Francisco Partners’ DJ Deb: ‘Exits will come back, but it may take a little time’

“As you can imagine, there’s a lot of turmoil in the world with what’s happening geopolitically, and within the software and AI worlds,” Dipanjan ‘DJ’ Deb, co-founder and CEO at Francisco Partners, told PE Hub in a wide-ranging interview on the heels of closing the biggest fundraise in the San Francisco firm’s 27-year history.

“There were a lot of questions from our investors about that during the fundraise, but ultimately, we had people step up,” he said.

Despite the constrained fundraising environment in the technology sector, Francisco Partners in July announced the closing on $21 billion in capital commitments across its FP VIII flagship fund (which raised $16.4 billion) and its mid-market Agility IV fund (which raised $4.6 billion). The funds exceeded their initial targets of $14 billion and $3.5 billion and bring FP’s total capital raised to more than $75 billion.

The San Francisco-based firm is still investing out of its $13.5 billion FP VII and $3.3 billion Agility III funds and expects to make the initial deals from FP VIII and Agility IV in the fourth quarter.

Here are excerpts from PE Hub’s conversation with Deb about how the firm expects to invest the new funds and about the current climate for tech investing.

As an investor, has AI fundamentally changed how you evaluate tech businesses, or is it changing what kinds of businesses can become attractive buyout targets?

AI is profound. I think we all need to stop being prisoners of the moment. Before people had electricity, automobiles, trains or cars, the world was different. If you look at history, there’s been huge innovation. We’re going into one of those revolutionary periods right now, and this is the closest thing to the internet, so it is impacting everything.

Every company we look at, we have to see what the potential for AI is in this industry. Will it hurt terminal multiples? Will it help terminal multiples? Can the company be dislocated? We take that into account.

I think we’re sitting on a massive bubble. But just because venture capitalists are saying this is going to change everything, it won’t change everything. Some things won’t change. There will be five or six companies that come out of this that will be multi-trillion-dollar companies just like there were in the last cycle, and I think 90 percent of the companies will lose a ton of money. It may take a little bit longer for the bubble to play out. But the one thing that never changes is human nature. I saw this in 1999 and 2000, and I saw this with the great financial crisis. And I think we’re seeing some of that again.

Do you have confidence in the exit environment going forward in software and technology?

Yes, I do, because things tend to be cyclical. Once people realize that AI will not eat everything, the exits will come back. But it may take a little time.

When do you think that it would be?

If I had to take a guess, it would probably be a year from now.

How do you expect to invest from the recently closed funds? 

We are organized by 12 different verticals. A partner runs each of those verticals, whether that’s in industrial tech, healthcare tech, edtech, fintech, semis, etc.

In our view, the best ideas are going to win out. That may mean division carve-outs, buying from founders, going private or structured investments. We don’t have a prescribed view on how we’re going to deploy capital, just that we’re going to deploy it over three to four years.

We’re going to keep doing what we have done. But obviously, taking into account what’s happening with the world, we call our strategy “complexity arbitrage,” which means you buy confusion, hopefully at a discount, and you sell clarity, hopefully at a premium. That will keep being the core ethos of our strategy.

What are you hearing from LPs in this current fundraising environment? 

Let me start with the negatives and then end with the positives to give you both sides of it. The concerns people have are that public markets have done very well. As an industry, realizations have slowed down, and then there’s this AI potential disruption threat to software. Then, there’s always the geopolitical turmoil; those are the four big ones.

Why were we able to raise so much money? I’d say a few things. One is we’re the only firm in the world that’s been in the top three of the HEC Paris-Dow Jones annual global large buyout performance ranking for the last six years.

Point two is I’ve lived through five of these disruptive threats in my investment career, going back to PCs, the internet, mobile, cloud and now AI. Many investors understand that while AI is a very disruptive threat, what’s going to happen this time is what happens usually. There is going to be a dispersion of winners and losers, and in some cases, some of the companies will perform poorly and terminal multiples will be truncated. But in other cases, this will strengthen the moats that companies have, and they’ll be able to use AI tools for efficiency.

My guess is 2021-24 will end up being bad vintages in private equity, while 2025-28 will be great vintages in private equity. A lot of times people make the mistake of overinvesting at the top and underinvesting at the bottom. We were able to convince our LPs that this will end up being a great vintage. And there’s vendor consolidation going on. We benefited from that.

If you were an LP and you had to make one PE commitment, what characteristics in a GP would cause you to write a check?

Trust. [The LP-GP relationship] is like a 10-year marriage or more. So it’s probably the most important factor.

Are there any subsectors you are following right now or interested in investing in?

We are interested in investing in subsectors where there are moats. Those include healthcare, industrial technology, cybersecurity, education technology, fintech, semiconductors, etc.

What attracts you to those types of businesses?

Using a football reference, AI is really good when you’re not in the red zones. But in the red zone, you have to get things perfectly right. Your taxes have to be 100 percent right. Your finances have to be 100 percent right. When you have industrial applications or healthcare applications, the patient record has to be exactly right. You can’t have faulty readings on meters. That’s why it’s more AI-proof and more AI-enabled.

You mentioned your background of investing during these periods of fundamental change. Have any of those experiences been lessons to help you navigate an environment like now?

Each new thing is never the same. We’re always going to make mistakes. The question is: Can we learn from each of them? And if we make a mistake, can we course-correct fast? That’s what we pride ourselves on. We’re always going to get things wrong, but are we honest about it to ourselves? What I do know is human nature never changes. When things are good, people get greedy. When things are bad, people are afraid.

In 2021, at the height of the last growth equity bubble, I remember we had an advisory board meeting with all our big investors in March 2021. I started by saying I know more people who have raised a SPAC than have had covid, because at the time every banker was calling me to raise a SPAC, which we never did. It’s just not black and white. There are shades of gray, and that never really changes.

What type of buyer will be the biggest source of liquidity: sponsors, strategics or IPO?

The IPO market has never been a big part of our exit strategy. It’s been less than 10 percent historically. The strategic market’s always been the biggest source of exits for us. I would say that is unlikely to change. If I had to rank order it, I would say strategic, then sponsor, then IPO and then other.