European Tech
in the Limelight

Private equity tech investment has been on an upward trend over the last decade. Although a smaller part of the European market than in the US, tech was nonetheless one of only two sectors – alongside healthcare – to experience investment growth in Europe in 2019. Deals hit €79bn last year1 , according to PitchBook, a record for the sector and a 6.5x increase over a ten-year period. Despite the impact of COVID-19 it is expected that investors will continue to recognise the value tech businesses have.

An Opportunity Not to be Missed?

Tech has been one of the most successful sectors of public markets since the financial crisis, driven by a group dubbed the FAANG (Facebook, Apple, Amazon, Netflix, Google) stocks, which have enjoyed exponential growth. Even in the midst of a volatile start to 2020, their combined worth is almost $3.5trn, more than 20% of the value of the entire Nasdaq. Since the outbreak of the coronavirus crisis this value has risen to almost 30%, with Microsoft added that becomes near 40%.

Private equity firms have enjoyed their own outsized rewards from tech investments. But unlike the stock market, where 63% of value is in hardware and consumer software, 72% of private equity tech investment is concentrated in enterprise software and IT services, according to Bain & Co2. That focus has returned limited partners an average multiple of 2.8x invested capital between 2010 and 2018, outstripping all other major sectors.

Activity has been concentrated in SaaS, cloud computing and software services, but is increasingly targeting healthcare tech. There were no fewer than 84 unicorns (start-ups with valuations over $1bn) in Europe in 2019, up from just 30 in 20143, with a study from GP Bullhound showing that the value of those companies grew more quickly than their US peer group. Moreover, half of the businesses are still private, demonstrating the development of a tech ecosystem that extends from seed to mature, profitable enterprises.

Private Equity Positioning for Action

Unsurprisingly, private equity groups want in on the action and a number of European sponsors have raised earlier-stage funds to access fast-growing companies sooner, such as Sweden’s EQT which raised its second VC fund in 2019 at €660m, and CVC Growth Partners which raised $1.5bn for mid-market tech deals last year. However, compared to the US, where VC fundraising totalled more than $100bn for 2018 and 20194, and a later stage tech-focused fund from Vista Equity Partners raised $16bn last year, the market remains less penetrated by domestic groups, giving international players more room to enter and move.



But while the attractions of fast-growing businesses are obvious, there are often hidden risks that private equity firms in particular need to identify and understand.

Identifying and Protecting Value

Most buyers know that tech value resides primarily in intellectual property – closely-guarded algorithms, back-end systems and even brand names. However, finding it and protecting is a different matter. When companies grow quickly, the intellectual property might be held in unexpected places.

Due diligence needs to untangle complicated ownership, while pre-deal legal restructuring can ensure that IP is held where it should be. Without the potential for synergies, private equity sponsors also need to see a clear path to monetising IP – turning users into revenue, and revenue into profits – while also ensuring it is protected from challengers.

Preparing for Scrutiny and Regulation

“If the rapid growth of European tech has caught the eye of private equity, then it has not escaped the attention of governments and regulators worldwide either. Policymakers have struggled to keep pace with the fast-moving industry and have taken a relatively hands-off approach thus far. However, buyers should not assume that will continue to be the case. 

Deals in dual-use, quantum and hardware technologies in particular are facing increased scrutiny in the UK as the government has been willing to take advantage of the lower thresholds for intervention and step in to review a number of transactions, including the recent acquisition of Inmarsat by an Apax and Warburg Pincus-led consortium. The implementation of GDPR has also had a significant impact on the risk profile of investments in data-intensive businesses given the wide-ranging compliance obligations faced by those businesses and the potential for significant fines or penalties. Following its exit from the European Union, the UK plans to establish a new regulator in 2020 to oversee the tech industry as it steps up measures to impose legal duties and codes of conduct for certain influential tech companies. Private equity investors also need to consider whether the European companies they buy hold data on US citizens or have US operations that could fall within the oversight of the Committee on Foreign Investment in the United States (CFIUS). Deals may require careful structuring, particularly when they involve a number of co-investors or co-sponsors, in order to avoid the scrutiny of regulators and governments both in Europe and elsewhere. 

Pressure for higher taxation also continues to grow in Europe. The UK’s Digital Services Tax will come into force from April this year and impose a tax of 2% of the revenues of search engines, social media platforms and online marketplaces which sell to, and derive value from, UK users. Austria, Italy and Spain are among the other countries developing or bringing in digital taxation, although France has held off implementing a 3% tax pending multilateral agreement on measures to be drawn up by the Organisation for Economic Cooperation and Development (OECD).



As European tech grows and matures, private equity activity is likely to increase. But at the same time, deals will also present rising challenges from IP protection to regulation. In all the excitement surrounding a fast-growing sector, firms need to take the time to identify risks, structure deals and prepare for greater oversight.

Michael J. Preston
Partner

London
T: +44 20 7614 2255
mpreston@cgsh.com
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Gabriele Antonazzo
Partner

London
T: +44 20 7614 2353
gantonazzo@cgsh.com
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Michael James
Partner

London
T: +44 20 7614 2219
mjames@cgsh.com
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1. Source: page 4,-Pitchbook European breakdown

2. Source: page 30,-Bain 2020 report

3. Source: pages 9 and 30,-GP Titan’s of Tech report

4. Source:- Fundraising activity section