reylock 'artners 0founded in =HN9 by 2harlie 4aite and -ill #lfers1 and organ, Kolland 6entures, the predecessor of lagship 6entures 0founded in =HC< by Eames organ1.9P A)"2 continued investing until =HQ= with the retirement of "oriot. In =HQ<, "oriot merged A)"2 with &extron after having invested in over =9: companies. E.K. 4hitney J 2ompany was founded by Eohn Kay 4hitney and his partner -enno chmidt. 4hitney had been investing since the =HM:s, founding 'ioneer 'ictures in =HMM and acquiring a =9; interest in &echnicolor 2orporation with his cousin 2ornelius 6anderbilt 4hitney. -y far, 4hitneys most famous investment was in lorida oods 2orporation. &he company, having developed an innovative method for delivering nutrition to American soldiers, later came to be known as inute aid orange juice and was sold to &he 2oca(2ola 2ompany in =HN:. E.K. 4hitney J 2ompany continues to make investments in leveraged buyout transactions and raised LQ9: million for its sixth institutional private equity fund in <::9. -efore 4orld 4ar II, venture capital investments 0originally known as Bdevelopment capitalB1 were primarily the domain of wealthy individuals and families. One of the first steps toward a professionally managed venture capital industry was the passage of the mall -usiness Investment Act of =H9C. &he =H9C Act officially allowed the G.. mall -usiness Administration 0-A1 to license private Bmall -usiness Investment 2ompaniesB 0-I2s1 to help the financing and management of the small entrepreneurial businesses in the Gnited tates. 'assage of the Act addressed concerns raised in a ederal )eserve -oard report to 2ongress that concluded that a major gap existed in the capital markets for long(term funding for growth(oriented small businesses. Additionally, it was thought that fostering entrepreneurial companies would spur technological advances to compete against theoviet Gnion. acilitating the flow of capital through the economy up to the pioneering small concerns in order to stimulate the G.. economy was and still is the main goal of the -I2 Page 9 of 51
program today.NP &he =H9C Act provided venture capital firms structured either as -I2s or inority #nterprise mall -usiness Investment 2ompanies 0#-I2s1 access to federal funds which could be leveraged at a ratio of up to 8/= against privately raised investment funds. &he success of the mall -usiness Administrations efforts are viewed primarily in terms of the pool of professional private equity investors that the program developed as the rigid regulatory limitations imposed by the program minimi%ed the role of -I2s. In <::9, the -A significantly reduced its -I2 program, though -I2s continue to make private equity investments. &he real growth in 'rivate #quity surged in =HC8 to =HH= period when Institutional Investors, e.g. 'ension 'lans, oundations and #ndowment unds such as the hell 'ension 'lan, the Oregon tate 'ension 'lan, the ord oundation and the Karvard #ndowment und started investing a small part of their trillion dollars portfolios into 'rivate Investments ( particularly venture capital and +everage -uyout unds
CHAPTER !: CATEGORIES OF PRIVATE EUITY INVESTMENT
. V+$ 3'%'= / an investment to create a new company, or expand a smaller company
that has undeveloped or developing revenues 2. B+,-+/ acquisition of a significant portion or a majority control in a more mature
company. &he acquisition normally entails a change of ownership 5. S3%'= 6%+'% / investments in a distressed company, or a company where value can be
unlocked as a result of a one(time opportunity 02hanging industry trends, government regulations etc.1 'rivate equity firms generally receive a return on their investments through one of three ways/ an I'O, a sale or merger of the company they control, or a recapitali%ation. Gnlisted securities may be sold directly to investors by the company 0called a private offering1 or to a private equity fund, which pools contributions from smaller investors to create a capital pool.
C6%$'%6 1$ %&6%8 % $%&' *+%, 1+6 $='%& $ 1$96 1 %&69 %3=+:
Page 10 of 51
ubstantial entry costs, with most private equity funds requiring significant initial investment 0usually upwards of L=,:::,:::1 plus further investment for the first few
years of the fund. Investments in limited partnership interests 0which is the dominant legal form of private equity investments1 are referred to as BilliquidB investments which should earn a premium over traditional securities, such as stocks and bonds. Once invested, it is very difficult to gain access to your money as it is locked( up in long(term investments which can last for as long as twelve years. "istributions are made only as investments are converted to cash? limited partners typically have no right to demand
that sales be made. If a private equity firm cant find good investment opportunities, it will not draw on an investors commitment. >iven the risks associated with private equity investments, an investor can lose all of its investment if the fund invests in failing companies. &he risk of loss of capital is typically higher in venture capital funds, which invest in companies during the earliest phases of their development, and lower in me%%anine capital funds, which provide interim investments to companies which have already
proven their viability but have yet to raise money from public markets. 2onsistent with the risks outlined above, private equity can provide high returns, with
the best private equity managers significantly outperforming the public markets. or the above mentioned reasons, private equity fund investment is for those who can afford to have their capital locked in for long periods of time and who are able to risk losing significant amounts of money. &his is balanced by the potential benefits of annual returns which range up to M:; for successful funds.
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CHAPTER ": TYPES AND FUNCTIONS OF PRIVATE EUITY 'rivate #quity investments can be divided into the following categories/ . L&$'8 B+,+ +everaged buyouts involve a financial sponsor agreeing to an acquisition without itself
committing all the capital required for the acquisition. &o do this, the financial sponsor will raise acquisition debt which ultimately looks to the cash flows of the acquisition target to make interest and principal payments. Acquisition debt in an +-O is often non(recourse to the financial sponsor and has no claim on other investment managed by the financial sponsor. &herefore, an +-O transactions financial structure is particularly attractive to a funds limited partners, allowing them the benefits of leverage but greatly limiting the degree of recourse of that leverage. 2. V+$ 3'%'= 6enture capital is a broad subcategory of private equity that refers to equity investments
made, typically in less mature companies, for the launch, early development, or expansion of a business. 6enture investment is most often found in the application of new technology, new marketing concepts and new products that have yet to be proven. 6enture capital is often sub( divided by the stage of development of the company ranging from early stage capital used for the launch of start(up companies to late stage and growth capital that is often used to fund expansion of existing business that are generating revenue but may not yet be profitable or generating cash flow to fund future growth. #ntrepreneurs often develop products and ideas that require substantial capital during the formative stages of their companies life cycles. any entrepreneurs do not have sufficient funds to finance projects themselves, and they prefer outside financing. &o compensate the risk of failure, venture capitalists seeks higher return from these investments. 6enture 2apital is often most closely associated with fast( growing technology and biotechnology fields. 5 .G$@ 3'%'= >rowth capital refers to equity investments, most often significant minority investments, in
relatively mature companies that are looking for capital to expand or restructure operations,
Page 12 of 51
enter new markets or finance a major acquisition without a change of control of the business. 2ompanies that seek growth capital will often do so in order to finance a transformational event in their life cycle. &hese companies are likely to be more mature than venture capital funded companies, able to generate revenue and operating profits but unable to generate sufficient cash to fund major expansions, acquisitions or other investments. &he primary owner of the company may not be willing to take the financial risk alone. -y selling part of the company to private equity, the owner can take out some value and share the risk of growth with partners. ! .D%6$66 ' S3%'= S%+'%6 "istressed or pecial ituations are a broad category referring to investments in equity or
debt securities of financially stressed companies. &he BdistressedB category encompasses two broad sub(strategies including/
B"istressed(to(2ontrolB or B+oan(to(OwnB strategies where the investor acquires debt securities in the hopes of emerging from a corporate restructuring in control of the
companys equity? Bpecial ituationsB or B&urnaroundB strategies where an investor will provide debt and equity investments, often Brescue financingB to companies undergoing operational or financial challenges.
" .M'% 3'%'=
e%%anine capital refers to subordinated debt or preferred equity securities that often represent the most junior portion of a companys capital structure that is senior to the companys common equity. &his form of financing is often used by private equity investors to reduce the amount of equity capital required to finance a leveraged buyout or major expansion. e%%anine capital, which is often used by smaller companies that are unable to access the high yield market, allows such companies to borrow additional capital beyond the levels that traditional lenders are willing to provide through bank loans. In compensation for the increased risk, me%%anine debt holders require a higher return for their investment than secured or other more senior lenders.
;. S3'$%6
Page 13 of 51
econdary investments refer to investments made in existing private equity assets. &hese transactions can involve the sale of private equity fund interests or portfolios of direct investments in privately held companies through the purchase of these investments from existing institutional investors. -y its nature, the private equity asset class is illiquid, intended to be a long(term investment for buy(and(hold investors. econdary investments provide institutional investors with the ability to improve vintage diversification, particularly for investors that are new to the asset class. econdaries also typically experience a different cash flow profile, diminishing the effect of investing in new private equity funds. Often investments in secondaries are made through third party fund vehicle, structured similar to a fund of funds although many large institutional investors have purchased private equity fund interests through secondary transactions. ellers of private equity fund investments sell not only the investments in the fund but also their remaining unfunded commitments to the funds. T F+3%6 1 P$%&' E*+%,
'rivate equity is often discussed in the financial and business press. At times it is maligned? at other times, championed. 'rivate equity has existed since capitalism began. +ong before public stock markets existed, companies had to tap private individuals and businesses for the equity needed to start and grow their businesses. As this has morphed into more formal private equity and venture capital firms that seek out businesses to invest in or buy, the crucial functions still remain. .E>'6% C'%'=
'rivate equity and venture capital firms provide the funds that businesses need to finance growth. Often firms that have inconsistent operating cash flow due to operational issues or changing market conditions cannot qualify for enough bank financing. In addition, rapidly growing businesses often use up their operating cash flow in acquiring assets or personnel. -ecause their operating cash flow may turn negative due to these expenses, they also do not qualify for debt financing. In addition, if these companies obtained all the financing they needed in the form of debt, they may be unable to make the debt payments. 2 .D%63%=%
'rivate equity often provides the discipline companies need. or public companies taken private through a private equity transaction, discipline is less of a function. &hese companies had to meet the standards and expectations of the public markets. Kowever, for many private companies, those without external boards and oversight often operate the companies Page 14 of 51
according to the owners whims. Owner(managers often have different criteria than those that are purely shareholders. 'rivate equity generally demands that companies operate efficiently to drive an increase in shareholder value and put the personnel, systems and processes in place to ensure this. 5 .M''89
'rivate equity provides management. any companies that private equity firms invest in have thin layers of management. &hey often have the founder or founders in various roles and may have one or more vice presidents. 'rivate equity provides not only the capital to hire more management, but also the expertise and resources to identify and screen management. 'rivate equity also may replace some or all of the current management with outsiders skilled in a particular industry or market niche. In addition, private equity provides board members with varying perspectives and insights. ! .C'36
'rivate equity provides contacts and resources. ast(growing technology firms can harness the know(how from a venture capitalist firms stable of past and current companies. &hese firms can connect with industry insiders who can help the company obtain contracts, partnerships and exposure that they would either not have had access to or would not have known about. " .O&$'== F+3%
&he overall function of private equity is to drive an increase in shareholder value. A consequence of this is better capitali%ed, better managed, more resourceful and disciplined companies. -eneficiaries of private equity grow faster and stronger, use the services of more companies and employ more people. &his creates a ripple effect, producing a significant positive impact on the G.. economy.
Page 15 of 51
CHAPTER ;: ADVANTAGES AND DISADVANTAGES OF PRIVATE EUITY ADVANTAGES Investing in a private equity fund has a lot of advantages compared to other investment areas?
here are some advantages of private equity for not only investors but also the companies that private equity firms acquire/ A&''86 1$ I&6$6 /
-y definition, private equity firms work outside the public eye and do not have to follow the same transparency standards that public firms and funds must adhere to. &his allows private equity firms to reform the companies without the constraint of having to report quarterly to the #-I, )O2 or similar distractions. 'rivate equity firms generally perform very rigorous due diligence on potential I investments. -y utili%ing a team of researchers the private equity firm is able to identify most risks that would not otherwise be found. &he management receives carried interest, a portion of the profits, so managers and their staff are motivated to produce good results to investors. Although carried interest is often critici%ed for taking money from the investors, it is a very big incentive for managers.
. E39%3 S3'$% ( India is one of the fastest growing economies in the world, with
enormous growth potential in many industries. &his means that capital requirements are high, translating into an ideal hunting ground for '# funds. 2.A+'3 O1 S?%== L'+$ ( India offers a huge advantage in the form of its highly talented and skilled labor pool, which can lead to the success of the firms in which investment is made through the private equity route. &he funds are not just bullish about the businesses in India but have also grabbed a fair share of highly rated managers like 6ivek 'aul, )ajeev >upta, Avnish -ajaj, Akhil >upta, and !ikhil @hattau. '# funds are invariably on the lookout for high profile managers, not only to manage their own funds but also as their representative on the board of companies in which they have invested. 5.S+3366 1 6&$'= 63$6 ( India has firmly established itself as the worlds I& superpower with almost all major software development companies having an Indian development centre. It is also becoming the the hub of back office operations, and a leading provider of -'O and @'O services. &his has led to greater confidence in the future growth potential of Indian companies. Page 16 of 51
!.M'+$ F%'3%'= 9'$?6 ( 2apital markets have stabili%ed in the recent past with
regulators like #-I keeping a firm watch on the market development. &his means both increased opportunities as well as an easier and painless exit route for '# funds. &he emergence of entrepreneurs in India who consider '# their full time occupation is also a positive sign. -esides, there are well established corporate houses diversifying their surplus investment, as a strategy for their assets allocation, through '# funds without involving themselves directly in the operations of target companies. ".S+33661+= MA6( A recent spate of mergers and acquisitions has given rise to yet another way of exiting from Indian companies for private equity investors. ;.S+33661+= $'3? $3$ ( &he first generation of private equity players have reali%ed significant success in the last several years. or instance, 4arburg 'incus earned huge returns out from its investments in Indian companies like -harti &elecom. A&''86 1$ C9',: 'rivate equity managers are paid very well and so it is easy to attract high caliber, experienced managers that tend to perform very well. &he same goes for lower level employees at private equity firms, they tend to be the top young business school graduates. &his helps the company to utili%e best talent in the industry without shelling out even a single penny from its pocket. '# helps a company to prepare for stock market listing 0I'O1 as the exit route of investment. It opens up enormous opportunities for companies to raise funds. &he continuous scrutiny by stock market participants, #-I J )O2 facilitates efficiency improvement and proper strategic decisions. '# helps those companies which cannot raise money from the market. -y private equity company get money from the investors, which help in the growth of the company. DISADVANTAGES OF PRIVATE EUITY
"IA"6A!&A># O) I!6#&O)/ "ifficult to access for small J medium investors( private equity +imited 'artnership funds may only be marketed to institutions and very wealthy individuals? in addition the minimum investment accepted is usually more than R=mn. =. R='%& %==%*+%%, 5'rivate #quity funds normally invest in a unlisted space and they find it difficult to exit the investment at their wish, since it require concentrated efforts to find a suitable investor for unlisted company. #ven in the listed space, the impact cost remains very high due to sheer magnitude of scale.
Page 17 of 51
A long term investment perspective is necessary to achieve gains for a private equity investment programme because the investment programme depends on the company growth. It depends on the gap between entry and exit of the investor. 2.P=%%3'= 3%% ( India, being divided into a number of states, causes an investment decision to be affected by politics. 2hanges in regulation and infrastructure development are often sidelined due to friction and conflict between the state and the federal government. M.C9%% 1$9 C%' ( 2hina is a direct competitor of India and most of the private equity investors, eyeing the Asian region, draw a comparison across both the countries to decide where their money should be parked. &he new state(of( the(art airports in 2hina bear a stark contrast to the abysmal conditions of the terminals in Indias main cities. 8.H%8 366 ( private equity managers charge relatively high fees for managing capital committed by external investors 0generally around <;1 and, if the fund performs well, take a si%eable proportion 0generally <:;1 of realised returns in excess of investment hurdle rates. D%6'&''86 1$ C9',: It is a lengthy process since private equity managers conduct detailed market, financial, legal, environmental and management due diligence, which could take several months before they make final decisions on investing. #ntrepreneurs have to give up some of their companys shares to a private equity investor, i.e. control. -ecause investor have some control over the company, so it is not easy for the entrepreneur to take decision independently. Ke have to take advice of the investor to take decision and it causes delay in the process. &he private equity managers have control over the timing of a sale of 0a part of1 the business. +ack of promotion in investment across sectors ( '# funds are being channeli%ed into only a few sectors like I&, infrastructure J real estate and telecommunications, to the exclusion of the remaining industries, desperately in need of funds for growth.
CHAPTER 4: STAGES AND PROCESS OF PRIVATE EUITY INVESTMENT
Page 18 of 51
DCLR ECNR
A OE E LE G
TNSP SGN R SGG
TM E T ET I T E
GR
EE
T C R
T EV N O P I N
A A
E
E E
A S
R
U T
U I
N
. S 6'8 inancing provided to research, assess and develop an initial concept before a business has
reached the start(up phase. 2. S'$-+ 6'8 inancing for product development and initial marketing. 5. E>'6% 6'8 inancing for growth and expansion of a company which is breaking even or trading profitably. !. R='39 3'%'= 'urchase of shares from another investor or to reduce gearing via the refinancing of debt. PROCESS OF PRIVATE EUITY INVESTMENT
&he 'rivate #quity 'rocess in N teps/ . D'= O$%8%'% (D'= S+$3%8) Page 19 of 51
D'= O$%8%'% or as some call it S"eal ourcing is how "eal akers get their deals, a
potential deal can either come through a company owner approaching them or from an intermediary who will try to bring both parties 02ompany and "eal aker1 to make the deal. In some cases, they may just approach companies who are expanding fast and wish to grow further. In a year, "eal akers come across hundreds of potential deals ( but only a few are selected. 2. D+ D%=%83 D+ D%=%83 is what you could call Sdoing your homework. -efore starting detailed negotiations, investor try to make sure everything is fair and secure. Although Auditors and 2onsultants are appointed to conduct the inancial, &ax, +egal and &echnical "ue "iligence ( they also work side by side to understand the target company and its industry better. All the information collected at this time, is then used during negotiation. 5. D'= N8%'% At the D'= N8%'% phase, investor set out the terms and conditions 0covenants, representations and warranties1 and other deal terms that defines 0or makes the deal1. 2ontracts such as Investment Agreement, hare 'urchase Agreement, anagement Agreement, Advisory Agreement etc are drafted to include all items that put the deal together. !. D'= C=6%8 (A3*+%6%%) D'= C=6%8 is probably the easiest part but also contains an element of risk. Its the conclusion of the deal, the signing of all Agreements and transferring funds from the buyer to seller, conducting other administrative functions 0usually done by a separate entity1 like updating any articles of association etc. ". P6 A3*+%6%% M%$%8 AND E>% (IPO T$' S'= $ B+, '3?) P6 A3*+%6%% M%$%8 requires the "eal &eam 0those who have worked on putting the deal together1 to closely monitor the company, both from an operational and financial point of view against the expansion plan and budgets that were setup earlier by the company. Improvements to business, from 2orporate >overnance, inancial )eporting, and Information low to trategy are made at each level through either the companys management or its board. As the company matures 0usually after < ( 8 years1 with the presence of the "eal &eam, investor prepare it for an E>% - %$ ' IPO or a &rade ale 0sale to a larger party, multi( national or conglomerate1 or in rare cases a -uy -ack by the owners. -y this time, the company will have grown quite a bit with still plenty of room to grow further. 0&heres a saying, in a deal ( always leave something extra for the person buying ( it makes everyone happy.1 And once investor have exited the company, they return their money with the profit they gained for company after taking their fees for all the effort put in the above process. Page 20 of 51
Although this may seem like a linear process ( it isnt exactly so, primarily because investors deal with a number of companies and each one is at a different stage in the private equity process.
CHAPTER <: VARIOUS ROLES OF PRIVATE EUITY IN INDIAN ECONOMY
ince <::8, India has witnessed a tremendous rise in 'rivate #quity financing. Indian companies are creating partnerships with '# firms on a scale that has not been witnessed before. Is this good for the Indian economyT 4hat kind of value does this relatively new form of financing offer to Indian entrepreneursT P$%&' E*+%, 66 I%' 39, According to the 'rivate #quity Impact study and research findings ( A quantitative comparison of 'rivate #quity( and 6enture 2apital(backed companies against their non 'rivate #quity(backed peers and relevant market indices, in terms of key economic parameters like ales, 'rofitability, #xports, 4ages and )esearch J "evelopment. In accordance with the research reports and findings from the study/
'#(backed companies grew at a significantly higher rate compared to non 'rivate
#quity backed companies as well as market indices like the !ifty and 2!$ idcap. 4ages at 'rivate #quity(backed companies grew at a significantly higher rate
compared to their peers who are not '#(backed. About HN; of top executives at 'rivate #quity(backed companies believe that without 'rivate #quity financing, their companies would not have existed or would have
developed slower. ore than N:; of top executives at 'rivate #quity(backed companies said that the number of employees at their companies had increased after the '# investment. Page 21 of 51
ROLES PLAYED BY PRIVATE EUITY IN THE GROWTH OF INDIAN ECONOMY
'#s not only provides resources of funds to the new ventures but also focuses on identifying and upgrading both product*process innovation and management functions
in accordance to the global economy. '#s plays a critical rule in the innovation process, not only as a source of finance to
innovation but through other functions that lie at the core of high tech "evelopment. '#s -ridge between sources of finance, entrepreneurs, scientists, suppliers, and customers by providing not only the required sources of funds but also an added value
of technologies and requirements. '#s typically also adds value to their portfolio companies through assistance in
strategic decisions in the day to day management of the firms. '# capitalists with technology J entrepreneurial background generate more value added than '#s with financial background
SOME OTHER IMPORTANT ROLES ARE .) I$9%'% ' M'$? B+%=%8 &he enhanced access to business and
advisory*consultancy
services
and
to
knowledge*technology that '# provide will contribute to the emergence of new markets in the global economy. oreover '#s help enterprises global product and global capital markets. &his is particularly important for #s and clusters wanting to expand the range of markets in which they would like to operate e.g new markets for intermediate inputs which the >lobali%ation process is opening. 2.) S+$3 1 E>$'= C''%=%%6 '#s complement the capabilities of innovative #s, sometimes in those areas were
entrepreneurs are less likely to be knowledgeable and capable e.g. export marketing? know whom, management, etc. 5.) F'3%=%'%8 C9=> C$'3%8 &his is particularly so in relation to marketing agreements, alliances, strategic partnerships, JA, etcUmany of these critical for fast access to global product markets. A central condition for success in many of these is prior experience which entrepreneurs frequently do not have. A '# sector may eventually have such capabilities and thereby have a strong impact on innovative enterprises quest to rapidly build global market share. !.) P$9%8 I$'%'= L%?6 It provides promotion and global links to the enterprise thus increasing the industry visibility of the firms to go for global expansion with the right partner. Page 22 of 51
".) S+$%8 1 G='= E>'6% 1 P$9%6%8 I&'%& SME6 &he value roles of '# is to provide equity based 0generally private1 finance and support
organi%ations could play important roles in promoting innovative #s and clusters in industriali%ing economies '# could become a pillar of the @nowledge #conomyUby facilitating the provision of services to Innovative #s? by being a node of three overlapping networks? and because its capabilities are largely based on tacit knowledge. oreover, by promoting # they are promoting invention 0and indirectly innovation and diffusion1, self(organi%ation and creation of new teams J tacit knowledge, and the continuous building of new markets. Interactive learning lies at the basis of these processes. ;.) F'3%=%' T$'6%% ' L'$%8 E39, ince the '# are learned and qualified investors, this could provide enterprise a new learning environment that constitute a key sector in the creation, diffusion and adaptation of tacit knowledge, codified knowledge and technology.
CHAPTER 7: WAYS OF ENTRY AND EIT IN PRIVATE EUITY WAYS OF ENTRY OR INVESTMENT
Page 23 of 51
&here are two types of listed private equity investment companies ( those which invest directly in companies and those that invest in funds which invest in companies 0fund of funds1. ome private equity investment companies invest in both direct investments and funds offering a hybrid of the two approaches set out below. "irect investors &he investment company has a private equity team who invest directly in companies, subject to the stated objective of the company. &he managers aim is to help these companies develop and progress, and sometimes restructure, in order to increase the long(term value of the companies so these companies can be sold at a profit. und of funds investors In a fund of funds, the investment company invests in a portfolio of private equity funds which invest in companies. unds of funds aim to diversify across a range of investment strategies and different sectors providing access to a range of managers. I&6%8 % PE F+6 "irect Investment &op =: 'rivate #quity "eals V &he top =: private equity deals accounted for more than MN; of total private equity deals in <::H. In <::C, top =: deals accounted for about 8:; of total deal value for the year V &he largest deal by value was @@)s L<99 mn buyout of Aricent, followed by iva 6entures investment in &el +td. and &'>s L<:: mn investment in Indiabulls )eal #state. V &op deals occurred across various sectors, with M of the top =: deals in )eal #state. WAYS OF EIT
&here are different ways in which a private equity investor can exit from an investment/ A. &rade sale A trade sale, also referred to as JA 0ergers J Acquisitions1, of privately held company equity is the most popular type of exit strategy and refers to the sale of company shares to industrial investors. &he trade sale is agreed in private and makes both the buyer and the seller less vulnerable to the external pressures of a stock market flotation. It is often advisable to keep the transaction a closely guarded secret because clients, suppliers and employees may interpret a trade sale negatively. &hese negative signals become even stronger if the negotiations fail. B. #ntrepreneur or anagement -uy(Out &he -uy(Out of the funds stake by its management team is becoming more and more successful as an exit strategy. It is a very attractive exit for both the investment manager and the companys management team if the company can guarantee regular cash flows and can mobili%e sufficient loans. &he accounting and financial aspects of this exit need to be studied very carefully. C. ale of the investment to another financial purchaser 0called a secondary market investor1 One financial investor may sell his equity stake to another one when the company has reached the stage of development or when the current development of the company no longer corresponds to the investment criteria of the original fund. &his can also occur if the financial Page 24 of 51
support required maintaining the companys development has exceeded the capacity of the fund. &his strategy has the advantage of enabling an exit when the team does not want a trade sale or a stock market flotation. D. I'O 0Initial 'ublic Offering1/ flotation on a public stock market A stock market flotation may be the most spectacular exit, but it is far from being the most widely used, even in stock market booms. A stock market flotation should correspond with a genuine wish to make the company more dynamic over the long term and to profit from the growth possibilities offered by a stock market. &herefore, the equity share placed on the market 0the float1 must be sufficiently large to ensure liquidity 5 the reward for appealing to the market. A flotation is not an end in itself but the beginning of a long process of development. A stock market flotation always leaves company open to the risk of an unwanted bid whereas equity held by an investor that company has chosen can be better managed. If company decides to opt for this route, it must be minutely prepared over a long period. #.Liquidation is obviously the least favourable option and occurs when the efforts of the head of the company and the investors to save the company have not succeeded. REASONS FOR PRIVATE EUITY PLAYERS ENTERING INTO INDIA
&he strong interest in India has resulted in very bullish stock market conditions, with trading volumes increasing substantially. &his has eased exit possibilities, with most of the early domestic and foreign entrants such as Actis 'artners, 4arburg 'incus, 2itigroup 6enture 2apital, -arings and 4est -ridge 2apital reaping significant multiples on their investments. It is little wonder that other global private equity players such as Mi, -lackstone and >oldman achs have been setting up shop in India, each with deep pockets. &he most of the private firms in India is still in the need of capital to expand them, in spite of having the required technology, labour and knowledge they are not able to become productive to the economy. &hus the advent of private equity players has provided an opportunity for these firms to grow with the economy. 'rivate #quity players have came to India with a research back up and thus they know the potential of these firms and thus there has been reduction in the corpus amount invested in 2hina than in India, which definitely gives a hunch where the Indian economy is booming.
RESPONSE TO PRIVATE EUITY IPOS
&he initial public offering completed by -lackstone intensified the level of attention directed toward the private equity industry overall as media commentators focused on the large payout received by the firms 2#O teve chwar%man. chwar%man received a severe backlash from Page 25 of 51
both critics of the private equity industry and fellow investors in private equity. An ill(timed birthday event around the time of the I'O led various commentators to draw comparisons to the excesses of notorious executives including -ernie #bbers 04orld2om1 and "ennis @o%lowski 0&yco International1. "avid )ubenstein, the founder of 2arlyle >roup remarked, B4e have all wanted to be private 5 at least until now. 4hen teve chwar%mans biography with all the dollar signs is posted on the web site none of us will like the furor that results 5 and thats even if you like )od tewart.B eanwhile, other private equity investors would also seek to reali%e a portion of the value locked into their firms. In eptember <::Q, the 2arlyle >roup sold a Q.9; interest in its management company to ubadala "evelopment 2ompany, which is owned by the Abu "habi Investment Authority 0A"IA1 for L=.M9 billion, which valued 2arlyle at approximately L<: billion. imilarly, in Eanuary <::C, ilver +ake 'artners sold a H.H; stake in its management company to 2al'#) for L
CHAPTER 0: SEBI GUIDELINES
=. &he ecurities and #xchange -oard of India 0#-I1 issued its )egulations for 6enture 2apital in =HHN, thus establishing the agencys authority over the funds, the limits on their activities, and incentives for them to finance and rescue troubled companies. &here are no legal or regulatory differences between venture capital and private equity firms. &he >overnment first permitted financial institutions 0Industrial "evelopment -ank of India, I2I2I, and I2I1, commercial banks 0including foreign banks1, and subsidiaries of commercial banks to establish venture capital companies under guidelines issued in =HCC. In addition, under current central bank regulations, banks investments in mutual funds catering to venture capital funding are considered to be outside the ceilings applicable to banks investments in corporate equity and debt. <. oreign venture capital funds have been permitted to operate in India since =HH9. &hey may either hold the shares of unlisted Indian companies directly 0up to a maximum of <9; of Page 26 of 51
equity1 or route their investments through domestic venture capital funds and companies. -efore guidelines were issued in eptember <:::, direct exposure by offshore private equity funds in shares of unlisted companies was treated as a foreign direct investment and had to be approved in line with the >overnments general policy on foreign investments. Indocean 6enture und 0now Indocean 2hase1, originally set up by >eorge oros and 2hemical -ank in October =HH8, was the first such overseas private equity fund. M. &he regulatory environment for the private equity industry was simplified in =HH95<:::. oreign institutional investors participated in the growth of the private equity industry through the foreign direct investment regulations of the >overnment and the simplified tax administration procedures under the Indo( auritius "ouble &axation Avoidance &reaty. 4hile the foreign direct investment route offered minimum investment restrictions for private equity funds, exit pricing and repatriation of capital were regulated by the )eserve -ank of India 0)-I1. &o bring these capital flows under the regulation of the venture capital industry, new #-I regulations were issued with simplified exit pricing and repatriation procedures for foreign investors. 8. ollowing amendments to the <::: budget, the >overnment has allowed private equity funds 3pass(through7 status, meaning that the distributed or undistributed income of the funds is not taxed. &o avoid double taxation, the income of a private equity fund is taxed only in the hands of the investor. 9. #-I was also made the sole regulatory authority, and private equity funds must submit quarterly reports to it. In eptember <::: #-I announced the guidelines that now govern venture capital investment, based on the Eanuary <::: recommendations of the 2handra shekhar committee on venture capital. After another set of amendments in April <::8, the following rules now apply/ 0i1 oreign venture capital investors can invest in India without the need for approval from the oreign Investment 'romotion -oard if they register with #-I. 0ii1 #ach investor in a venture fund must invest at least )s 9::,:::, and each fund must have at least )s9: mn in capital. 0iii1 A fund may invest in one company up to <9; of the funds capital. It cannot invest in associated companies of ventures that it finances. 0iv1 A fund must invest NN.NQ; 0lowered from Q9; in April <::81 of its investible funds in unlisted equity or equity(linked instruments. &he remaining MM.M; can be invested in subscriptions to initial public offerings 0I'Os1 of companies or in debt instruments of a company in which the venture fund has already made an equity investment. 0v1 &he April <::8 amendments removed the previous =(year lockup period for I'O subscriptions. &hey also allowed investments within the MM.M; category in preferential Page 27 of 51
allotments of equity shares of a listed company, subject to a =(year lock(in, and in equity shares or equity(linked instruments of a listed company that is financially weak. 0vi1 &he removal of the profitability criterion as a listing requirement had an important effect on the private equity industry as it provided an exit mechanism for investors. &o replace the profitability requirement, a firm would be delisted if it did not earn a profit within M years of listing. 0vii1 &he acquisition of shares in a venture fund by the investee company or its promoters is exempt from the provisions of the takeover code and will therefore not mandate an open offer. 0viii1 utual funds may invest 9; of the capital of an open(ended scheme and =:; of the capital of a closed(ended scheme in a venture fund. 0ix1 In April <::8 the #-I also removed some previous restrictions and allowed venture funds to invest in real estate companies, gold financing companies, and equipment leasing and hire(purchase companies registered with the )-I. N. &hese regulations have significantly improved the regulatory environment for private equity funds operating in India, such as -& India 'rivate #quity und. In addition, they reflect the strong commitment of the Indian >overnment to support the provision of long( term equity finance to domestic entrepreneurial companies
Page 28 of 51
CHAPTER 11: Ref!" ! #!#$%&$ '()*( %+e*, #!)-%,e e./), The anticipation of a new government after the elections in 2014 is expected to trigger new vigour and fresh eagerness among investors in India. Subseuentl!" the P#$%&'s expect increased activit! in both the listed and unlisted mar(ets.
COMPANIES ACT 2013 &he !ew 2ompanies Act was enacted on
right of first offer and tag along rights. A new entrenchment provision, introduced into the articles of association of companies, allows for specific articles to be amended only after certain conditions and procedures are complied with 0that are more restrictive than those for a special resolution under the 2ompanies Act1. &his in turn protects the governance rights of the '# investors. &his will enable better enforcement of the veto and other governance
rights of '# investors. '#*62 funds holding more than a <:; shareholding in the investee company will be deemed to be 3associate companies3. '#*62 funds holding less than <:; may also be deemed associate companies if they hold veto rights in connection with business decisions of the investee company. 2ertain disclosures in relation to the associate companies will need to be made by an investee company in its balance sheets. If the '#*62 fund has been incorporated as a company, then financial statements of the fund will have to be prepared on a consolidated basis and include details of the
associate companies. An extensive definition of the term promoter to include/ Any person named as a promoter in the annual returns of the company? •
Page 29 of 51
•
Any person who has control over the affairs of the company, directly or
•
indirectly, whether as a shareholder, director or otherwise? or A person in accordance with whose advice, directions or instructions the board of directors of the company is accustomed to act. As a result, '# firms exerting control 0including negative control1 in certain cases may be construed
=.
as a promoter. everal compliances have been extended to private companies that previously only applied to public companies. or example, a preferential allotment of shares, as well as an issue of debentures, is not permitted without shareholders approval, even for investment in a
private company. <. &he corporate governance framework has been made much more strict. or example, restrictions are now imposed on directors entering into forward contracts in relation to the companys securities. 2ommon law duties of directors have now been codified and breach of such duties can attract monetary penalties. M. &he scope of listed companies has been extended to include private companies whose securities 0for example debentures1 have been listed. &herefore, certain governance provisions applicable to listed companies may also apply to private companies with listed debt securities. &hese include certification of the annual return, reporting changes in promoter shareholding or the shareholding of the top ten shareholders, auditor appointment provisions, and so on. 8. )estriction on a company making investments through more than two layers of investment companies. 9. embers and depositors of a company are entitled to bring class action suits, if they believe the management or affairs of a company are being carried out in a manner prejudicial to the interests of the company, or of the members. &his may give rise to additional vexatious litigation by shareholders in a public company*minority shareholders in a company.
PUT AND CALL OPTIONS SEBI on M October <:=M, the ecurities #xchange -oard of India 0#-I1 issued a
notification 0#-I !otification1 validating option contracts, subject to the terms and conditions set out in the #-I !otification. &he #-I !otification was issued in furtherance of the powers vested in it under the ecurities 2ontract )egulation Act =H9N 02)A1. Gnder the #-I !otification, #-I has stipulated that option contracts are valid, provided that all the following apply/
Page 30 of 51
•
•
•
&he title and ownership of the underlying securities is held continuously by the selling party for a minimum period of one year from the date of entering into the contract. &he price or consideration payable for the sale or purchase of the underlying securities pursuant to the exercise of any option is in compliance with all the applicable laws. &he contract is settled by way of actual delivery of the underlying securities. &he #-I !otification specifically excludes from its scope any contract entered into before the date of the #-I !otification. &herefore, the #-I !otification does not protect option agreements made before M October <:=M from enforceability challenges. In <:=M, the upreme 2ourt of India clarified that the 2)A and the rules, regulations and notifications issued under it also apply to unlisted public companies 0see Bhagwati Developers Private Limited v. Peerless General Finance and Investment Company (201! " #CC $%&!1. Accordingly, the #-I !otification also applies to an option contract of an
unlisted public company. RBI on M: "ecember <:=M, the oreign #xchange anagement 0&ransfer or Issue of ecurity by a 'erson )esident outside India1 0eventeenth Amendment1 )egulations <:=M 0eventeenth Amendment1 were issued. urther, on H Eanuary <:=8, the )eserve -ank of India 0)-I1 issued a circular 02ircular1 dealing with the pricing of optionality clauses. In terms of the eventeenth Amendment read with the 2ircular, shares or convertible debentures containing an optionality clause, but without any assured exit price, can be issued by an Indian company to a person resident outside India under the "I route. &he pricing guidelines applicable to such options, as well as a lock(in period of one year from the date of allotment of such instruments, have also been specified. &he pricing differs on the basis of the instrument in question 0that is, equity shares or preference shares and debentures1. &he 2ircular clarifies that existing contracts will have to comply with conditions of the 2ircular to comply with the existing Indian foreign exchange laws. &herefore, parties to the contract are modifying their contract 0to the extent necessary1 to comply with the 2ircular and the eventeenth Amendment. &he applicability of this 2ircular to oreign 6enture 2apital Investors 062I1 is not clear and clarity is awaited on this point.
GENERAL ANTIAVOIDANCE RULES GAAR &he government proposes to introduce >AA), a law against tax avoidance through foreign investments. >AA) was first envisaged under the "irect &ax 2ode proposed in <:=:, and was introduced in the inance Act <:=<. &he inance Act <:=< proposed >AA) to apply from = April <:=M. &he >AA), as incorporated in the inance Act <:=<, was harsh and drew criticism. &herefore the 'rime inister appointed a committee headed by "r home, to examine the Page 31 of 51
draft >AA) proposed under the inance Act <:=< and to recommend suitable changes. 2ertain rules that provide for monitoring of the >AA) were notified in <:=M and are to come into effect on = April <:=N.
DIRECT TA CODE The )irect Tax &ode was *rst proposed in 200+ to consolidate and amend the law relating to direct taxes. The draft )irect Tax &ode is currentl! being
considered b! the
government. The
announcement
of the
implementation of the )T& is !et to be made.
CHAPTER 2: RISK IN PRIVATE EUITY A.F+%8 $%6? / 'rivate equity investors raise funds from big institutional investors such as
pension funds, sovereign funds, wealth funds, university endowments, insurance companies, fund of funds, etc. #ach fund raising 5 investing 5 fund close cycle is of about =: years duration. &here are times, when private equity funds find it difficult to raise capital for new funds. uch a situation may arise due to adverse economic conditions like the one being witnessed currently or due to factors specific to the fund.
Page 32 of 51
&he ease of fund raising depends on a number of factors like the si%e of the fund, reputation of the fund sponsor, past returns and the team of general partners managing it. anaging funding risk/ V A number of private equity firms maintain a group of preferred set of limited partners of the fund, those which are more predictable than others. V irms prefer raising large funds during better economic conditions and draw capital in form of capital calls, during the life of the fund rather than raising smaller si%ed funds. V any firms tweak their compensation structure during down cycles, making it attractive for limited partners of the fund. rom the regular <; management fee and <:; carry, firms are seen to reduce the fixed management fee to = 5 =.9; keeping the carry same or increasing it slightly. V any big firms maintain a level of overhang, or raised but not invested capital. &his gives them a competitive advantage of investing in difficult times, when there is not much capital around and valuations are low. B. R%6?6 1 '&$6 39%3 3,3=6 ' >% &%$9
&he major source of this risk comes from the fact that an economy goes through cycles, and valuations of the same cash flows may differ considerably. 2ontrol premium paid by private equity investors are much higher during boom times, than times of recession. &his is largely because of investing activity gains high momentum during formation of bubbles. M%%8'% 1 $%6? 1 1+%8 3,3=6:
&o mitigate this risk of economic cycles, the following practices are adopted by private equity groups/ V Invest uniformly across economic cycles. &hey do not invest in spurts. V Invest based on valuations of future cash flows of the company and not just on comparables and multiples as market comparables may sometimes be misleading. V Avoid competitive bidding? co(invest in deals of large magnitude. V Kave concrete exit plans in place, with key milestones and targets for the portfolio. C. R%6?6 $%8%'%8 1$9 %+6$, 6896:
&here are a number of private equity firms which speciali%e in a particular industry, or an industry segment or even a particular product category. &his is mostly to leverage their understanding of that particular segment. It has been shown that this strategy is better compared to a diversified investment strategy, as it is easy for investors to diversify their Page 33 of 51
portfolio at their level. -ut being too specific brings risks associated with that particular segment. 2ompanies that speciali%e in certain industries carry additional risks of facing downturns in that particular industry. or instance, many '# firms invested only in high(technology companies during the dot com bubble of <::= when valuations were at their peak. After the bubble burst there was little value left in their portfolio and many tech focused 62 and '# firms shut down. An evidence of this can be shown from the vintage year ratio chart? investments of the =HHH ( <::= vintage have resulted in distributions less than those of the invested capital. itigation risk from investing in industry segments/ V 4hile investing in a particular industry segment, private equity firms invest uniformly across economic cycles. V "iversify within the industry segment. V Invest across seed, early and late stage companies in that particular segment. D. R%6?6 $%8%'%8 1$9 $1=% 39'%6
A number of risks may emerge from inside of the investee companies. &hese risks include/ •
T3=8, R%6? 5 )isk of the technology not seeing light of the day or not being
commercially viable. •
M%%8'%8 $1=% $%6?6/ &he way a firm deals with these risks defines its portfolio
management philosophy and helps it create a difference. ome of the best practices while dealing with the above risks are/ •
T3=8, $%6?6 / Invest in technologies which they understand, or get opinion from
external experts. tage investments in parts and set milestones for the management team. Invest in competing technologies with smaller ticket si%es. Invest in developing an ecosystem. Invest across different stages in their lifecycle seed, early, late and mature stage companies. •
M'$?$%6?6/ 4ork closely with the management team, help it develop prototypes
and get feedback from key customer samples. Kelp the investee develop a sustaining business model, leveraging on its industry experience. •
C9', $%6?6/ 'rivate equity partners invest a lot of time and effort with each of
their portfolio companies managing unique risks faced by them, with respect to management and technical team, capital structure, cost and revenue management, etc. Incentives of management team are often re(aligned with those of the investors, usually by way of granting equity options as part of their compensation. 'erformance based milestones are often set for the management team to achieve. Page 34 of 51
CAPTER 5: DIFFERENCE BETWEEN PRIVATE EUITY AND VENTURE CAPITAL Venture capital can be viewed as a segment of private equity, from an academic point of view. But for the purpose of making investment decisions, their respective characteristics are suciently distinctive that we should treat them as separate asset classes. Those characteristics include target companies, risk-reward proles, minimum capital contributions, deal structures, liquidity, ta! benets, control vs. minority share acquired, investor e!pertise, and others. "#ee comparison chart below.$ %n simplest terms, private equity is capital that is invested in private companies. By private companies, % mean companies whose ownership shares or units are not traded publicly, because the owners want to restrict the number and&or kinds of people who can invest in them. 'rivate
Page 35 of 51
equity investors tend to target fairly mature companies, which may be under-performing or under-valued, with the goal of improving their protability and selling them for a return on their investment "capital gain$ ( or in some cases, splitting them apart and selling their assets at a prot. Venture investors, on the other hand, target early-stage and e!panding companies "often pre-revenue$ with fast-growth potential, with the ob)ective of nurturing and growing them quickly, then selling them in *+ deals or taking them public.
C"#%!)$ C(%!, f! I-e$,!$: PE % VC P!)-%,e E./),
Ve,/!e C%#),%&
Target companies
,ature companies" often underperforming or under-valued
Start ups" earl!-stage companies" usuall! prerevenue
Target industries
ll industries" usuall! with established mar(etplace for the product or service
/igh-growth industries li(e high-tech" biomedical" alternative energ!
)epends on inherent ris( of speci*c *rm and industr!. Target can be 203$!r over *ve !ears" more li(el! 103$!r or less
,an! failures" some solid returns" a few spectacular successes. #xpectations must reect the ris(s.
Investment si5e 678
100 million to 109s of billions for big P# funds: 10; million for small funds
=ess than 10 million
=iuidit! hori5on
> to 10 !ears
4 to ? !ears
Share acuired b! investor$fund
&ontrol 6often 10038 of compan!
@suall! minorit! sta(e in compan!
'unding structure
#uit! and debt
ften euit! onl!" but can be structured to *t needs of both parties
Investor activeA
Investors ma! be passive with respect to management" unless purpose of acuisition is to improve compan! performance
Investors provide advice" connections" distribution: monitor cash burn: etc.
I
expectation
* ROI = return on investment ** Often a convertible instrument is used and triggered by pre-dened milestones. [All entries in the comparison chart are estimates and generaliations.!
Page 36 of 51
CHAPTER !: LIUIDITY IN THE PRIVATE EUITY MARKET
"iagram of a simple secondary market transfer of a limited partnership fund interest. &he buyer exchanges a single cash payment to the seller for both the investments in the fund plus any unfunded commitments to the fund. 'ain article Private e)*ity secondary mar+et &he private equity secondary market 0also often called private equity secondaries1 refers to the buying and selling of pre(existing investor commitments to private equity and other alternative investment funds. ellers of private equity investments sell not only the investments in the fund but also their remaining unfunded commitments to the funds. -y its nature, the private equity asset class is illiquid, intended to be a long(term investment for buy(and(hold investors. or the vast majority of private equity investments, there is no listed public market? however, there is a robust and maturing secondary market available for sellers of private equity assets. Increasingly, secondaries are considered a distinct asset class with a cash flow profile that is not correlated with other private equity investments. As a result, investors are allocating capital to secondary investments to diversify their private equity programs. "riven by strong demand for private equity exposure, a significant amount of capital has been committed to secondary investments from investors looking to increase and diversify their private equity exposure. Investors seeking access to private equity have been restricted to investments with structural impediments such as long lock(up periods, lack of transparency, unlimited leverage, concentrated holdings of illiquid securities and high investment minimums. econdary transactions can be generally split into two basic categories/ Page 37 of 51
•
•
S'= 1 L%9% P'$$6% I$66 5 &he most common secondary transaction, this category includes the sale of an investors interest in a private equity fund or portfolio of interests in various funds through the transfer of the investors limited partnership interest in the fund0s1. !early all types of private equity funds 0e.g., including buyout, growth equity, venture capital, me%%anine, distressed and real estate1 can be sold in the secondary market. &he transfer of the limited partnership interest typically will allow the investor to receive some liquidity for the funded investments as well as a release from any remaining unfunded obligations to the fund. S'= 1 D%$3 I$66 5 econdary "irects or ynthetic secondaries, this category refers to the sale of portfolios of direct investments in operating companies, rather than limited partnership interests in investment funds. &hese portfolios historically have originated from either corporate development programs or large financial institutions
INVESTMENTS IN PRIVATE EUITY
"iagram of the structure of a generic private equity fund Although the capital for private equity originally came from individual investors or corporations, in the =HQ:s, private equity became an asset class in which various institutional investors allocated capital in the hopes of achieving risk adjusted returns that exceed those possible in the public equity markets. In the =HC:s, insurers were major private equity investors. +ater, public pension funds and university and other endowments became more significant sources of capital.C:P or most institutional investors, private equity investments are made as part of a broad asset allocation that includes traditional assets 0e.g., public equity and bonds1 and other alternative assets 0e.g., hedge funds, real estate, commodities1.
Page 38 of 51
I&6$ 3'8$%6 G, 2anadian and #uropean public and private pension schemes have invested in the asset class since the early =HC:s to diversify away from their core holdings 0public equity and fixed income1.C=P &oday pension investment in private equity accounts for more than a third of all monies allocated to the asset class, ahead of other institutional investors such as insurance companies, endowments, and sovereign wealth funds.
D%$3 &6. %%$3 %&69 ost institutional investors do not invest directly in privately held companies, lacking the expertise and resources necessary to structure and monitor the investment. Instead, institutional investors will invest indirectly through a private equity fund. 2ertain institutional investors have the scale necessary to develop a diversified portfolio of private equity funds themselves, while others will invest through a fund of funds to allow a portfolio more diversified than one a single investor could construct.
I&69 %963'=6 )eturns on private equity investments are created through one or a combination of three factors that include/ debt repayment or cash accumulation through cash flows from operations, operational improvements that increase earnings over the life of the investment and multiple expansion, selling the business for a higher multiple of earnings than was originally paid. A key component of private equity as an asset class for institutional investors is that investments are typically reali%ed after some period of time, which will vary depending on the investment strategy. 'rivate equity investments are typically reali%ed through one of the following avenues/ •
•
•
an initial p*,lic o--ering 0 IP.1 5 shares of the company are offered to the public, typically providing a partial immediate reali%ation to the financial sponsor as well as a public market into which it can later sell additional shares? a merger or ac)*isition 5 the company is sold for either cash or shares in another company? a recapitali/ation 5 cash is distributed to the shareholders 0in this case the financial sponsor1 and its private equity funds either from cash flow generated by the company or through raising debt or other securities to fund the distribution.
+arge institutional asset owners such as pension funds 0with typically long(dated liabilities1, insurance companies, sovereign wealth and national reserve funds have a generally low likelihood of facing liquidity shocks in the medium term, and thus can afford the required long holding periods characteristic of private equity investment.
Page 39 of 51
CHAPTER ":WORLDS TOP 0 PRIVATE EUITY FIRMS
According to an updated <::H ranking created by industry maga%ine 'rivate #quity International the largest private equity firm in the world today is &'>, based on the amount of private equity direct(investment capital raised over a five(year window. As ranked by the '#I M::, the =: largest private equity firms in the world are/
)A!@
')I6A&#
K#A"WGA)&#) G!"
=
&'>
ort 4orth
L 9
<
>oldman sachs 'rincipal investment area
!ew Fork
L 8CHHM
M
&he 2arlyle >roup
4ashington "2
L 8QQM<
8
@ohlberg @ravis )oberts
!ew Fork
L 8:8N:
9
Apollo >olbal management
!ew Fork
L M9=CM
N
-rain 2apital
-oston
L M8H8H
Q
262 2apital 'artners
+ondon
L MMQ
C
&he blackstone >roup
!ew Fork
L M:C::
H
4arburg pincus
!ew Fork
L
=:
Apax partners
+ondon
L <=MMN
-ecause private equity firms are continuously in the process of raising, investing and distributing their private capital rose can often be the easiest to measure. Other metrics can include the total value of companies purchased by a firm or an estimate of the si%e of a firms active portfolio plus capital available for new investments. As with any list that focuses on si%e, the list does not provide any indication as to relative investment performance of these funds or managers. Additionally, 'reqin 0formerly known as 'rivate #quity Intelligence1 an independent data provider, ranks the <9 largest private equity investment managers. Among the larger firms in that ranking were Alp Invest 'artners, A$A 'rivate #quity, AI> Investments, >oldman achs Page 40 of 51
'rivate #quity >roup and 'antheon. &he #uropean 'rivate #quity and 6enture 2apital Association 0B#62AB1 publishes a yearbook which analyses industry trends derived from data disclosed by over =, M:: #uropean private equity funds.
CHAPTER ;: CASE STUDY ON PRIVATE EUITY FIRMS
).D'=9%' C9 - KKR A+ KKR ounded in =HQN and led by Kenry @ravis and >eorge )oberts, @@) is a leading global
alternative asset manager with L9<.< billion in assets under management as of "ecember M=, <::H. 4ith over N:: people and =8 offices around the world, @@) manages assets through a variety of investment funds and accounts covering multiple asset classes. @@) seeks to create value by bringing operational expertise to its portfolio companies and through active oversight and monitoring of its investments. @@) complements its investment expertise and strengthens interactions with investors through its client relationships and capital markets platforms. @@) is publicly traded through @@) J 2o. 0>uernsey1 +.'. 0#uro next Amsterdam/ @@)1. @@) has invested more than over L=.= billion in India since <::N, which includes investments in Aricent, a global innovation, technology and services company? -harti Infratel, a telecom infrastructure provider and 2offee "ay )esorts, operator of the 2afD 2offee "ay chain of cafes in India. A+ D'=9%' C9 (B'$') L "2-+ has business interests in two major segments, 2ement and ugar. It has cement plants in southern states of &amil !adu 0"almiapuramJAriyalur1 and Andhra 'radesh 0@adapa1, with a capacity of H&'A. A leader in cement manufacturing since =HMH, "2-+ is a multi spectrum cement player with double digit market share and a pioneer in super specialty cements used for Oil wells, )ailway sleepers and Air strips. &he company also produces around =N: 4 of 'ower through thermal and renewable energy with an aim to increase the power generation from non(conventional methods. Over the past Q decades, the company has earned the trust of the employees, distribution chain as well as all its stakeholders. "2-+s vision has been acknowledged by the existing 'rivate #quity investor, Actis who has been on the -oard and adding valuable insights for the organisational growth. &he company is looked upon and respected for being a value(based organi%ation. "2-+ has been recogni%ed and awarded Kewitts -est employer for the year <::H. It has been ranked among the &op &en in the anufacturing industry. "2-+ is Kead Wuartered in !ew "elhi. It has employee strength of more than M,9:: people. Page 41 of 51
PE I9'3 DCBL "almia 2ement 0-harat1 +td. 0"2-+1, and @ohlberg @ravis )oberts J 2o. +.'. 0together
with its affiliates, 3@@)71 announced the signing of a definitive agreement under which @@) has agreed to invest up to )s Q,9:: mn in "2-+s wholly owned unlisted subsidiary 032ompany71 which will house post restructuring "2-+s H&'A cement manufacturing capacity, "2-+s stake in O2+ India +imited 09.M&'A capacity1 along with the upcoming green field projects of =:&'A across the country. &he use of proceeds will be for both organic*inorganic growth and de(leveraging. 34hen we realigned our businesses in arch, <:=:, one of our goals was to create separate pure play entities that could thrive on their own and have flexibility to raise capital. &his transaction with @@) is not just about capital but the foundation of a long term relationship. It will enable us to enhance our capacity and market share through organic as well as inorganic routes, while benefiting from @@)s global network and proven value creation capabilities,7 said r. 'uneet"almia, " of "almia 2ement 0-harat1 +imited. 34e are excited to be working with a dynamic and entrepreneurial family with a successful execution track record in India. 4hile the cement industry by nature is cyclical, this is a long( term investment in a great family business, its management team and in Indias economy. &his is a way to invest behind and contribute to the continued development of Indias residential, commercial, and public sector infrastructure,7 said r. anjay !ayar, 2#O of @@) India.
2). P'$'6 P'$9'3+%3'=6-A3%6 'aras 'harmaceuticals is one of Indias leading O&2 healthcare and personal care companies, with a track record of introducing successful branded products. Its two leading brands, OO6 0a pain relieving ointment1 and "2old 0a cough syrup1 are both in the top =: O&2 brands in India. 'ersonal care products are among the fastest growing consumer segments with a growth rate in recent years at =8 percent. 'aras have grown faster and expect to grow by <9 percent in F <:=:(<:==. Actis, a '# firm, invested G" 8< mn in <::N for a minority stake, raising it to a majority shareholding in <::C, which they continue to hold. Actis rationale for the initial investment was based on 'aras ability to create strong brands in niche, fast(growing areas. &hey were impressed with the companys ability to compete effectively against global organi%ations with innovative products? for example, the success of OO6 in a market dominated by market leader Iodex 0a >laxo brand1. Actis view of 'aras noted above is shared by its promoters. As a key company insider commented/ 3A company goes through three stages/ incubation, implementing the initial Page 42 of 51
vision and professionali%ation.7 At the second stage, the team needs to be willing to take risks and follow the founders vision. 'rofessionals are likely to be too risk( averse to do so as failure would hurt their long(term career prospects. At the third stage, once the vision has been implemented, professionals need to take charge. It was at that third stage that 'aras sought Actis as a '# investor to enable the transformation to a professionally(run company. In fact, the money was the minor part of the transaction in a sense, since it was used primarily to buy out the promoters holding rather than to be infused into the company 0the company was already cash rich1. 'aras required the '# firm to possess a deep understanding of the industry as well as understand the company, both of which Actis possessed. As a company insider notes/ 3'# is expensive money/ it should only be used if it comes with other benefits.7 '# backing provided the company credibility as a professionally run(organi%ation and there was an influx of younger, highly trained talent that replaced family recruits. 'aras recruitment of the best quality professionals led to positive impacts on operational management with a greater focus on efficiency, tighter financial controls, brand leveraging and an improved marketing and distribution strategy. &he transformation of 'aras from a family run to professional company faced the challenges of cultural transformation and was not a simple task but accomplished by focusing on these key areas and showed clear results. #-I&"A margins rose from <: percent prior to '# funding to about M: percent afterwards. ubsequent to the Actis investment, the company has also expanded internationally, especially in the iddle #ast and !orth Africa. I9'3 1 PE P'$'6 As is evident from the above, Actis impact was transformative in the sense of changing how the company was run, while being supportive of a quality that was already ingrained, that of conceptuali%ing and developing a range of high(margin products that could successfully compete with large players, many of which are global organi%ations. Actis achieved its transformation by getting to know the company, and then bringing in talent in selected areas that were critical for raising margins and enabling the efficient introduction of new products, while retaining the innovative core intact. Among the many positive effects was a change in practice in procurement, governance and reporting, thus enabling a stronger brand being builtT As a result, revenue growth rates rose to 8: percent and gross margins rose by =: percent. Actis also supported the strategic shift in sales and distribution networks? as well as international expansion. 2ritically, Actis was able to bring in a sophisticated board support through a domain expert and bring on board a prominent business leader 0who is their advisor1 as an advisor to the company. I9'3 1 PE %+6$, Page 43 of 51
&he investment shows that a domestic company can succeed while competing with global organi%ations. Although there are other successful examples, such as "abur, 'aras is a special case of achieving this through professionali%ing a family(run firm in a credible way, with a majority of non(family ownership, while retaining the benefits of incorporating the initial promoters into the core management structure.
5.A%$ D33' - ICICI V+$6 C'%'= I$'%'= Air "eccan was established in <::M with the objective of setting up a budget airline, the first of its kind in India. 'rice sensitivity and the aspirations of the typical Indian consumer were cited to be the main reasons for a budget airline. Initially, the companys operations revolved around the founder, 2aptain >. ). >opinath. odeled on outhwest Airlines in the G.. and )yan Air in -ritain, Air "eccan positioned itself as an airline for the masses. eeking capital for growth, Air "eccan obtained '# investment from I2I2I 6entures, which invested G" M: mn in <::8 for a =H percent equity share. Air "eccan also received '# investment from 2apital International, an American '# firm, which, it hoped, would provide a global presence and learning from the operations of similar airlines in other countries. -oth I2I2I and 2apital International played an active role in formulating strategy. 4ith the '# firms assistance, Air "eccan appointed a person from )yan Air to run the business. &he funds were intended to build capacity in a phased manner. Accessing '# funds was critical for being able to raise the much needed debt and to guarantee leases, without which project implementation would have been difficult. &he funds were also used to enhance plane capacity quickly by ordering N: airbuses on purchase and leased bases. -y <::Q, Air "eccan flew into NC cities, as compared with the incumbent, >overnment owned Indian Airlines coverage of 89 cities. &he high capacity was both an advantage 0as it became an attractive acquisition target for @ingfisher1 and a disadvantage 0as it adversely impacted the company financially due to the economic slowdown and unforeseen spike in fuel cost1. &he airline industry began to face significant changes in its operating environment from <::9. +arge rises in fuel prices and competition from other budget airlines like pice Eet, Indigo and >o Air adversely affected Air "eccans profitability. 4ith I2I2I 6entures assistance, some of the aircraft that had been purchased were re(contracted on a lease basis, thereby improving cash flows. In <::N, Air "eccan offloaded <9 percent of its equity in an I'O. &he I'O took place during a very difficult time for Indian equity markets. ortunately, with I2I2Is support in the form of stepped up funding as well as marketing to other investors, the issue was completed at the offer price. At its peak, the market capitali%ation of Air "eccan reached G" =.= billion.
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-y late <::Q, the ongoing pressure of competition and lower than expected growth forced Air "eccan into significant losses. In <::C, the company was merged into @ingfisher Airlines, a premium domestic airline. @ingfisher was attracted by Air "eccans large fleet that enabled @ingfisher to rapidly scale up its operations. Although the initial understanding was that Air "eccan would be the budget brand of @ingfisher, it was later rebranded with the @ingfisher name. I9'3 1 PE A%$ D33' &he '# investment in Air "eccan brought both operational and fiscal discipline. '# firms helped setup a proper organi%ation structure and created a formal business plan. &he financing enabled Air "eccan to pursue its aggressive business model of running a budget airline. I9'3 1 PE %+6$, Air "eccan had a big impact on the industry. Its no(frills flights focus on second(tier cities, and aggressive pricing led to aggressive growth and spurred the entry of comparable budget airlines. Its practices were imitated by established competitors and became part of industry practice. &he result was a fall in the average cost of air travel in India. &o a significant extent, these new business approaches were enabled by the initial round of funding and the models that were introduced by '# financiers seeking to imitate the success of budget airlines in other countries. &hus, we may conclude that '# significantly impacted the industry.
!).S$%$'9 T$'6$ F%'3-TPG hriram &ransport inance 0&1, Indias largest commercial vehicle finance company, was established in =HQH. As of arch <:=:, the company runs 8QH branches and service centers offering finance for purchasing commercial vehicles, including trucks, three( wheelers and tractors. &he company also offers ancillary services, including working capital and a cobranded credit card. &he company has been consistently profitable for several years. or the financial year ended arch <::H, &s revenue was I!) MN.H billion and '-& was I!) <.H billion. It employed =<,9:: persons. &he company has been quoted on the stock exchanges for several decades. As of arch <:=:, its market capitali%ation was I!) H=.N billion. &he truck financing business at the time, and even as of <:=:, was fragmented and high( cost due to the risks and transactions costs of lending to unorgani%ed, single(truck owners. & catered to this market but was also beginning to access the organi%ed borrowers that were coming into play as the trucking business became more organi%ed in India. &hese factors had enabled & to perform well in a regulatory environment that was significantly more
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favorable to banks than to !-2s. Kowever, the company was undercapitali%ed at the time of receiving the '# investment. &he company subsequently received multiple rounds of '# investment. In <::9, '# firm 2hrys 2apital invested G" M: mn for a =Q percent holding in &. It exited in <::C(:H. >lobal '# major &'> invested G" =:: mn in <::N and, as of <:=:, remains an active investor. &'> was interested in the financial sector in India, but the banking regulations prevented it from buying a large holding in a regulated bank. &'> was attracted by &s stability in terms of customers and credit(ratings, in the midst of the !-2 meltdown at the time. & further attracted &'> because of its reputation of integrity, efficient management and customer loyalty. &he first '# funds were used by & to integrate its regional operations and control them from its home base in &amil !adu, as well as to consider international expansion. &he second round of investing, from &'>, brought in high standards of credit evaluation and corporate governance. &'>s portfolio of Asian finance firms, such as irst -ank, @orea, provided it with the experience to establish these stronger standards. &hese were needed as the management was largely promoter dominated, which made credit rating agencies and investors somewhat cautious. Also, their securiti%ation business was relatively undeveloped. Kelped by better practices, &s portfolio, which was at G" = billion in assets when &'> invested, had risen to G" N.9 billion by <:=:. I9'3 1 PE STF '# initially enabled a national strategy, when 2hrys 2apital invested in &. &ill then, &s four regional entities operated independently. &hus, in the words of a company insider/ 32hrys 2apital provided capital during the growth phase of &.7 &'>s investment transformed the company through better internal management practices and corporate governance. &he same insider notes that, where 2hrys 2apital enabled growth, &'> 3added value7. &'> helped in improving the credit rating of the company and developing the companys securiti%ation business. &'>, therefore, is an example of a '# investor with deep pockets and experience in running financial firms in Asia and elsewhere bringing these advantages to &. I9'3 1 PE %+6$, & is the countrys largest player in commercial vehicle finance. &he primary impact of the '# investment on the industry was to begin the transformation of the business from a fragmented, money(lender dependent business to a more organi%ed business.
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CONCLUSION: 4ith its solid performance during the study period of <:=: to <:=8, the Indian '# has re( emerged in good shape from testing times of the global credit melt down and subsequent economic problems. 4hile the period ahead looks bright, It remains to be seen whether current condition will prove to be a strong platform for sustain growth. 2ertainly, the Indian growth story remains on track and continue to attract '# interest. !ew opportunities several underpenetrated sectors like infrastructure, financial services, health care and manufacturing are waiting to be tapped and appear to be generating and increased level of '# engagement. &he '# industry itself is demonstrating interesting signs of growth and evolution. &he number of domestic funds continue to expand, 4ith the experience gained in the global '# funds are spinning out new breakout funds and promoters are warming up to the idea that '# partners are more than just another source of capital and can help them achieve exceptional growth, way beyond what the promoters can achieve alone
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BIBLIOGRAPHY: B?6 ' M'8'%: A I$+3% I&69 '? H8 1+ ' P$%&' *+%,. B+6%66 K@=8 ' IT % P$%&' E*+%,. F%'3%'= E39%36. T E39%3 %9. T T%96 1 I%'. W6%6: @@@.93$=.39 @@@.6%.8&.% @@@.$%&'*+%,%1.39 @@@.$%.$8.%
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APPENDI .T E39%3 T%96 A+8 2" 20!.
SAIF A%,' B%$=' P$%&' E*+%, %&6 R6 <0 3$$ % M''6' B&$'86
G-AI/ outh Asia(focused private equity firm AI 'artners is increasing its stake in >ujarat basedanpasand -everages ahead of the companys plannedinitial public offering 0I'O1, three people with direct knowledge of the development said. AI 'artners, along with Aditya -irla 'rivate #quity, is investing )s Q:(C: crore in a pre(I'O round of fund raising by the company in a transaction that values anpasand -everages at )s =,::: crore. B&he company has raised )s C: crore ahead of its proposed I'O. &he company will come out with the issue by next financial year,B an investment banker with knowledge of the development said. 6ishal ood, managing director of AI, confirmed the investment. B4e have invested just over )s Q: crore along with Aditya -irla '#. 'ost the investment, AI holds just under M:; stake in the company.B anpasand -everages manufactures the ip brand of fruit juices in mango, apple and other flavours. AI 'artners, which manages more than LM billion in the outh Asian markets, had invested L=: million in anpasand in <:== for a significant minority stake. B&he fund is very keen on retaining some stake post the public issue and hence, has increased its stake ahead of the I'O,B another person involved in the deal said. &he company has appointed investment banks @otak ahindra 2apital and India Infoline to manage the I'O. Aditya -irla 'rivate #quity will roughly own a stake of around 9; in the company after the transaction. B&he company plans to raise)s <9: crore through its public offering. AI will partly exit its stake in the company.B -harat -anka, the chief executive of Aditya -irla '#, could not be reached for comment. anpasand manufactures mango juices mainly at plants in 6adodara, 6aranasi and "ehradun. &he company is looking at raising capital through the I'O for further capacity expansion. It is planning to set up more factories and expand the 6aranasi facility. &he new plants will be located at 6adodara, -angalore and the -engal(-ihar border. anpasand -everages has a total capacity of Q9,::: cases per day, which the company is looking to double in three years.
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B4e had initially focused on tier(II and tier(III markets, which were our target markets. &here is still a great supply gap in those markets,B "hirendra ingh, the companys managing director and founder, told #&in an interview in ay. anpasand is expected to earn revenue of around )s 9:: crore in F=9, up from about )s M:: crore in the previous year. &he firm has been able to build a strong network in small towns and rural markets, where the majority of its revenue comes from. 4ith the equity capital markets booming, private equity(backed companies will be looking to tap the markets through public issue. 2 .T T%96 O1 I%' A+8 0! 20!. LT I1$'6$+3+$ F%'3 =?6 $'%6 %==% % ' $%&' *+%, 1+
G-AI/ +J& Infrastructure inance is looking to raise roughly L= billion in a private equity 0'#1 fund focused on investing in power, roads, ports and other projects, three people with direct knowledge of the matter said, with the sector set to pick up as the new government gets cracking on improving Indias creaking facilities. &he infrastructure finance arm of engineering giant +arsen J &oubro resumed the fund( raising exercise after the general election and aims to finish by next year. &he money is expected to be raised from domestic and foreign institutional investors. A senior executive at a global secondaries fund, a direct investor in such '# funds, confirmed that it was one of those approached. Bome of the global pension funds, sovereign wealth funds and family offices have 0also1 been approached for the fund raising,B the executive said. &here is renewed interest in infrastructure with the !arendra odi government keen to ensure that projects stuck for years get going again so that the country can take advantage of an economic turnaround thats looking increasingly likely, given the economic and industrial data. "elays in execution, mostly due to lack of government approval, and high(debt levels have plagued infrastructure companies over the past few years. Investor confidence has been dented, leading to a slump in capital expenditure. &his meant that the +J& Infra '# fund had met with muted investor demand when it was launched last year. B&he change in government has helped revive the mood. Kowever, only when positive policy measures are undertaken will investors come back to India,B said a limited partner 0+'1 who was approached by +J& Infra. B&he fund si%e could come down due to the lack of investor appetite for infra at this point of time.B +imited partners contribute money to '# funds. An +J& Infra inance spokesperson said by email/ B4e had a first closing of approximately )s 9:: crore from domestic investors. 4e are assessing the interest of international investors given the change in their outlook towards India and will begin the formal process after completing the first(level assessment.B India holds opportunity for '# funds in the sector, according to >lobal consulting firm "eloitte. B'rivate equity represents a modest share of the L=(trillion to be spent on infrastructure in <:=<(=Q, about half of which would come from private sector funds, compared with a target of one(third in the previous five years,B it had said in a report. Page 50 of 51