DealStreetAsia webinar transcript: ‘To a large extent, due diligence processes became virtual even pre-pandemic’

Radical changes in dealmaking are surfacing as a result of a surge in deployment of private capital combined with the restrictions imposed by the pandemic. While technology has emerged as a key enabler, particularly for mid-sized PE firms, it is still many years away from effacing the human factor in dealmaking.

When asked if there is likely to be a return to a pre-pandemic normal or if it was more likely that the new reality of flexible work and meetings over Zoom would dominate dealmaking, Ewan Davis, managing director at Quadria Capital, believed it would be a hybrid. He said, “The last two years have taught us that we can work in ways that we would not have chosen before, which have been more efficient. Of course, some travel is imperative and since nothing beats an in-person meeting, especially with crunch time on a deal or sensitive issues which need to be discussed with promoters. That’s best done face-to-face in a closed room. But for more business-as-usual discussions, there was a preference to do them in person for no reason other than that it was nice to catch up.”

Davis was speaking on DealStreetAsia’s recently concluded webinar around ‘How frictionless dealmaking is creating a level playing field for midsized firms.’

For many members on the panel, technology driven solutions had been a part of their lives long before the pandemic. While Pratibha Jain, group general counsel and head of corporate affairs at Everstone Capital, agreed with Davis, she added, “Because service providers are much more technologically advanced, you are able to deploy very quickly. Getting deals done over the last 18 months was not an issue. From due diligence to meetings to cloud services that manage data to regulatory diligence through AI and even financial modelling – it is now much better from a technology perspective.”

Jon Crandall, managing director for Asia-Pacific at Ontra, was careful to delineate the areas where technology could and could not contribute. Citing the instance of his firm’s recent $200 million series B funding led by Blackstone, he said, “It was 100% done virtually using digital data rooms, Zoom etc. There wasn’t anything in the process that would require or benefit from in-person meetings.” But there was a vital caveat – the MD at Blackstone who led the deal had a pre-existing relationship with Ontra, having backed its last funding round at Battery Ventures. Crandall said, “Relationships are something that tech does not really surmount. Once you have established that rapport, you can build, grow, and scale together. Tech just makes the process very streamlined.”

This was particularly true of due diligence when the legal teams representing investors had to examine potentially thousands of pages of agreements. Crandall said, “Having a system that is organized makes it really efficient as it keeps track of revisions and can quickly draw your attention to expiration dates, escalation clauses or insurance, and maintenance ahead of time.”

Another issue brought up in the course of the webinar was the increasing competition in the private equity space. Nakisa Jobling, MD and head of legal at Tybourne Capital Management, said, “It’s become apparent that moving into PE can be a very lucrative way to diversify strategies. There’s money to be made and given the difference in investment profile, it can really offset volatility in public businesses and diversify income streams. I see more hedge funds in this market, supplementing their public portfolios with the occasional private investments.” She however believed that PE firms with a separate fund strategy still had an edge and added, “Given stiff competition to access the best deals and get a seat at the table, you ought to be a credible PE investor as opposed to a hedge fund that’s dipping its toes.”

The webinar was sponsored by Ontra and moderated by DealStreetAsia’s editor-in-chief Joji Philip.

Sign up to receive the webinar recording and read a transcript below, edited for brevity and clarity:

Do you think we will return to a pre-pandemic normal or is the new reality of flexible work, less travel and dealmaking by Zoom here to stay?

Ewan Davis (ED): It’ll be a hybrid.

The last two years have taught us that we can work in ways that we would not have chosen before, which have been more efficient. Of course, some travel is imperative and since nothing beats an in-person meeting, especially with crunch time on a deal or sensitive issues which need to be discussed with promoters. That’s best done face-to-face in a closed room. But for more business-as-usual discussions, there was a preference to do them in person for no reason other than that it was nice to catch up.

But a lot of travel is very inefficient. I hope it stays in the past so that we can be more productive with our time.

Does this mean that deal teams don’t have to be based together anymore? 

ED: We made a strategic decision a few years ago that kind of bit us on the bum during the pandemic! Because we focus on healthcare and there is a finite universe of companies that we track, know and work with, we didn’t think it made sense to have boots on the ground in Vietnam or Indonesia. We would hub out of Singapore because it was only a two-hour flight away. And then COVID happened.

We still don’t think we will put people on the ground just yet. What we have been doing is sending colleagues to these countries for extended periods of time, when we make an investment.

We are comfortable that we can have people away from HQ for months on end, and function absolutely fine. In fact, that was the only way that we got some of our investments and exits done. We will retain that flexibility going forward.

Is it too early to assess the implications of virtual dealmaking?

Pratibha Jain (PJ): It is too early to call. We were getting into the zone of meeting new promoters, and looking at deals. After 18 months, people were traveling like crazy, wherever they could. But there are fears due to the new variant.

The good thing about Everstone is we have people on the ground everywhere: in the US, Singapore and three offices in India. That has really helped since ultimately, PE is a more traditional business than law firms or financial advisors.

Especially for buyout strategies, you need to know who you are doing a deal with; have to work with them to grow business and be intricately involved to have a successful exit. Traditionally, we have been synched to do that when we meet in person.

Having said that, I’m a great believer in technology. I have personally worked remotely for 10 years. I set up the Delhi office for my previous firm — everybody else was in different jurisdictions. We invested heavily in technology and it really worked.

I’ve done very big deals in the past, where PE firms have hired me because I was based in a certain jurisdiction where the target was located. But ultimately, there were no physical meetings. Lawyers are much more comfortable with technology and virtual meetings.

Everstone pursues multiple models. What did you have to change during the pandemic especially when it comes to legal due diligence?

PJ: Because service providers are much more technologically advanced, you are able to deploy very quickly. Getting deals done over the last 18 months was not an issue. From due diligence to meetings to cloud services that manage data to regulatory diligence through AI and even financial modelling – it is now much better from a technology perspective.

It really helps in managing those assets when you are operating remotely. We are increasingly buying technology which will cut across various funds, both from an operational and a legal perspective. That’s been really key especially for the in-house team to reduce the amount of time spent just managing documents or processes. The compliance tools that are available now would have required many more team members in the past.

As late stage investment is increasingly becoming more active – and we’re seeing more hedge funds becoming involved in this space — how do firms such as yours evaluate and execute deals, especially during the pandemic?

Nakisa Jobling (NJ): It’s become apparent that moving into PE can be a very lucrative way to diversify strategies. There’s money to be made and given the difference in investment profile, it can really offset volatility in public businesses and diversify income streams.

I see more hedge funds in this market, supplementing their public portfolios with the occasional private investments. But without committing to a separate fund strategy solely dedicated to PE. Given stiff competition, to access best deals and get a seat at the table, you ought to be a credible PE investor, as opposed to a hedge fund that’s dipping its toes.

Part of doing that successfully is to ensure your internal talent pool diversifies alongside your strategy. Deals these days are fast paced and with the absence of in-person meetings, relationships alone can’t take you all the way. You need to prove that you know what you’re doing. In some cases, that can be achieved with your existing talent pool since you do get team members who’ve worked on both public and private markets. Often in hedge fund teams, I see people who have come out of PE into a hedge fund environment.

But in other cases, the main way is to strategically plug the talent gap. The person representing you to a potential target, even if on a Zoom call should be credible and represent the firm well. That would be the main way that the business needs to evolve to participate in PE markets.

When doing due diligence on private deals, you don’t have access to as much data as you have for listed companies. How do you get into these deals and take these decisions?

NJ: In many ways, you can actually get access to a lot more information from a private company because you’re not constrained by what’s publicly available. And there’s no question of MNPI, or insider dealing. We approach it as any other PE house would — entering into confidentiality agreements, which then gets you access to information, under a promise of secrecy.

We then go through an appropriate due diligence process with external counsel always involved. This is obviously completely different to investing in a public company where you don’t have to get lawyers involved. But in PE, as long as you’re supported by appropriate legal counsel, you can definitely get access to enough information.

I don’t think access to management is a huge obstacle. It’s set in convention as part of the investment process. If it’s denied, that’s a huge red flag.

Ontra recently raised $200 million from Blackstone Growth and Battery Ventures, and you also rebranded from InCloud Counsel. How much of this deal was done virtually?

Jon Crandall (JC): It was 100% done virtually using digital data rooms, Zoom etc. There really wasn’t anything in the process that would require or benefit from in-person meetings.

The caveat was that the specific MD at Blackstone who led the deal was actually someone we had a relationship with prior to the series B when he was at Battery Ventures. Relationships are something that tech does not really surmount. Once you have established that rapport, you can build, grow and scale together. Tech just makes the process very streamlined.

We have several 100 customers around the world in the PE space. One of the obvious points of diligence for an investor is examining the nature and terms in customer contracts. When you have to survey hundreds of agreements, it takes a lot of time either from your internal team or external counsel.

Having a system that is organized, keeps track of revisions and can quickly draw your attention to expiration dates, escalation clauses or insurance maintenance ahead of time, makes it really efficient.

Does this is mean that a lot of this work can be automated and it can be realistically disrupted?

JC: I’m not sure we’d use the word “disrupted”. What both in-house counsels and law firms are really good at is risk analysis, thinking about negotiation, leverage, and novel issues that may not have come up, while structuring deals at a high level.

You don’t need these resources to identify the governing law clause across 500 documents or to personally negotiate 100 NDAs. That’s not an efficient use of resources. We are trying to make it so that they can focus on the parts that they do best. And to make better, faster and cheaper decisions by offloading the parts that are really distracting.

Has COVID forced both investors and companies to look at M&A differently – to include partnerships, JVs and alternative investments?

PJ: We were already looking at strategies for buyout. The partnerships that you’re building on the ground are very important and it’s important to have the right management team. This holds true whether it’s having the right management teams in a platform deal structure to ensure that you actually get returns; or even a pure buyout where you’re partnering with the promoter.

The whole idea of us coming into a deal is to lead it to growth that can then provide a good exit to our clients and investors. COVID-19 has really accelerated that trajectory.

Is due diligence the top challenge when deals are being closed at this speed?

NJ: It’s important to not cut corners on due diligence despite the pace of transactions and to find ways of being as thorough as you would be in person. But to a large extent, due diligence processes had become virtual pre-pandemic, with people using virtual data rooms, online searches and video conferences for time and efficiency.

The bigger challenge is to get through regulatory processes. Because with the pandemic and lockdowns, the authorities are backlogged. There’s a slight trend of increasing regulation in an already difficult climate. Approvals can be a gating item to doing deals, particularly if the deal has a very ambitious timeline. Often, the need for approvals is uncovered as part of due diligence.

But most other due diligence findings can be commercially addressed through tweaks in the deal documents and price adjustments. If you uncover a need to go through some kind of regulatory process, that’s outside the party’s control and a more difficult obstacle to surmount.

Valuations over the last few years have continued to remain high. Capital today is a commodity. So when it comes to PE, is maintaining discipline the biggest challenge?

ED: If we want to stay in business as fund managers, we have to keep that focus but there’s always pressures from deployment: the fear of missing out on the next big thing.

We have a very clear set of investment principles that govern our decision making. If we find ourselves straying, then we have to refocus. We have a very high conviction over certain segments of healthcare, and that’s where we are placing our bets and building relationships with leaders. We work with them to try and build a growth and business plan, and a management team that we can invest behind. We are very clear on what is a fair and sensible valuation and stick with that.

For all the deals we have done this year — and it’s been a record year for deployment from a budget perspective — there’s an equal number of opportunities that we’ve walked away from. We are not necessarily the smartest guys in the room, so maybe we missed something!

But in our judgement, some of the deals are just too expensive, and that ultimately impacts our returns and shortchanges our investors.

Global data has also shown that during the last two years, PE had record dry powder that has only gone up. For the industry in general, how do you see the 2020-21 vintage? 

ED: The order books for everyone in professional services are full: booked out for months ahead with no capacity until January or February. Trying to get due diligence advisors in Southeast Asia specifically has been challenging. Warranty and insurance providers do not have enough agents to process your deals. If your package is too small, they are not interested.

There’s a huge amount of activity going on, which belies the numbers that say there’s a build-up of dry powder. The markets have been and remain very active.

The last two years have been fascinating. Clearly the pandemic is a global tragedy and it’s been harrowing. From an investment perspective, companies in the healthcare space are going through one of the most challenging times, certainly for the current and next generation of leaders.

Having gone through the trials and tribulations of COVID, you can really identify the winners, the agile businesses and the very strong management teams. It’s a fantastic commercial due diligence test. A lot of investments that have been made through this vintage have gone through just implicitly, far greater tests. They will bear out much stronger. Even if there are increasing amounts of dry powder, from what has been deployed, you’ll see pretty good returns from this period.

In the past, public markets were not too receptive to tech companies and loss-making startups but we have seen that start to change. With markets coming back in terms of dealmaking will PE and hedge funds both look for control or buyout deals?

NJ: I don’t purport to speak for the market, but I’m personally not seeing an increasing appetite for buyout deals. There’s some of the opposite in fact: many of the most attractive opportunities are late-stage growth companies, where founders won’t be open to giving away control. The investment risk profile substantially increases with a buyout deal, as well as the day-to-day oversight involved as an investor.

These are difficult elements to get comfort on, without being on the ground when the deal is done. I’m therefore not seeing a lot of hedge funds dive straight into buyouts if they dabble in PE. That’s reserved for traditional PE houses who have the capital and the track record to take on the burden and risk.

The pandemic has brought several new aspects — the renegotiation of contracts, and additional clauses for protecting investors in agreements among others. With an additional set of lenses being added to dealmaking, how much of this can be addressed by tech?

JC: A fair degree but certainly not all of it. I’ll start with what tech can’t do: address the risk considerations that go into adapting to changing trends. When COVID happens, you want people who have expert judgement and experience to advise on how to identify and mitigate risks. There you really need human judgement.

But in order to make those judgments, those people need to be armed with information and underlying facts. What did the contracts of the target company look like? What did the provisions actually say? How do we go about pulling in dozens if not hundreds or thousands of contracts? Categorising, cataloguing and comparing them takes a huge amount of manpower. But tech is really good at it and can do that very quickly.

When COVID really started hitting from an economic standpoint around last March or April, everyone wanted to identify force majeure provisions. Tech is really good at finding all those provisions, tracking the differences between them and generating a report for inhouse or external counsel to read.

It’s not just COVID: you have similar things happen all the time from a regulatory perspective due to changes – for instance the LIBOR transition. Large asset managers, particularly those dealing with derivatives contracts, have to go through and catalogue thousands of agreements. That’s a perfect use case for machine learning.

That said, machine learning isn’t 100% accurate. It is maybe 98% accurate which can still be disastrous in legal analysis. From our perspective, it’s important to back up the tech with experienced lawyers and leverage it to make them more efficient.

Does that mean having a strong lawyer network on top of tech is the business model for a company like yours?

JC: We call it human in the loop. I don’t think there’s any legal tech company that is even close to replacing human lawyers yet — maybe 20 or 50 years down the line, that might change.

LPs have all the data on GP performance on returns. Why is it that LPs are not relying as much on tech?

PJ: The difference might be first time funds versus experienced firms like us who have deep relationships with LPs. The numbers can only take you so far. Ultimately, investors rely on interpersonal relationships.

The LPs are much better placed to invest based on data and tools that can help them assess GP performance. But that’ll only be for experienced GPs with a track record. For first-time GPs, it will create more problems than it will solve.

Do you think the flight to quality will only increase if the pandemic continues or can tech bridge that gap?

JC: Fundamentally, the flight to quality is a flight to comfort. Building trust between LPs and GPs is fundamental to success. You ultimately need to be responsive, accurate and insightful in your dealings with investors, on top of returns.

Midsize and small managers are nimbler. They don’t have a legacy of 50 years and thousands of contracts, and global organisations in need of an overhaul. A survey from Deloitte said that around 97% of asset managers focus on tech at the portfolio company level, during due diligence. But a little less than 60% of asset managers actively look at their own use of tech. The 40% of asset managers who are not doing that will be left behind.

What we’re seeing these days, with the increase in strategies that asset managers are undertaking and growth in fund sizes and ESG trends, is that a larger number of investors are asking for sign letters that are longer, more complicated and have a greater number of provisions. For instance, key man provisions, investment restrictions, ESG requirements, bespoke reporting requirements etc. It’s really complicated to manage. Nobody has a good way of doing it. Everybody just used Word files, and maybe if they’re really proactive Excel tables, which is just not scalable. Being more thoughtful about how you track all of that can really go a long way and help you get faster and better at answering questions that your investors ask. You can catalogue the data quickly and respond in a way that builds and retains trust.

An audience question for Nakisa: what do you make of the legal and regulatory challenges in a market like Vietnam?

NJ: The way we do our investments is to look at the market as a whole. Across the region, we benchmark against competitors. We found that Vietnam is definitely investable. The opportunities will boom in the foreseeable future. The regulatory and legal framework around businesses will become more investor-friendly. As long as you do your homework, the trajectory is very positive.

Pratibha, you have worked on some of the biggest deals in South Asia across multiple geographies, jurisdictions and sectors. How do you keep up to date with so many markets and trends?

PJ: I rely heavily on tech. We set up updates on the deals that we are looking at. Attending conferences is really helpful to know what’s happening. We also bank on advisors. I expect our legal counsel to be up to date on not only the deal but the jurisdiction and issues related to it. The more I see a firm linked up with technology, the more comfortable I get. Just relying on people is not going to be enough anymore.

What are your predictions for 2022?

ED: A number of emerging trends will continue, particularly around businesses that focus on preventative healthcare. The power of the consumer in Southeast Asia will be a huge tailwind behind consumer health and wellness, both in services and products. In healthcare you will see the continuing digitalisation across traditional businesses as well as new digital models.

PJ: The adoption of technology as a differentiator for businesses like PE. We will have to adapt much more quickly than before. There will be a significant reliance on understanding how a combination of teams on the ground and technology is going to help, compared to the traditional getting on the ground for big meetings.

I’m really looking forward to how that works out in an industry that’s known for crazy hours.

JC: Despite the diversity of our coverage in asset management, rapid growth is a common thread. Almost all firms are adding team members and new offices. The AUM in PE in Asia is supposed to triple by 2025. There’s no way that professional services are growing that quickly: neither law firms nor accountancy or professional advisory firms.

The only way to manage that is by becoming more efficient and that’s really by adopting tech.

The caveat is obviously the latest COVID variants, and also some emerging macro trends like the move towards more inflation in the market, and the real estate market in China after Evergrande. They do put up a question mark, but despite that, there’s going to be pretty hefty growth in Asia.

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