As Cloud computing overtakes industry, should private equity groups jump in?

By Carolyn Duffy, CPA
 
As cloud computing storms the business world, it's impossible for private equity (PE) firms to ignore it. The real question is whether they should adopt it for their portfolio companies.
 
This isn't a one-size-fits-all question for PE groups. When considering cloud computing, several factors need to be taken into account, including investment focus, control issues, and the likely acquirers of portfolio companies. However, by and large, the cloud presents many of the same opportunities for PE firms as for everyone else. For those reasons, it merits serious consideration.
 
Cloud computing – defined loosely as any computing function that involves using the Internet – has gained popularity on three levels: general software packages; service platforms that can be modified for customers; and infrastructure, such as storage and computer servers. As compared to having to buy software, servers and space to house them, and technicians to implement and update them, cloud applications are browser-based. Cloud computing offers lower upfront costs, shorter implementation cycles, and constant updates. It also offers access from any location and real-time operational and financial visibility into a company.
 
Private equity owned
 
Some industries don't yet have many cloud applications to choose from. Process manufacturing, involving food, beer, wine, dairy, or processed foods, is one example. The construction industry is beginning to put some of its applications into the cloud – think of field personnel logging progress completion reports into their PDAs. So, first you need to make sure there are sufficient applications available to your industry.
 
Once you're satisfied there are suitable cloud software applications for your industry, you have to decide who owns the primary license for the cloud software or service. If the PE firm owns and controls the system, it can sublicense the same package to its investment companies. This can be attractive, as many investment companies don't have more than a basic financial system, such as QuickBooks.
 
By adopting cloud computing for operational and financial systems of both PE and portfolio firms, a PE group maintains control of the flow and quality of information. A PE firm can set up a chart of accounts that corresponds to the kind of reporting it wants and configure it in a standard way across all investments.
 
Say, for example, a firm invests in software companies. A cloud system could be implemented in numerous investments because we're comparing apples to apples for operational or financial information. The same is true for manufacturing, even if different products are being manufactured. Inventory is inventory, and the same metrics for analyzing cost of goods sold apply, whether it's jewelry or clothing. These are examples of industries where the cloud can serve well because there are robust applications for them.
 
A basic cloud package can be useful even for a sprawling PE firm with investments across many industries. For example, at Hein & Associates, we recommended a cloud system for an investment firm that owned two client companies, one in building maintenance and another in health services. Because they were both basically selling time and expense, it worked well. Both companies feel they're on a good system, despite the fact they're in different industries.
 
Once a portfolio company is sold, the company's data can be easily migrated into most other systems, such as cloud or on-premise. After the sale, the seller no longer has access to the information.
 
One issue to investigate regarding a PE-owned license is linked to control. Legal counsel may have to advise on who owns the information. It may seem fairly simple; if the PE firm owns a controlling share, then it would naturally own the information. But there may be exceptions, and it becomes especially murky when there isn't a majority ownership.
 
Investment company owned
 
If the investment company owns the license, it, not the PE group, would have complete control of the data and processes. Having a portfolio of investments, each with its own license, would cost more, but it may be perceived by a buyer to be more valuable. Additionally, a company may find that it can benefit more from a particular cloud application, with features endemic to its particular industry, than from a basic package. All of the above can play into a PE group's decision for an investment company to own the cloud application license.
 
The consideration of the buyers of portfolio companies is also important. Let's say you sell one of your portfolio companies to a major conglomerate and the acquirer runs on a major on-premise system and has alternative cloud systems at work in outlying offices. An investment with its own license could be attractive to that conglomerate because it doesn't want its field operations to run on the on-premise system.
 
It would be my preference for PE groups to own their own licenses and sublicense to their investments. The world is going to the cloud anyway. Wouldn't it be great to simply have consolidated data instead of buying software, hiring engineers, and installing upgrades? I look to venture capital groups to be early adapters because of their comfort with technology.
 
The cost involved with the cloud is so much less, and cloud solutions provide solid analytics. I've been horrified at large companies that run on spreadsheets or QuickBooks. When companies don't have to buy mainframes or hire engineers, there's no excuse for them not to have all the tools that the cloud can bring. PE firms and their portfolio groups are no exception.
 
About the author:
 
Carolyn Duffy, CPA, is a director of business advisory services for Hein & Associates, a full-service accounting and advisory firm with offices in Denver, Houston, Dallas, and Southern California. She specializes in cloud computing software implementation as well as designing and implementing methodologies for SOX 404 and IT service lines. Carolyn can be reached at cduffy@heincpa.com or 303-298-9600.
 

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