PE investors looking for great returns within a short time frame are having a hay day in a rebounding economic scenario.
A recent report by consulting firm Bain & Company, pegs India as the top three investment destinations for private equity (PE) funding in the world. The United States is the most favoured PE destination, followed by China.
An increasing number of businesses in India are looking upto third party investors to raise funds for growth. News papers are flooded with reports of a little known PE fund investing in an even lesser known company. Jagannadham Thunuguntla, Equity Head, SMC Capitals Ltd says, ‘The overall mood in the market is quite good. If the same robustness remains, probably, one can expect PE deal activity of about US$ 15-20Bn during next year. The rise in investment activity has been largely attributed to development and expansion of various sectors of the economy like infrastructure, healthcare, pharma, renewable energy, education and consumer durables.
What is Private Equity?
So, what exactly is private equity? As the words denote, it is equity investment into a privately held company. The PE investor can be considered to be a serial investor, who is making a short-term investment in an established company. Typically these are investments by organisations rather than by individuals. While the investor is looking for higher than market returns in quick time, the company is looking for large amounts of capital to fund expansion and growth. The fund requirements would typically be too large, the average ticket size being US$ 20 mn or about Rs. 90-100 Crores. Secondly the risks may be high for the entrepreneur to look at other funding options such as bank loans. Secondly the company may also not yet be ready to go public. PE investors generally put in the money in exchange for a minority stake and a seat on the company’s board. Very rarely do PE investors look for a majority stake in the company.
Who is eligible for PE?
Private equity is not for startups. This ilk of investment is for established companies who have a viable expansion plan for growth. The chances of getting PE funding gets better if you happen to do business in a high growth sector of the economy. Just as different Venture Capital investors invest in particular sectors, similarly each PE fund has its preferred sectors.
Within each sector, they identify growth areas or specific areas where they have expertise in. Within these high growth areas, they look for companies that can promise to outperform the market in the short term. Say if the economy is growing at 8%, they will gauge which sectors will grow faster than others. If these sectors are to grow at 10-15%, which companies will grow faster than this rate? This is to say that the market leader in automobiles will grow faster than the competitors and thus the company will attract more of private equity.
Why Private Equity?
If you are looking at private investment into the equity of your company, it can come from three routes-Angel investment, Venture Capital Investment and Private Equity. The reason why you should choose PE over other equity investments will depend on three factors- the size of fund requirement, role of the investor, extent of involvement of the investor and risks involved.
Angel investment comes at the earliest stage of formation of a company, sometimes even at the ideation stage. The amount of invested money which is generally the seed capital (funds required for starting a business), is much lesser in value. Angels are mostly in the profile of individuals rather than organisations. One of the most important roles of an angel investor is to mentor the budding entrepreneur and his business. Since angels chip in at the earliest stages of the business, the risk involved is the highest.
Venture capital investment comes at later stages of the enterprise. Companies which can promise to grow fast, backed by strong market demand can attract venture capital. However from an investor’s point of view, he perceives a lot of risks on the market front. This comes more from venture funds than from individuals. Venture capital is generally associated with much higher levels of investments than angels. Private Equity on the other hand comes once a company is well established and is looking for large value funds for rapid expansion. The amount of stake control PE investors would take is generally minor or lesser than what a venture fund may ask for. However on the PE side, the risk is more on the growth or finance side.
How to attract PE?
Most PE funds would look for high profit margins, promoters profile and their vision. Since they usually finance the expansion of a company, scalability of the business model is the major reason why PE investors would like to invest in a company. As Jagannadham Thunuguntla says, ‘In the initial stages, the entrepreneurs may not have the luxury of selection of the PE investors. Many of the times, promoters get overenthusiastic with the credentials of their own companies and keep rejecting the offers of the PE investors, in the anticipation of better valuation from some other investor. In such cases, they will miss out all the potential opportunities and regret later.’
However, if a company has the choice of choosing the PE investor, then they can choose that investor who has understanding of the industry, who has the international perspective and somebody seasoned who has made investments in that respective industry.
The amount of investment you can attract will depend on the fund deployment plan of the company and the valuation of the company. ‘Valuation differences between the investors and the company promoters is the major hurdle for the deals to conclude,’ says Jagannadham. It also depends on the preparedness of the PE investor- how much he is ready to invest. Few PE investors invest not more than US$ 5 million (that is, Rs. 20-25 Crores) per company.
PE fund check list
1. Promoters track record
2. Mid-sized businesses with major expansion plans
3. A niche or growing segment
4. Openness to corporate governance and compliance
5. An exit option-IPO or acquisition in 3-5 years
What you should consider?
1. They will be on your board- Are you really convinced on them?
2. What’s their portfolio? Do they understand your industry?
3. What else do they bring to the table?
4. What are their specific requirements-reports, approvals etc?
5. Read the fine print-devils often lurk in detail.
1. India is world’s top 3 PE investment destination after US and China.
2. Who can get PE-established firms with a viable growth plan?
3. They are investments from private funds into private companies. They are more from organizations than from individuals.
4. The ticket size is generally much bigger than angels or VCs.
5. Invest mostly in mid-level companies to fund their expansion.
6. Investors invest huge amount for quick returns over a short period of time.
7. Generally the fund requirement is too large and the risk involved is too high to take the loan route. This is generally for companies who are not ready to go public.
8. Sectors attractive for PEs are healthcare, infrastructure, fast moving consumer goods etc.
Jagannadham Thunuguntla, Equity Head, SMC Capitals Ltd says, "PE funding scores over several other funding options for an entrepreneur in several ways. In case of bank loans, there is a responsibility of payment of interest and repayment of principal on a timely basis. If the company can’t repay at the intervals defined, then it leads the company to NPA (Non-Performing Asset), causing lose of reputation and credibility. And in case of PE funding, besides money, the PE investor also provides ideas and advices to the company. Also, there is no risk of periodic payments of interest and principal. In case of PE funding, the fund will exit the company by selling at the time of IPO. Further, if a company receives PE funding, its stature and reputation go up in the business circles.