Risk management program

The Power of Data Analysis to Drive Private Equity Firms

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The Power of Data Analysis to Drive Private Equity Firms

“Hedge funds, private equity and venture capital funds have played an important role in providing liquidity to our financial system and improving the efficiency of capital markets. But as their role has grown, so have the risks they pose.” – Jack Reed, Senior US Senator

Asset Allocation in today’s world does not follow the simple idea of having a stake in a company where the price is low and selling it high, wherever possible. The prices remain high across the market with fierce competition and diminishing scope of arbitrage for risk mitigation. This puts private equity firms in a complex situation where they require special insights and guidance to identify a fairy priced asset, analyze the associated risks, and create a value that will maximize the return.

The basic key to investing wisely that will generate the best returns is to analyze the data that is available to enhance the value of the entity. Data analysis has a massive untapped potential that the investment and portfolio management teams are not aware of, and hence they fail to pose questions like – How robust is a target company’s infrastructure? How mature are its services and solutions? What is its level of technological advancement compared to its competitors? Is it spending enough on Research and Innovation? Amidst such questions, this blog looks into the scope of data analysis for a private equity firm – how can they analyze the relevant information, lower the risk, and make the best investment.

The Challenges

Private Equity firms have companies in their portfolio that stretch across various industries, and hence the data with respect to these companies is also diverse. To add on to this, each company is producing its own reports, which poses the basic problem of data uniformity, complexity, and overflow of irrelevant information.

How to Approach the problem?

The first and foremost step is to extract the relevant data as per the private equity firm’s requirement. The executives need to match the essential set of information with the available data set. Now, interpreting the right set of adaptable data has its own challenges.  This issue is magnified for Private firms that may want to compare key metrics across multiple companies within the same industry. For example, it is seen that organizations that grow through acquisitions generally attend to multiple data management issues. As the organizations merge, these companies normally face alterations in classification, data organization, etc. that make it difficult for them to extract meaningful information.

The Solution

Private Equity firms need to access data beyond their hard drives. Social media monitoring is an important source to identify the image of the company. Any service-based company has ample amount of reviews by its employees on platforms like Glassdoor and LinkedIn. Manufacturers have their products reviewed on Amazon and Facebook pages. Therefore, it is vital to develop a strategy to assess the value, trends, and the impact of the review comments made as well as other unstructured external data. Sentiment analysis is an evolving trend but it still fails to identify the sarcasm of human opinion. Therefore, Private Equity firms should consider tracking and monitoring the relevant indicators to identify the possible risk threats as and when they occur.

Moreover, it is no longer sufficient to look at traditional factors such as market situation, historical recital, industry trends, cash flows, and capital expenditures. Private equity managers need to assess and compare where individual target companies and their competitors stand in the market. When private equity firms have this knowledge, their view of potential acquisitions will change. For example, it is justified to pay premium to the target company that is technologically advanced. Other companies lag so far behind in terms of innovation that they’re not worth purchasing regardless of the price.

Also, location analysis holds a significant role; companies need to gather information about customer demographics, geography, and buying patterns to draw valuable insights. For example, what are the macro-economic, financial, geo-political factors that affect the business environment? The correct analysis helps in understanding the competitive advantages and disadvantages of the specific companies which will in turn help in building the investment strategy.

Once a company has gathered a sound basis of market information, trend analysis can be performed to help it decide about its future processes, capital expenditures, and supply chains. The gathered evidence can help companies evaluate their production agendas, labor costs, portfolio levels, marketing overheads, capital expenditures, and overall supply chain requirements.

By deploying a data analytics strategy, private equity firms and their portfolio companies can meaningfully combine and leverage data from a variety of contrasting sources to shrink their risk factor. Companies should regularly re-examine the data (at least quarterly) and maintain a continuous vigilance in order to derive better insights.

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