The Intersection of Venture Studio and Private Equity
Venture Studios are the expression of maturity in the entrepreneurial ecosystem after the reiteration of cohorts, accelerators and incubators. Pipeline-enablers, operators, and capital sources have matured in their assessment of start-up patterns aiding mitigation of risk and shortening time to value realization.
In the Venture Studio model, seasoned operational experts identify the target industry and the problem to be solved, thus creating a focused solution backed by extensive due diligence. Further, the Venture Studio deploys its resources in a very controlled manner to test its hypothesis, create a product, and launch a company. The experience and methodology of the Venture Studio minimize the capital exposure and significantly shorten the timeframe when compared to a startup outside of its ecosystem.
Following the validation of the new startup, the Venture Studio can select the proper C-suite and scale by deploying capital while maintaining control and oversight. Broadly speaking, the pattern followed by a Venture Studio is one of control, validation, and methodology rather than riskier betting on a startup idea and the even larger risk of poor execution or inability to mature and scale.
Private Equity’s ultimate (and very comprehensive goal) has always been the rapid increase of asset value. This goal is typically achieved via an in-depth look into efficiencies and costs. The reputation of PEs is often unfairly cast in the darker tones of heartless, greedy operators that mercilessly cut jobs and kill the positivity of a working environment. The truth is that businesses exist to make money, and very often, the windy road to success and growth produced wrong decisions and operational excess along the way that was never properly evaluated and trimmed.
Private Equity firms have very seasoned operational partners who have studied the industry, have relative experience in scaling companies, and can take a fresh and unbiased look at a portfolio company. This will likely result in optimizations that can lead to workforce reduction and change in patterns and practices. Great PE firms know how to effectuate such changes in a manner that preserves the mission and values of the portfolio company. This approach can definitely improve the bottom line, but only by a limited margin.
PE firms can also augment the cost optimization strategy through a roll-up acquisition that either expands the market footprint of the portfolio company, adds new product offerings, or improves the infrastructure of a company.
However, add-ons that bring in infrastructure typically have a higher price tag than a “built” solution - yet are preferred because of the shorter time horizon for realizing the increase in asset value. The higher capital deployment is not the only risk in an infrastructure add-on transaction – the post-acquisition integration process and, perhaps even more significantly, the actual fit of the acquired solution pose inherent risks as well. When the infrastructure in question is technology/software, the risk of delayed integration and misfit is even greater.
Technology is the only solution for the asset optimization of a portfolio company that can deliver measurable results within the acceptable timeframe for a PE firm given the current macro- and micro-economic landscapes. Building a technology stack within a portfolio company in order to either drive productivity, reduce costs, or open up new revenue streams simply takes too much time and capital as it is a long process of trial and error. Acquiring technology in an add-on transaction, however, poses some significant risks as well. Even though the timeframe is shortened, the proper fit, the necessary continued implementation and improvement of the technology, and the post-acquisition integration are potential pitfalls. Further, the acquisition cost still requires significant capital deployment.
At NXT Companies, we see Private Equity and Venture Studio as two models that can co-exist and mitigate some of the risks of infrastructure add-ons. We call it Private Equity 3.0.
PE firms are already holding and developing assets shared with their portfolio companies – namely, the operational partners and their expertise. We believe that the same can be done with software platforms. The strategy is mitigating the risk of acquiring software that does not fit, is difficult to improve, and is a significant capital expense for any singular portfolio company. Our model suggests an acquisition and then continuous development of a modular technology stack in a subsidiary that is controlled and owned by the PE in perpetuity. Much like in the Venture Studio model, the modification, growth and application of the software stack is based on controlled methodologies. Again, borrowing from the Venture Studio model, the firm can deploy a version of its software stack to a portfolio company via a licensing structure.
The software can be modified and improved for the specific industry and portfolio company, and these improvements actually benefit the parent software stack - which in turn can be deployed again in another industry/portfolio company. The risk of misfit, integration and modification access is virtually reduced to zero.
Additionally, such an asset is an attractive value-add proposition for a target company that may be considering whether an acquisition is the optimal course for them. At NXT Companies, our technology stack has independently been deployed in industries such as automotive parts, construction (windows sales and installations), raw materials (metals), consumer products (restaurant quality firewood delivery), services for the private charter industry, equipment rental for movie productions and others. These are all independent portfolio companies to NXT, yet they thrive on the same technology platform. The platform itself benefits from modifications, improvements, and new modules that were dictated based on particular needs in each industry. The growth of the platform is allowing us to have a broader net of targets and also shortening the time to deploy the technology in a particular portfolio company.