India's Private Equity and Venture Capital has seen significant evolution over the years. The investment world has witnessed continuous growth with a rise in scale of deal activities. The strong growth witnessed within the sector is because of the improvement in the process and practices such as the improved due diligence process covering both the business model and the entrepreneur.
Market Dynamics
In May 2024, PE firms invested US$ 6.9 billion in more than 100 deals. In the past few years there was a decrease witnessed I investments made by the PE firms, but in May 2024 the industry has witnessed a growth of 61% over the last year indicating the untapped potential available in the Indian Markets.
Investment Dynamics
Private Equity Fund is an aggregation of investments made by group of HNI’s, endowment funds, pension funds and sovereign wealth funds, which are then managed by general partners of PE firm. These funds typically invest in private companies with high growth potential, funds are built on a high risk – high return model.
Over the past decade, Private Equity in India has proven, to achieve a high return, acquiring a majority stake in the target company is necessary. This approach has allowed the PE firms to implement strategic and operational changes effectively, improving growth and valuations. In terms of investment market, currently India is the third largest emerging nations in the world with possibly being the one, delivering the highest returns.
Strategic View
Private Equity has been instrumental in India’s economic development. India with their entrepreneurial mindset have achieved the status of being called the land of startup. The government has initiated various schemes to promote these brilliant minds and the startup culture. With rising startups and India being one the fastest developing nation, PE firms have succeeded in expanding and achieving their goals in the Indian market.
Investor’s Perspective Towards PE
- Strategic Alignment: Investors have a purpose in their mind and choose the companies that align with their strategic goals, whether it’s acquiring a new technology, entering a new market or expanding its market reach.
- Valuation: Various methodologies are used to value the company before making an investment and the companies which have potential for growth, better cash flows or are undervalued against the market, these companies become the potential for investment.
- Timing the market: PE firms main aim is to take a profitable exit from the venture through IPO’s, secondary buyout or a M&A. Before making an investment, they plan an exit strategy depending on how lucrative the market is.
Investee’s Perspective Towards PE
- Control and Governance: PE investors generally seek a seat in Board Members and enough control to make strategic decisions. Companies should consider how much control are they willing to giving before taking an investment.
- Capital Requirements: Companies, to expand its operations, gain more market share, and technological advancements require fund. These companies seek these capital requirements from PE investors
- Planning and Resources: Apart from the capital, PE firm brings the industrial connection, their experience and the expertise which help the companies achieve their long-term growth.
Investment Process
- Deal sourcing and teasers: The initial stage for PE firms is to discover and assess investment opportunity through equity research, internal analysis, talking to industry experts or executives from target company and going through teasers for the companies which are up for sale.
- Initial Screening and NDA signing: After collecting a data of certain number of companies, they are screened against the investment criteria/thesis of the company. The companies in which PE firms are interested to take the conversations forward, they sign the Non-Disclosure Agreement and get access to the confidential information of the target company.
- Due Diligence: The initial due diligence is conducted on the target company based on the information obtained from primary and secondary sources. Main aim for this due diligence is to estimate the return on investment based on forecasted projections.
- Internal Investment Proposal: A proposal is created post the initial due diligence and is presented to the investment committee. The main aim is to get a formal approval and move ahead with the companies which have the potential to grow.
- Non-binding Letter of Intent (LOI): The LOI is provided by the investments team to the target company, the document contains a range for the purchase price, PE firm’s experience and expertise, post-acquisition capital structure, strategy moving forward, etc. All the details mentioned in the document are based on the information disclosed by the target company.
- Second round of due diligence: Another round of due diligence takes place, this time a bit more detailed covering the aspects like Audited and Unaudited Financial Information, Employee details and agreements, Board records, Intangible assets owned by the company.
- An Operating Model is created: In this step, PE firms create a model which has a detailed revenue and cost breakdown. The main aim for this step is to understand the details of the factor which will be responsible for return for the acquisition.
- Preliminary Investment Memorandum (PIM): PIM is a document created to be presented to the Investment Committee of the PE Firm. It is usually of around 30 pages. PIM consists of executive summary, overviews from the perspective of company, industry, financial and valuation. The document also covers the risk associated with the target and the exit strategy.
- Final Due Diligence: Post the approval from the investment committee, the PE team conducts a final round of due diligence which covers details for the stakeholders involved and any remaining information which the PE teams need to be sure of.
- Final bid and signing the deal: Post the completion of final due diligence, a final bid is sent to the target company containing the final price, financing documents and merger agreements. Once the seller with his advisors picks the final bid, merger deal gets signed and the transaction is completed.
Regulatory Framework
India’s regulatory framework governing private equity investments and M&A are the Indian Contract Act, 1872; the Indian Stamp Act, 1899; the Income-tax Act, 1961; the Foreign Exchange Management Act, 1999 (FEMA); the Competition Act, 2002; and the Companies Act, 2013. While these laws ensure that structured investments are made by the PE Firms, it continues to be a challenge for PE to navigate through them.
Challenges
PE Firms in India face several challenges, including diverse culture and traditional market practices. Regulatory hurdles, such as restrictive covenants placed on leveraged financing for M&A transactions acts as a demotivating factor for PE firms.
With growing Indian economy, PE Firms from around the world are attracted to build and invest in Indian markets, eventually leads to intensifying the competition for existing PE Firms, also being a major reason to driving up the valuations for private companies.
In India, there are a large number of portfolio companies which are a bit restrictive against PE Funding as they know PE firms have a planned exit before they invest, which makes the director of board companies believe that this could disrupt and effect the normal working of the business.
Future Outlook
Despite these challenges, future of Private Equity India looks promising. As the markets will grow and ease of regulations will prevail, the importance of strategic synergies will increase, PE Exits will majorly be dominated by the strategic investors followed by the secondary exit and IPO.
The growth drivers for the PE Investments will be the increase in consumption along various sectors, also the upliftment of the rural areas and their contribution in the growing economy.
In the past years, PE has played a vital role in developing the economy from incorporating corporate governance to building out infrastructural projects. As the markets will grow, PE firms will continue to adapt and grow themselves, being a major contributor to Indian economy’s growth.
Advice & Suggestions
- Understand the PE Firm’s Role: It is important to recognize that the PE firm is an active working partner rather than a passive partner. They will have a say in strategic decisions and probably representatives at the board table as well. The target firm should be well prepared for this active participation and ensure their alignment is towards the strategic goals.
- Clarify the investment motive: PE firm’s main is to achieve maximum profits and returns on their investment, the way they choose to achieve may or may not align with target company’s objective. It is important to understand whether PE firms aim is to drive the growth of the company or achieve its return by restructuring the firm and selling of its assets.
- Maintain Company Culture: it is important to preserve the company’s culture to boost employee’s morale and ensure the continuity of company’s values and mission as their risk everything might get disturbed post PE investment,
- Retain Key Talent: The target company should have the strategies in place to retain and incentivise key employees after the investment process as it is important to communicate clearly to retain the top talent as involvement of PE might create uncertainty.
- Leverage the partnership: It is important that the target company utilizes PE firm’s resources, expertise and industry connections to accelerate growth and optimize its operations.
