THE TECHNOLOGY STACK: ASSESSING THE BIG OPPORTUNITY IN PRIVATE EQUITY
Posted on January 27th, 2025
The dominance of the technology sector stretches beyond public markets, with nearly a third (30%) of the value of the private equity market made up of tech firms. A winning combination of growth, scalability, and profitability has put software and Software-as-a-Service (SaaS) at the top of the tree in terms of investment opportunities for private market investors. Here, we discuss the development and utilisation of Artificial Intelligence (AI), and how private equity can offer alternative ways to tap into growth.
AI is rapidly reshaping industries throughout the world. Generative AI (Gen AI) is one type of artificial intelligence in which models are trained using existing content and are able to learn to create new content by identifying patterns, relationships and underlying structures within the data. Driven by advancement in machine learning, deep learning and natural language processing, an inflection point was reached in 2022 and advances from here seem likely to accelerate. We can see clearly how AI and Gen AI experienced a boom in interest and attention in 2024 with the rates of venture capital investment near tripling on 2023 (see chart below).
Source: Schroders Capital. Note: 2024* is until May 2024 Annualised
What is the scale of opportunity?
Gen AI possesses the capability to revolutionise many industries, with the potential benefits for businesses being vast. Productivity gains, streamlined operations, personalised services, cost reduction, informed decision-making and increased revenue generation all widely apply. More industry-specific applications range from the potential to create art and fashion, through to medical diagnostics and drug discovery.
So, how do investors assess the opportunities on offer? The technology stack below offers a roadmap:
- Infrastructure – these are the building blocks for AI. This layer consists of all the resources and services for developing and deploying Gen AI applications such as chips and semiconductors as well as cloud infrastructure.
- Model – this is where the Gen AI models are developed and trained. This layer includes the storage, management and manipulation of the huge data sets being used, as well as the data itself.
- Application – at the top is where Gen AI applications are built and deployed. This layer comprises apps which are open to thousands of companies and are used to easily harness the innovation enabled by the infrastructure and models.
Currently, development of Gen AI sits between the first and second layers of the ‘tech stack’, between infrastructure and models, suggesting there is much more to come as the technology evolves. The potential as the tech moves up the ladder towards ever greater application in everyday life is significant, and an area of huge potential opportunity for the innovators and investors who are able to lead the way.
Private equity investors can tap into this growth in a number of ways. Venture capital and growth strategies present opportunities to invest in new developments at the infrastructure level, supporting the ‘enabling’ tech that means AI can succeed at the model and application layer. Meanwhile, scaled software businesses with sticky customers and strong pricing power can present attractive buy-out opportunities.
Ultimately, AI developments represent a significant opportunity to invest in disruptive business models, but also for companies more broadly to develop market advantage and cost efficiencies. With $100bn spent by tech giants including Alphabet, Amazon, Meta and Microsoft in the year to June 2024 – a 47% year-on-year increase – it is clear that this is where the opportunity lies, and where all eyes are focused, for the forseeable future.
Identifying the investment managers and strategies with the capabilities to identify and utilise these emerging technologies, harnessing the opportunity set on offer, should form part of a wider private equity portfolio.
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