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A peek at the set of parameters that influence the investment decisions of most PE players
If you are a promoter of a firm, what do you really need to showcase to prove Private Equity (PE), which is currently booming in India? How do you become a Gokuldas Exports or Allcargo, both of which have successfully wooed one of the world’s largest PE players, the US-based Blackstone? The trick, it seems is to convince investors that you offer an almost perfect and appropriate investment opportunity and that, over the years, the valuation of your firm will grow substantially by domestic wealth standards, which may or may not be so based on global standards. However, to achieve this objective, all promoters, who wish to attract private equity, should ask the one basic question: what do private equity firms look for in a start-up or a mid-stage venture?
Deepak Dayal (Vice President, First Tier Capital) avers, “While one cannot pinpoint a single determinant of success, yet the focus for PE firms is on two core areas, the capabilities of the management team, and the prospects for sustaining and defending the company’s revenues and profit formula.” This sounds quite logical; in fact, investors pay a lot of attention on the quality of top management than to any other factor when they decide to invest in any firm. Some experts argue that of the 10 parameters that are taken into account before investing in a firm, eight are directly or indirectly linked to the management team in place.
Consider the case of Infoedge whose team, according to PE firm, ICICI Ventures, had the passion, vision and commitment. Finally, ICICI Ventures saw a great opportunity in the execution capability of the top managers which, it seems, had the ability to take the business proposal to a critical target and addressable market. This was reason enough for the investors. In the past, most businesses have failed because of the lack of management dynamics, rather than the market or technology reasons. This is the reason why IDFC decided to invest Rs.2.600 million, its largest-ever investment in a single firm, in Goodearth Maritime. The investor pumped in Rs.350 million in Doshion Ltd., a water-management company, because of the company’s proven technical and project-execution records.
Most PE players do take into account the investee’s historical financial performance to predict future financial projections. Agrees Sanjeev Aggarwal (MD, Investment Advisor, Helion Ventures), “PE firms are very good at making projections from past data.” The traditional form of financing, based on current business models, is no longer the order of the day since business plan keep changing by the minute and firms invariably have to scout for new things that they need to pursue to be a step ahead of their competitors. Therefore, investors today are more interested in funding companies that have proprietary technology or know-how.
According to Kalpana Jain (Senior Director, Deloitte Touche Thomastu India), other important funding-related factors include the size of investment, sector and location. Private Equity firms cater to investment opportunities, where the business has the potential for realistic growth in an expanding market and this is backed up by a well-researched and documented business plan. This is especially true after the burst of the dot.com bubble, when several venture capitalists and PE firms lost a lot of money that was invested in ideas, rather than provable growth plans. Explains Mukund Krishnawami (Founder & MD, Lighthouse Fund), “Since we lost money, we have become very skeptical.” Sharing his thoughts on this issue, Jitendra Gupta (Executive Director, Finance, Macawber Beekay) adds, “Unless a business proposition is able to offer the prospect of significant turnover growth within a stipulated time frame, it is unlikely to be of interest to a private equity firm.”
Therefore, it’s not surprising that a few sectors become the flavour of the year at some point in time and others occupy those slots at some later stage. At present, PE players are gung-ho about investments in infrastructure. At a recent seminar, Shivani Bhasin, a Principal in IDFC private Equity, said that India will invest nearly $450 billion in infrastructure over the next five years, and thanks to several incentives given by the government to private players, investment in the sector will double to 8% of the country’s GDP in the same period.
The other exciting sectors for the PE firms now are media and telecom infrastructure. Warbug Pincus has invested $33.33 million for a 7% stake in Dainik Jagran. The opportunities are so large that no one wants to miss the bus in the print media; global private equity investor Blackstone Group has invested $275 million in the Hyderabad-based Ushodaya Enterprises, the owners of Eenadu and ETV. Temasek Holdings, Investment Corp. of Dubai, Goldman Sachs Group, and others have invested $1 billion for a 10% stake in Bharti Infratel (the wholly-owned telecom tower subsidiary of Bharti Airtel). In addition, Kohlberg Kravis Roberts & Co put in $250 million for an estimated 2% stake in Bharti Infratel.
Competition and competitors are yet another set of parameters that investors like to dwell upon before zeroing in on their investment decision. Putting forth his view on the issue, Anubhav Gupta (Investment Analyst, Kim Eng Securities India) says, “The current competitive advantage possessed by the investee firm, the investee’s market and competitive position and the current competitors are certainly considered by the investor.” Therefore, New York Life Investment Management India Fund pumped in Rs.225 million in Avesthagen, a systems biology firm, because the latter has the potential to develop valuable intellectual property portfolio. Similarly, the PE firm’s $25 million infusion in Sarvana Global Energy was because of the cost competitive edge of the latter.
Considering the risks involved and the lock up period of the capital, it is but natural for private equity investors to expect their investments to significantly outperform other forms of investments such as bonds and equity markets. Probe Gupta a bit and he elaborates on the finer details: “A good concept and the execution approach are pivotal. The investors show considerable amount of interest in start-up companies with high growth prospects, probably those being managed by experienced and ambitious teams, who have the capability to transform their existing business (plan) into reality. There is no thumb rule as such, provided there is a real growth potential then the private equity industry is interested in all stages, from start-up to buyout.”
Private equity is a creative mode of financing and investors invest with the aim to exit to earn profits. Ajay Kapur (CEO, SIDBI Venture Capital) adds, “The investors values the investee on comparable multiples and more so where the investee company is likely to witness growth by the time the investor wishes to exit. A clear exit strategy and possible mechanism are prime considerations.” There are few ethical investors who do not invest in companies, which in the near future, might compete with their existing investments. This stands out to be an important parameter for selection of startups. The investments are often followed by efforts at streamlining to revive the loss-making companies or substantially improving the performance of profit-making ones. Since private equity companies derive their returns from the appreciation in the value of the acquired asset or company, they ensure that they offer much more than financial assistance in terms of the offering they bring on the board. These efforts are aimed at adding value to the investments before the private equity investors can exit.
However, after the dotcom bubble, and given the risks, hard work and patience to earn returns, there is some form of reluctance on the part of the investors to invest in a start-ups. Many analysts are of the opinion that unless there is an overcrowding in the PE space or else the pricing becomes unattractive, most investors are not likely to revert to early-stage deals.
The industry certainly thrives on a disparity of views, but nevertheless it’s continually growing. In the present financing scenario, it is all the more important than ever to have a business plan, pitch and value proposition even before the investee companies hold talks with potential investors. Any investee company with a potential, a committed and experienced management with sound track record, capacity and organisational skills to implement business plans into actions can easily grab the attention of the PE biggies. The investors on their part gain exposure to specific markets by being specialists.
Edit bureau: Gyanendra Kashyap
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Source : IIPM Editorial, 2008
An Initiative of IIPM, Malay Chaudhuri and Arindam chaudhuri (Renowned Management Guru and Economist).
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