The global economy was thrown into disarray in 2020, exposing critical supply chain vulnerabilities and causing businesses to rethink strategies. According to a recent Accenture report, 94% of Fortune 1000 companies said the pandemic led to supply chain disruptions, while 75% said COVID-19 negatively affects their businesses. To overcome these challenges, companies explore new ways to mitigate risk and reduce operational costs. These efforts attract private equity (PE) firms looking to limit their own risk by investing in companies better equipped to withstand market instability.
One strategy PE firms adopt to guard against economic disruption is to prioritize asset-light acquisitions.
What Is an Asset-Light Business Model?
Companies that practice an asset-light strategy invest more in operations than they do in hard assets. By minimizing the costs and risks associated with owning a significant amount of collateral, companies maximize their flexibility and ability to scale quickly.
The asset-light approach is a departure from the vertically integrated approach traditionally taken by many of the world’s largest companies. Vertically integrated companies focus on owning as much of the production and distribution process as possible. In doing so, they prioritize acquiring tangible assets such as property, machinery, infrastructure, and business divisions.
While the vertically integrated business model offers companies superior control over their operation, it requires more capital to initiate and manage. It also makes it more cumbersome for companies to quickly adapt to changing market conditions.
An asset-light approach, on the other hand, is inherently flexible and requires less up-front capital investment. Companies that employ this strategy invest more in intellectual property or software than they do in physical assets. These businesses outsource functions like manufacturing, distribution, sales, and customer service rather than handling them in-house. By keeping costs and operations lean, asset-light companies quickly respond to changing market conditions.
Uber is one of the world’s most well-known asset-light companies. Whereas traditional taxi companies own their vehicles, along with the garages and shops required to park and maintain them, Uber bypasses such investments. The company’s business model relies on software that connects customers to drivers who use their own vehicles: Uber contracts, rather than employs, these workers. The company’s asset-light approach allows it to quickly scale across world economies without investing in the substantial up-front costs for vehicles, storage centers, and employees. As a result, Uber is now the world’s largest rideshare company with a net worth of $96 billion.
Why More Companies Turn to the Asset-Light Approach
The World Economic Forum calls the COVID-19 pandemic “a wake-up call for companies to have a plan to deal with disruptions to ensure business continuity.” Many companies have become more asset-light to rise above the pandemic’s economic damage and supply chain turmoil.
This strategy helps companies immediately reduce costs and raise cash. To offset revenue losses and limit ongoing risk, companies look to sell off non-core business units. EY’s 2020 Global Corporate Divestment Study reveals that 72% of companies believe they waited too long to sell assets in 2020, up from 63% in 2019. By proactively divesting from non-essential assets, companies prepare themselves to weather future market changes—and become more appealing to PE firms looking for recession-resilient investments.
Increased shareholder activism is another force driving companies to adopt an asset-light approach. According to the EY report, 96% of shareholder activists want their company to carve out underperforming or non-core business units within the year. These companies streamline their operations by shifting responsibilities such as international HR and payroll to external experts.
Beyond satisfying shareholders and helping companies overcome COVID-19 challenges, going asset-light provides enduring benefits. According to a Boston Consulting Group study of more than 2,600 companies across 24 sectors, firms with this approach see:
- Greater ROI on their assets
- More consistency in year-over-year profits
- Better ability to keep up with technology changes
- More flexibility to overcome supply chain complications
By adopting this model, companies set themselves up for success even after the pandemic passes.
Why PE Firms Have Shifted Toward Asset-Light Investments
Considering that asset-light companies are well-positioned to mitigate risk and maximize profitability regardless of market conditions, it’s no surprise PE firms increasingly focus on acquiring them.
EY found that PE firms are 17% more likely to increase their valuation of companies that divested their manufacturing units before selling. PE firms’ willingness to pay more for asset-light businesses speaks to their belief in their long-term economic viability.
Due to the pandemic, people spent more time online than ever. This growing shift toward digitization stands to benefit asset-light companies. As people increasingly go virtual for business, commerce, social, and entertainment purposes, corporations that dominate the digital space will grow. From giants like Google, Facebook, and Amazon, to smaller startups focused on food delivery and housing, these business models are inherently asset-light. As a result, PE firms who invest in them boost their ability to thrive in an increasingly digital economy.
Acquiring asset-light companies also provides immediate logistical benefits for PE firms. Every added cost is crucial in the current economic downturn, and firms that acquire or partner with asset-heavy companies must absorb added operating costs. By investing in companies that divest non-core business functions, PE firms avoid excess costs related to HR, international employee compliance, and more.
How an Employer of Record Solution Simplifies Cross-Border Carve-Outs
Despite its many advantages, the asset-light approach still presents challenges to PE firms. Asset-light companies often lack centralized offices and are thus geographically spread out. During cross-border carve-outs, firms acquiring physically dispersed business units must legally hire and onboard workers in multiple countries. This process creates complications for PE firms—especially if each international market has only a handful of employees. In this case, firms must decide if it is viable to undergo the lengthy, costly, and inflexible entity establishment process to support such small employee populations.
Resourceful PE firms overcome this challenge by turning to a global Employer of Record solution. As a result, firms take an asset-light approach themselves by trusting a partner for the otherwise costly and administratively complex international HR functions.
Velocity Global is an experienced partner that helps companies navigate the complexities of cross-border M&A transactions. Our experts ensure your supported employees remain in compliance with international labor regulations. We provide all onboarding and payroll services on a global scale, so your firm can focus on incorporating new business units into your existing corporate structure. By handling all the employment details, we help you maintain cost-efficiency and agility during cross-border transactions, regardless of your target acquisition size.
Ready to find out how Velocity Global can streamline your cross-border transactions? Reach out today to find out how.