2022 Private Equity Industry Update

Welcome to the Karma School of Business podcast. This episode is brought to you today by BluWave. I'm Sean Mooney, BluWave's founder and CEO. BluWave is the go-to expert of those with expertise. BluWave connects proactive business builders, including more than 500 of the world's leading private equity firms, to the very best service providers for their critical, variable, on-point and on-time business needs. In this episode, we're going to talk about the top trends in private equity in 2022, and by extrapolation what PE did to take forward action in advance of what they saw coming in 2023. As you'll see, definitely some lessons learned that every business leader should be catching up on if they're not doing so already. Enjoy.

Today, we're going to give you an inside look into how the best, most proactive business builders in the world have been preparing for in advance and navigating towards the coming economic storm. The trends we're going to discuss are based on a distillation of the data involved with the thousands of projects BluWave is supporting with more than 500 PE firms. The private equity industry does best when times are worst. My advice is to do as PE does, take note of how they're navigating, and do the same. Once you have a plan, every business builder out there with gumption can do the same. You can also get access to these same best-of-the-best resources for your portfolio companies if you're a PE firm and not already using us. And if you're a business leader, you can also get access to these same exact resources for your company as you similarly take action with the mindset of running towards the storm and reframing risk through the lens of both safety and success.

So first, let's talk about the mix of activity that took place in private equity in 2022. As we look at our data in 2022, value creation activity related to new deal diligence activity surgeed. Value creation accounted for a record 72% of all private activity as captured by the BluWave value creation index. That's up more than 14% increase year over year. That is ... it's pretty amazing. The significant value creation activity in 2022, when we look at it, was a result of a few things. Number one, 2021’s robust deal flow that created a large population of new portfolio companies and thereby needed more value creation activity. Number two, there was a decreased amount of deal flow in 2022, which by default led to fewer due diligence needs relative to 2021. And number three — and I think most importantly — the private equity industry has had this running-towards-the-storm attitude through all of 2022, in which the PE firm's focused on equipping their portfolio companies with every resource they needed to not only survive but thrive during a coming recession versus recoiling in fear of risk.

So 2022 was clearly of time of preparation and action in private equity. Let's look at where private equity invested their time in the different functional areas in 2022. One of the first things that we saw in last year, and really a growing trend over time in all of private equity, has been this surging activity related to human capital — everything related to people and business. Human capital was the single biggest area that private equity spent time on in 2022. Human capital initiatives accounted for 41% of all private equity activities in BluWave's Activity Index. That's a 5% increase year over year, but kind of a staggering year-over-year trend. Most people, when they think about private equity, don't think about hiring and people and the art of humanity. This has been a transformational trend in private equity, where they're spending more and more and more time on people, people, people.

The private equity industry continued to lean into human capital last year in 2022 as they focused on really transforming companies versus optimizing them, which means when you're transforming a company, you need meaningfully enhanced, if not wholly new skill sets in each of your companies. So in 2022, PE firms continued to address tight labor markets while also bringing in wartime generals in place of peacetime ministers where needed to manage through this economic malaise that's underway. Another growing trend in 2022 was a focus on bringing in talent more deeply down within the portfolio company organizations, explicitly tying their people strategy to their long-term value creation strategy. So meaning if they're allocating investments and people in relative proportions to where they actually think value creation is going to happen, and that means no longer just focusing on the C-suite, but all the way down the organization top to bottom, in terms of holistically creating new capabilities in line with where they think they're really going to create value over a three- to six- to 10-year period.

Next up, we saw the private equity industry continuing to focus heavily on strategy. In 2022, strategy resource usage via the BluWave network accounted for 17% of all PE activity as captured in the BluWave Activity Index. This really, if you look at it, was actually a slight decrease from 2021 levels. The decrease in overall strategy, though, can be explained by a few things. It's not that they were doing less. One, it can be explained by the relative decline in the mix of due diligence activity versus value creation activity that we talked about earlier. Strategic resources are most heavily used by the private equity world in new deal due diligence streams because they're trying to understand dynamics, but also inform value creation plans, and they do that before they even buy the companies. So with a relatively lower mix of diligence versus value creation, strategic activity mix declined in kind. Didn't mean they were doing less, it's just they were doing fewer deals.

When we just view PE activity strictly through the lens of due diligence projects, we actually saw a pretty meaningful increase in the uses of strategic resources to understand companies. In 2022, but also in general in private equity, firms are placing a growing premium on 100% understanding market dynamics, particularly as it relates to the relatively fewer deals that were transacted in 2022. As I think all savvy investors know, the market always wins. If you have a great market, the market wins. If you have a bad market, the market wins. If you have an okay market, the market wins. PE is doing everything they can to expertly understand market conditions from both defensive and opportunity-maximization perspectives. Every business leader should really be thinking similarly and doing the same. I think as we see deal flow increase in coming years, I think it'll actually start picking up. Maybe second half of next year, but certainly next year or thereafter, we're going to see a higher, stronger mix of strategic resource usage in line with that higher mix of due diligence activity.
Operations was the next biggest area of activity within the PE world. It accounted for 13% of all private equity activity in 2022 as captured by the BluWave Activity Index. We saw significant operations investments being made across both due diligence and value creation. In particular, we saw significant activity related to addressing inflationary pressures, operational performance improvement needs, and in support of tuck-in acquisitions. We really saw this activity actually start in 2021, and 2022 was more of the same, as the PE industry took headwinds straight on and offered life rafts to struggling competitors in the form of tuck-in acquisitions.

The next biggest area of focus was technology, which accounted for 12% of all PE activity per of the BluWave Activity Index. This was a 20% increase over 2021. Huge amount of increase. In terms of the why, there's a number of reasons. One is labor markets remained tight in 2022, and it became increasingly difficult to source the needed labor. Many PE firms chose to invest in technology so that they could automate processes and reduce their need to rely on hard-to-get labor. Additionally, we saw the PE industry lean more heavily into data and analytics in 2022, as they realized the differential value of real-time, actionable information and how it helps their portfolio companies navigate turbulent times. This led to a broad-scale adoption of data quality and visualization endeavors in emergent efforts in high-level analytics and AI. These data, and even the AI tools, are increasingly being democratized. Every business should be getting up to speed on these if they are not already. At the very least, think about taking steps via getting clean data and using tools like Snowflake and Tableau and Power BI to visualize it. Once you do those steps from there, you can start, in a not-too-difficult way, taking the next further steps that'll get you towards using some of the more really cool gizmos and gadgets.

The last major area of focus in PE was sales and marketing, which accounted for 10% of all PE activity per the BluWave activity index. In 2022, we saw a staggering 25% increase in year-over-year activity in sales and marketing. Sales and marketing increased in large part because the PE industry understands more than virtually anyone else that growth is one of the largest, if not the largest, correlate to exit valuation. And with the softening economy underway, PE firms have been focused on winning as much market share and getting as much growth as possible by enhancing every one of their sales and marketing activities. Additionally, as PE firms have tried to keep up with inflation, many are using things like very thoughtful pricing strategy advisors that help them protect their margins and cash flows. Every business leader should be thinking and doing the same.
So these are the tip-of-the-iceberg trends in private equity. We hope that this gives every business leader, whether you're a PE investor or an operating company leader, a bit more information in terms of where fellow top business builders are spending their time and taking action to approach this economy with a mindset to not only survive but really thrive. There's a lot more nuance that we share in BluWave's 2022 Insights Deck. If you'd like to request a copy, please call your BluWave client coverage manager or visit www.bluwave.net/insights-report.

That's all we have for today. For more information, 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, please 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.