In 2023, a quarter of all targets we diligenced presented themselves to investors as tech-enabled service businesses – a trend that is growing every day. For these targets, a key outcome of diligence is helping an investor ascertain (or a seller explain): “Is this business really tech-enabled?”
What does it mean to be tech-enabled?
Definitions matter, so let’s start here. Typically, we define “tech-enabled” as a business that provides a service or physical product facilitated by a proprietary piece of software that the business has developed. While pure-play tech and software companies primarily focus on innovating new products, a tech-enabled business uses technology to make their core business run better. Amazon’s retail e-commerce business is an example of enabling the delivery of traditional products and services through the use of proprietary technology, but there are examples in every industry.
Tech enablement takes many different forms. For example, it may mean introducing a digital front-end to enhance the experience and relationship “stickiness” for service-based customers. In other instances, it reduces delivery times or increases efficiency to expand gross margins. We consider a business truly tech-enabled when the technology contributes to value creation by unlocking a new market, differentiating the offering, increasing the average revenue per customer or reducing costs of running the business.
Why does tech enablement matter?
In many cases, the business makes the claim that it’s more valuable than industry peers based on its tech enablement. So investors are keenly interested in understanding whether this so-called “tech enablement” actually makes this business worth more money than its competitors.
From hundreds of tech due diligences, we’ve found that the answer depends upon three equally important factors:
- Is the tech real and differentiated?
- Is the organization set up to manage and scale the tech?
- Does the tech clearly improve business performance?
Is the tech real and differentiated?
The tech within tech-enabled service businesses isn’t limited to customer-facing apps. Sometimes it helps facilitate a more efficient internal operational delivery model.
Within the category of “tech-enabled,” we also see highly proprietary configurations built on broader platforms. Under this definition, the business is not just using enterprise applications well – they have a unique and intense focus on building their own customized business solutions to solve challenges for both customers and internal teams.
Regardless of the application, having a proprietary tech-based solution is a defining characteristic of tech-enabled businesses. And similar to how we evaluate commercial software products, we want to understand the foundation on which any proprietary solution is built and maintained:
- Who wrote the code, and where does the source code reside?
- Is the code well-documented?
- Is the language widely used and well-supported?
- Does the code present any inherent IP or security risks?
One reason we’ve seen rapid growth in tech-enabled businesses is because it’s now easier than ever to build and launch a new application leveraging established platforms, open-source solutions and external vendors. So, assuming that the tech solution does not leverage outdated technology or present key person risks to maintain it, most solutions meet the criteria for “real” software.
We then turn our focus to the other factors that define “tech-enabled.”
Is the organization set up to manage and scale the tech?
There’s a big difference between having technology and managing it as a product. Software products require the discipline of a product roadmap, a release process and a tech organization that can continually iterate on the product to meet future use cases defined by the market.
Service-oriented organizations are rarely set up like this, and tech-enabled businesses typically do not have strong technical skills built into their DNA. It’s especially important in these cases to manage proprietary tech development efforts appropriately and evaluate whether it makes more sense to build or buy. If a company is investing a critical amount of resources, cost and time in creating proprietary technologies or tools, then those tools should significantly enhance operational efficiencies, reduce costs to the business or greatly differentiate the core offer.
While there are different and creative ways to organize both product and engineering resources in non-software businesses, we want to see that the company has thought about the challenges unique to managing their tech solution. We expect to see an approach that is yielding rapid progress, defines clear accountability and is driven by the market. One engineering resource working with a services leader may be sufficient early in the journey. In the long term, however, that approach is unlikely to make for a scalable solution.
To determine the sustainability and scalability of the tech, we need to understand:
- Is the solution architecture fit-for-purpose?
- Who owns responsibility for the tech, and how is this team structured?
- How is the solution maintained?
- Is there a roadmap and regular release cycle for updates?
- How will the solution scale to meet increases in transaction volume or number of users?
Does the tech clearly improve business performance?
We encounter a lot of tech out there looking for problems to solve. But what investors really want to know is how the technology translates into delivering some element of “faster, better, cheaper.” It’s not a trivial exercise.
As an example, consider a business using a proprietary solution to automate its resource management process. Automation is a logical pursuit of efficiency. But has automating the process actually translated into higher resource utilization or operating leverage?
Another common rationale for tech enablement is data collection. Collecting a wealth of proprietary data can potentially create a competitive moat or lead to new revenue stream. However, investors need to consider whether the expense and risk of collecting and maintaining that data is worth it.
To help investors consider how the tech impacts business performance, we provide insights on topics such as:
- Does the tech materially differentiate the business from its competitors?
- How is the core service offering enhanced by technology?
- Is automation used appropriately to improve process efficiency?
- How does the organization use collected data to strengthen their services or operations?
- Does the proprietary tech introduce any risks to the business?
- Does the company have an effective build-vs-buy decision process?
- Is the company best suited to write and maintain the proprietary technology without distracting from its core business?
Enabling the potential of tech-enabled businesses
It’s perfectly okay for tech-enabled businesses to be imperfect. What’s important is understanding where the business is on its tech journey.
As part of the exit preparation process, tech-enabled businesses should detail their plans for scalability, document plans to address risks, build out a roadmap and shape a tech story that allows investors to see the potential of the tech. These steps demonstrate that the business knows what it means to be tech-enabled. In addition, the process prepares the team to confidently address common concerns when they meet with potential investors.
Investors, for their part, look to their tech diligence partner for help understanding the current state of the tech and the roadmap. Ultimately, they need to discern the potential for an above-market valuation versus the target’s peers. They’ll also want to determine any risks that could derail their investment strategy.
With clear communication among all parties, the path to value creation through tech enablement is evident.
