Private Equity Investments in Indian Companies
Private equity and venture capital both have been the main
accelerators for growth of the world economy. The contribution of the private
equity industry to economic development and with timely investment, growth and
profitability trends to be the primary goals. On examining the investment
climate in India, there is a growing global stature which a far more open
economy coupled with positive indications of reforms and perception of value that
encourages investments into the country. This has been drivers that powered
India’s GDP growth rate to over 9% in 2005. PE investment has had an integral
role with overall foreign investments in India. PE players have contributed at
various stages in private companies, roles being majorly in funding projects through
seed funding in addition to considered buyouts by entering at mature stage.
Basic understanding of ‘Private Equity’
Private equity basically denotes the capital
that is not noted on a public exchange. Private equity tends to be an equation
of funds and investors. Investments are made for private companies and those companies
engaging in buyouts of public listed companies. The buyouts of any public companies
will eventually result in the delisting of the public equity. Private equity
depicts a medium to long-term finance provided in return for an equity stake
meant for potentially high growth companies. With the case of a few instances
some use the terminology “private equity” to refer only to the buy-out and
buy-in investment sector. However, in Europe but not the USA, the term “venture
capital” is used to cover all stages, i.e. synonymous with “private equity”. In
the USA “venture capital” refers only to investments in early stage and
Since the 1970s private equity has
strengthened with pools of funds created by private equity firms in order to
privatize most extra-large companies. A significant number of private equity
firms carried out leveraged buyouts (LBOs). Through such buyouts, notable sums
of funds are provided in order to help finance large purchases. Efforts by the private
equity firms aim to achieve improvement in prospects, profits and overall financial
health of the company. The ultimate motive and goal usually is a resale of the
company to a different firm or for cashing out through an IPO.
A few advantages of private equity can be
collated and summarized as below:
Availability of capital to under-capitalized
Where in any company, equity injection
is required which is too small to raise from public markets
Easy to obtain fund from a
Relief from compliances of
transparency standards applicable to public companies as required for Public
companies for raising from IPO
Adoption of best management practices
Brings operational efficiency in
Overall growth to economy
Institutional and retail investors are usually
the providers of the capital in private equity. This investment is meant to be
utilized to fund new technology, make acquisitions and even expand working
capital. Investors are inclusive of institutional and accredited investors,
especially them who can allocate substantial sums of money for an extended time
period. In quite a number of instances, long holding periods are often
preferred for private equity investments so as to ensure a turnaround or to
enable liquidity events such as an initial public offering (IPO) or a sale to a
2. The Market for Private
(A) Types of Funds / Investors:
PE funds can be considered to be a collation
of private equity raised by PE firms from various investors. These pooled funds
are utilized for investing into target companies. They are typically structured
either as a Limited Liability Partnerships (LLP) or Limited Liability Companies
(LLC). Fund Managers usually acts as general partner in these funds and
actively involved in investment and management decision of the fund. In addition
these firms may control several similar funds at a given point of time.
Apart from the described PE funds, there are
also Venture capital funds in market which provides private equity to
companies. These funds are very much similar to a PE fund and refer to equity
investments made for launch, early development or expansion of business. These
normally funds Entrepreneur seeking to start or expand business and for
companies at a high risk early stage and no alternative funding is available.
These are specialized in early stage financing of start-up companies and it prioritizes
on entrepreneurial undertakings rather than on mature businesses.
There are wealthy individuals who provide
private equity in form of seed money to entrepreneurs of companies to start
companies. These investors usually invest at very early stage in companies even
before the Venture capitalists. The contribution by Angel investors is smaller
in comparison to the amount from VC.
(B) Mechanism and Structuring:
The establishment process for a PE is depended
on interaction of two parties. This comprises of a PE fund being the major
investor and a PE firm, who acts as the Management Company to the Fund. In most
cases the PE fund is structured as Limited Partnership. Limited Partnership is
tax efficient structure ensuring that the earnings is directly taxable in the
hands of investor in PE fund due to its pass through status. The advantage of
choosing LP structure is that it is inductive of a pass through status,
resulting to no tax leakage at the PE fund level.
A legal structure of a PE fund consists of a
General Partner (GP) and a Limited Partner (LP) A GP is a partner who assumes
sole responsibility and unlimited liability in the fund. The PE fund is structured
such that the firm who handles investment of PE fund is the GP or the Management
Company. Characteristic of a GP of the
Fund is that this partner is established as LLC in order to achieve tax or flow
through status and to impose an additional layer of legal liability protection.
A PE firm, as a GP in Fund, is a management company who makes all investment
decisions and is compensated with management fees for the management and
investment decisions of PE Fund (that generally covers the cost of running the
fund, including salaries and overhead). Generally, a common fee ranges between
1% to 2%, although, it may vary based on numerous factors. Also the GP or
management company is also entitled to a share in profits on the PE Fund’s
investment (popularly known as ‘carry’ or ‘carried interest’ (CI), a GP normally
is entitled to 20% carried interest in the Fund).
All other partners who contributed to PE fund
with a capital contribution, have passive role and limited liability. Such
partners are LPs in Fund. These LPs are not involved in operation of the Fund and
entitled to share in profit after deducting share of GP.
(C) Business Methods:
Ideally an investment commences with the
investor seeking out a company requiring investment or being approached by such
a company. Following this, a basic document, such as a memorandum of
understanding (MoU), a letter of intent or a term sheet is executed between the
investor and the company, in order to lay out the framework of the investment.
Once the document is prepared, the investor usually conducts, at the minimum, a
legal and financial due diligence on the company. This is often inclusive of a
business due diligence and background check on the promoters of the company.
The due diligence process may include the investor and the company negotiating
one or more investment documents, including share subscription agreements,
share purchase agreements and shareholders’ agreements with the company and the
promoters/shareholders. Upon the execution of these documents, and post the
clean-up of significant diligence issues, the investor invests in the company.
3. The Process &
Stages of PE investment and Funding
The process of an investment starts with being
communicated either by promoters or by any intermediary. Investors may agree to
pool their money and in some cases even the PE investors / advisors approaches
portfolio companies with potential for PE funding. In a PE investment, the
following processes are implemented:
Overview of preliminary proposal of
Study of background of target
Due diligence for the deal
Negotiation of deal
Issue of investment memorandum / term
Preparation and execution of various
legal documents at PE Fund level for pooling of funds such as shareholders’
agreement (SHA). SHA is an agreement between PE Fund and existing shareholders
of the investee company. The terms in the agreement governs the relationship
between existing shareholders, promoters and the Fund making investment. In
addition the agreement document defines the rights, duties of the PE Fund as a
shareholder, any restrictions on issue / sale or transfer of shares / further
capital by Investee Company, right to appoint directors, veto power,
affirmative powers to directors. Exit options are also mentioned like strategic
sale, sale to promoters, drag-along / call-put option, sale in IPO etc.
Investment agreement is executed
between PE fund and investee companies laying down various terms agreed for
investment / acquiring stake in investee company, any specific conditions
attached to investment or return of money etc
Actual investments completes with the transfer
of funds by PE Fund to investee company. After actual investment, the PE fund
monitors its investment and various compliances of Investee Company in order to
safeguard its money and interest of its investors.
Private equity normally covers financing
required in private companies at different stages. It not only covers financing
require to create a business, but also includes financing the subsequent
development stages of the Company’s life cycle. PE Funds invest in Indian
companies that are in need of long-term equity or risk capital at various
stages of life of the company.
There are various stages in funding, mainly
involving and being:
As the name suggests, seed funding is required
at entrepreneurial level before actual start-up phase has been reached.
Basically, this financing is for research, assess and develop an idea or
initial concept. At this stage, investors are mostly business angels (either
entrepreneurs or directors who fund these projects).
Start-up financing is used for product development
and initial marketing. At this stage business may be in creation phase but
products have taken shape but have not yet sold commercially. Mostly Venture
capitalists enter at this stage to fund the business for setting up of
/ Expansion stage
Once the business has taken its full swing,
products are sold and business has reached or approaching its breakeven point,
the business requires funds or high growth capital to expand its production
capacity and sales power or to develop new design/products or to finance any
acquisitions and / or increase working capital of business. The most
interesting part of this stage is that it is here when mostly professional
investors fund the expansion opportunities of companies. They invest in
companies which already have a strong history or a robust structure in place or
where significant amount of investment has already been invested. It now
becomes the aim for a target company to ensure balanced growth while obtaining
and utilizing these funds, as financing may be required in various and multiple
stage / Buyout
In a buyout either shares in a company held by
family members may be repurchased or where a large company decides to dispose
its business unit or eventually, when investors from previous stages of
development exit from business. This stage may also be referred as total or
partial retirement of head of company. Buyout allows company to carry on
trading, facilitate generational change at top of a company and enable
restructuring more efficiently by injecting fresh capital. Buyout in a variety
of instances also helps the management of the company by sharing professional
knowledge of PE Firm in that sector, their network contacts and long-term
With various PE investment having been
recorded across various stages, majority of the PE investors are attracted to
growth and expansion stage. This stage gains its importance as it benefits the target
companies and PE investors in terms of much needed capital for growth and
expansion plans of target companies as well as higher return on equity to PE
Tracing the Origin and Development of Private Equity
The initiations of Private Equity as an
organized form of funding were post World War II. The first firms to enter this
space are believed to be two US based firms, American Research and Development
Corporation (ARDC) and J.H. Whitney & Co., both founded in 1946.
Despite being called private equity, the
investments made by these firms assumed different forms at various stages of
its evolution. It started off as venture capital investment which wascharacterized
by relatively small investments into early stage companies. This followed with leveraged
buyouts which facilitated exits to small business owners. Finally the venture culminated
into dedicated investments made by institutionalized PE players. In the United
Kingdom, private equity took off at around the same time as it did in the US, however
with setbacks as a result of adverse investment conditions imposed by various
governments. Entering into mid 80’s, the State took progressive steps to
promote venture capital industry, rationalization of marginal tax rates, etc.
The inception of the Unlisted Securities Market (USM) in the early 80’s proved
advantageous for the exit of small firms because of relatively easier listing
In India, PE was still relatively new, while
early stage investment vehicles or venture capital funds were launched as early
as the mid-1980s, it was only around the mid-1990s that a few firms started
investing in Indian companies.
5. PE Investment and
Funding Trends in India
Until early 2001, the focus was more towards
high growth sectors such as Information Technology (IT). With the technology
slowdown following the dot-com burst, investors diversified their interest into
other high potential sectors such as manufacturing, infrastructure, e-commerce,
pharmaceuticals and biotechnology. Another effect of the global slowdown in
2008-2009 has been the shrinking deal sizes for investors. The PE industry has
faced substantial correction in valuations of Indian enterprises, and the
extraordinary growth bubble has seemingly burst. Investors became much more cautious,
and were willing to invest in the traditional economy seeking reasonable and
steady growth. Around 2011 there was a rise of private investments in public
equity deals, with a close to double increase in the number of deals struck.
However, 2012 was another year for smaller deals.
The last few years have also tested the legal
strength of many deals, some investors have attempted to enforce their exit
rights, though few have succeeded on account of the regulatory restrictions
that India imposes on foreign exits.
Given that liberalization of India’s economic
happened in 1991, the sector, it has been heavily dependent on Western-style business practices and
entrepreneurialism. It is believed that the investors are seeming to be more
discerning and demanding. In addition there is an enormous maturing in the
businesses they fund and are turning out to be globally competitive.
Quite a number of private equity firms are
owned and managed by India. Although Indian businessmen are trying to learn
Western best practices, cultural and social factors contribute to making this a
very different market. Law and property rights are very different. Many things that
are taken for granted simply don’t work the way they would in the United States
or the UK. Entrepreneurs who made money in the last couple of decades want to
give that money back to help create more entrepreneurship, hence accelerating a
pathway for an angel investor community.
The Indian Market for Private Equity
is a growth story, a fact that has remained constant over the ups and downs in
PE investments in India over the last couple of years. As of 2005-07, India
firmly established itself as one of the top seven PE investment destinations in
the world. It is now quite observant that the focus is shifting from the
developing world to the developing economies. A favorable demographics in India,
offered a growing GDP. This interested funders along with the rising FDI
investments coupled with forward looking policy reforms. Such demographics
enabled India in receiving more than approximately USD 15 billion in investment
from the PE players.
Around 2008 with the fallout of financial markets
that affected developed economies, the effect rocked India too. This pace and
intensity caught many investors unprepared and hence made PE investments in
Indian companies to turn cautious.
Investments worth approximately around USD 4.5
billion were made around 2008. This showed a drop of more than 70% compared to the
2007 peak. However there were changes observed and analyzed in investment
choices. This was measured and experienced across the boom and decline periods
which led to investor confidence in India’s growth. The growth and confidence continued
and the deal activity increased to about USD 9.7 million in 2011.
The current investment environment in India
comprises of several new and previously unforeseen challenges for the PE
investors. In the never ending search for growth, typically investors aim to
satisfy two preconditions, namely:
Care for capital
Realization of expected returns.
A deficit in the above preconditions has been
the main restraints in the Indian market. This has created a scenario for the investors
continuing to go slow in deploying capital, and in remaining optimistically
cautious when investing in India. Trends show a distinct adaptation of
investment preferences seen in proportion to economical climate of the country.
Distinct trends were being noticeable for sector wise investment preferences,
entry stage and size of investments, promoter expectations and with holding
period and exit mode.
A trend with the prominence of open market and
secondary sale along with strategic sale also began. This was in connect with
PE funds seeking returns with a stable stock market, hence paving a pathway for
a preferred mode for exit in 2010. The year 2010 experienced a record number of
exits with total value being approximately around USD 5 billion and a volume of
as high as 174 exits. There were strong records of exits in 2010 which boosted
investor confidence. PE exits in 2011 were minimally promising due to
unpredictability in Indian capital markets and other economic challenges. Other
noticeable trends were seen with IPOs being nearly dried up, while open market
and strategic sale transactions continued. The total value of exits fell by
about 50% to USD 2.5 billion in 2011 compared to a an encouraging peak of 2010.
Assumed forecasts for early stage investments
depicted an increase with the equity attraction to the minority shareholding.
The emergence of a new breed of first time entrepreneurs, would promote
investments in technology across the mobile, retail, and the internet space.
India’s strength in the IT sector was first
witnessed in the late 1990s and early 2000s. The Y2K risk mitigation services
in addition, gave global investors confidence in India’s IT capabilities.
Following this 60% of PE investments in the early part of the decade attributed
to the IT sector. The year 2007 was at its peak, with a shift in the focus
towards various other investment opportunities. These opportunities comprised
more than 50% of the total PE investments during the year. This included real
estate, construction and infrastructure segments and telecom, media and
entertainment. The technology sector continued to find uniform attractiveness
amongst investors. While the combination of adoption or smart phones and
tablets combined with mobile internet is viewed as a winning combination,
medical devices and innovation in healthcare delivery models also caught
investor attention. Another emerging trend was the increasing flexibility
provided by the investors to their investees regarding usage of invested funds.
Recent transactions were indicative of funds being provided to companies for
scaling up through inorganic route especially in the ecommerce space. Investors
are focused, with an eye to invest in companies which in some cases also
included portfolio companies. These
companies are of interest to investors primarily due to having provided good
returns in the past. This scope of returns drives scale up by mergers and
With the continuing trends, investments
continued in the real estate and construction sector during 2010 with a total
investment approximating around USD 2 billion. The power and energy sector
topped in terms of value during the same period. In 2011 private equity
witnessed a shift in trends with investments within real estate and
infrastructure sector from commercial and residential moving towards large
infrastructure projects such as airports, ports and roads.
Investment attractiveness increases with
clarity in respect to the regulatory framework with the role of the Government
to include favorable policy development aimed at welcoming investments into the
country. According to International Monetary Fund’s (IMF) World Economic
Outlook Update as released in January 2017, India was estimated to have grown
by approximately 7.6 % as in 2015 and claimed the status for the fastest
growing developing economy. However there experienced a downward revision in
2016 to an approx 6.6 % mainly attributing to the demonetization announced by
the government around November 2016.
Despite the demonetization’s negative effect, there
witnessed positive influences such as industrial productions rising and exports
peaking to the highest ever around December 2016. Further with the Government’s
endeavor to increase investment in core infrastructure, PEs support in the
areas of infrastructure, healthcare, education and renewable energy stands a
bright scope. This was with the expectation to further expand the participation
of private equity in Indian core infrastructure companies.
The role of PE and Government led initiatives
would be a solution to the limitations on alternative sources of funds such as
debt against assets, equity investment remain a sought after option. Hopefully
role of the Government would be to evolve from merely a standalone policy maker
to a facilitator of these investments. Hence it seems very likely that India’s
growth story is likely to stay with investor confidence with the correction of
economic downturns and refinement of policies in line with the economic shifts.