the area and the extension of use cases have reinforced, if need be, our conviction on the magnitude of the opportunity.
GenAI is having a massive impact across all asset classes, and this is more an opportunity than a problem, but it is causing seismic shifts and changing how investors should read companies. And if this is true for software businesses, it goes well beyond that.
So, why are we worried? And what is to be done?
First, let's look at what is happening at the Private Equity buyout level. Private equity firms are facing a double whammy.
First, many of their existing software lines appear to have unsustainable debt ratios in today's environment. In the bygone area of affordable debt, some software LBOs were financed with loans based on ARR from software subscriptions, implying leverage sometimes exceeding ten times EBITDA (which is very high!). But, as growth has slowed and become more challenging, and with interest rates remaining high, many of these loans still need to be revised. Gaining a clear understanding of these companies' revenue and cost drivers and resolving margin leakage issues is critical in the perspective of future refinancings for these companies.
Second, PE firms are now seeking to exit many of their investments as the exit window reopens, but the spread in valuations is high between high-quality assets – those that command strong quality of Revenue, Growth, and Margins – and tier-2 ones. Preparing their assets for sale will be critical to ensure optimal valuation. I explore in our first article how I find growth to be the crucial factor behind successful exits and how to build an adequate framework for evaluating its components correctly.
Then, at the Venture Capital level. Though Q3 figures for US VC activity are not yet out, it is clear that VC activity continued to decline over Q3, except for artificial intelligence and machine learning, which shows strong resilience, largely due to the GenAI wave. This results from valuations perceived to be still too high – and not in minor proportions – and from a sluggish exit market. Though the recent introductions of Arm, Klaviyo, and Instacart have given reasons for cautious optimism (that has yet to be confirmed), a recent Pitchbook study reveals that 77 US start-ups are waiting to go public and that $800 billion was trapped in the VC ecosystem as of the end of 2022. Thousands of start-ups, representing an essential part of the EU and the US economies, are struggling to raise and are at risk of extinction. For founders, it is critical to establish a clear road to profitable growth, as this is the only condition for taking your company to the correct next step, be it venture funding, M&A (incl. through PE), or IPO for those candidates that meet the increased requirements.
While the horizon for new investments is uncertain (but hopefully brightening), today's focus should be at portfolio level to allow high-growth companies to write their next chapter of growth with optimal conditions. This latter will certainly imply some kind of positive GenAI transformation but securing financing will be critical for PE and VC-backed assets first.
Software LBOs. Growth problem.
Private equity exit activity has picked up over the last two quarters after a very slow start to the year. But there is no proof yet that things are back to normal... In fact, as the deal market reawakens, it’s looking quite different than the one before the downturn.
We’re seeing a growing separation in the prices acquirers will pay for the best companies versus middling ones. So what makes the difference? And how does Growth come into play? I share my views on how Growth is a catalyst for value, but not any kind of growth.
Understanding the GenAI Tech Stack : Part 3 — Foundation Models
Make no mistake, GenAI is still very hot and continues to evolve at an astounding pace. Despite the critics and the collective hysteria on the topic — fueling the question of whether or not this is hype — GenAI has already had a more successful debut than software-as-a-service (SaaS), with over 1B$ in start-up revenue alone. In June, we delved into essential knowledge for investors regarding the generative AI tech stack. We highlighted three fundamental elements within it — the Foundation Model, MLOps Model, and Application Model — including the unique opportunities and risks associated with each of these components. This month, we will explore Foundation Models in greater detail.
In this article, Alex Rampell, General Partner at VC firm A16Z, explores the profound economic opportunity that GenAI represents for incumbent companies, and for private equity investors as a whole able to back those companies embracing the AI opportunity.
Charted: How Long Does it Take Unicorns to Exit? | The Visual Capitalist
While the growth of unicorns has been exponential over the last decade, exit activity has virtually ground to a halt in 2023. Recent IPOs are raising hopes that the exit route will reopen. This article presents an interesting visualization from Ilya Strebulaev who breaks down the time it took for 595 unicorns to exit from 1997 to 2022. So what will 2023 look like?
Dealmaking languishes at decade low on private equity drought | Financial Times
In this recent article, the FT explores how global dealmaking is languishing at a 10-year low as high interest rates chill private equity activity, with a zoom on megadeals of $10B + that are particularly affected. A more hostile antitrust environment is also putting M&A to a halt.
Upslide
D'Ornano + Co. has advised global tech investment firm Partech in their minority stake investment in UpSlide, a developer of a platform that automates brand-compliant presentations and reports, linking elements in PowerPoint or Word and inserting updated credentials into proposals.
Animaj
D’Ornano + Co. supported Left Lane Capital in its investment in Animaj, a Paris-based company who has raised €100m (in equity and debt) and acquires profitable YouTube channels creating kids-focused content, optimizes them within YouTube and scales them into franchise brands.
Continuum Industries
D’Ornano + Co. has advised Singular on their $10M Series A funding in Continuum Industries. Continuum Industries, a Scottish startup, has developed innovative AI software to automate and streamline early-stage design and planning for linear infrastructure projects, significantly saving time and resources for engineers.
Akeneo*Unifai
D’Ornano + Co. has supported Akeneo, a Product Experience company and provider of Product Information Management solutions, in its acquisition of Unifai, an AI platform for data collection, cleansing, categorization and enrichment.
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