Decampment of private equity investments

Author: | Published: 1 Aug 2012
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India's phenomenal growth, dynamic entrepreneurism and hunger for capital to finance opportunities over the past decade, coupled with liberalisation of the Indian markets, has led to the establishment of firm private equity (PE) roots in the country and the investment industry. PE has shaped itself to the contours of the Indian economy, its unique business culture and high growth sectors. While this quintessentially adaptable industry has taken on many distinctive traits in India's hothouse growth environment, led principally by domestic consumption, it is important to bear in mind that PE investors are chiefly influenced by the overall health of the global economy and the investment climate – since they predominantly raise funds from the international market.

The Indian PE market, which started around 1996 to 1997, scaled new heights in the early part of the last decade. This was primarily driven by the success demonstrated by India in assisting with Y2K related issues, as well as the overall boom in the IT, telecom and internet sectors. While the total value of such deals in India in 2000 was US$1.16 billion, the average deal size was approximately US$4.14 million. Thereafter, PE activity tailed off in these sectors, with a resurgence only occurring in India after 2003 but no longer with a focus only on the IT and ITES sectors. This is partly because growth in the Indian economy is no longer limited to the IT sector, but spread evenly across sectors such as biotechnology, pharmaceuticals, healthcare, medical tourism, auto-components, travel and tourism, retail, textiles, real estate and infrastructure, entertainment, media and gems and jewelry. A decade ago, the key driving factors behind the flow of PE investment into India were the country's strong macro-economic fundamentals characterised by a high growth rate, high gross domestic investment and a booming stock market. Domestic stock markets recorded higher returns and a booming secondary market and regulatory reforms in the primary market widened the exit possibilities for PE. Despite its relatively young age, this industry has already seen its fair share of cyclical turnaround. In the late 1990s, the dot-com boom in Bangalore fuelled rapid growth, but the bubble bursting wiped out many players from the Indian market. Demonstrating its resilience, the industry recovered from a deal-value low point of US$470 million in 2003 to a peak of US$19.03 billion in 2007. In line with the increasing need to improve India's facilities, the biggest sectors for PE investment were real estate, infrastructure management and telecom. However, the overall PE deal distribution indicates large investments across varied sectors such as power, banking, pharmaceuticals and media.

Despite the growth and resilience of India's PE market, it retains two extremely distinctive traits: the reluctance of Indian promoters to cede management control and the relatively small size of the deals. Statistics reveal that average deal size in 2010 increased marginally to US$24 million from about US$21 million in 2009. In line with their small values, 60% of PE deals in 2010 were for minority ownership positions of less than 25%.


The lifecycle of a PE fund typically is 10 years, but these 10 years do not generally commence until the fund raises substantial capital and it does not end until all assets are sold. Accordingly, the lifecycle of the fund may stretch to as long as 12 to 15 years. Typically, the lifecycle may be segregated into six stages: (i) fundraising and formation of the partners; (ii) acquisition search; (iii) investments; (iv) growth valuation and developing investee company; (v) exits; and (vi) capital returns.

In this article, we will discuss the lifecycle of an investment post the acquisition stage and the exit options often availed by the PE investors in an Indian context.

Once a PE fund is formed, the hunt for acquisition opportunities and putting that cash to work commences. This is a complex process that involves analysing potential target companies or industries, plowing through business plans, documents and corporate filings, and filtering through thousands of potential leads. Once the suitable acquisition leads or investment opportunities are identified, it's time to make decisions and begin and complete the process of investment in the portfolio or companies that the PE selects. In the growth stage (since PE is typically in the nature of growth capital), PE typically spends its time building and growing the company for periods ranging from three to seven years.

Exit options

At the time of entry, PE investors must be very clear about their exit options and strategies, and knowledge of appropriate and preferred exit options is a necessary concomitant of entry. Profits accruing to PE investors hinge on the terms of their exit and therefore investors like to be prepared right at the outset. Preparation typically includes outlining the key features of an exit strategy in the investment documentation, strengthening the company's board, developing a detailed growth strategy, and creating an exit committee to analyse and spearhead the terms of exit. For a long time, the primary mode of exit had been an initial public offer (IPO). However, post the recent recession and the uncertainty in the capital markets, PE investors are looking at alternate options. These options include buy-backs by the investee company or redemption of shares, put option on the promoters or sale of shares to a strategic buyer or a trade buyer.


The most apparent benefits of an IPO are higher valuation, management cooperation since they can remain in operational control, the investor choosing to benefit from a longer term shareholding in the company, and price discovery of the actual valuation. However, an IPO is dependent on prevailing market conditions and involves considerable transaction costs and careful planning. The process itself takes a long time to implement, during which a drastic change in market conditions may warrant abandonment of the project. The other drawback is that the IPO may not give large PE investors a full clean exit and may often result in a mid cap valuation that does not result in the best price discovery. In spite of the partial recovery of the economy in 2010, there have been few IPO exits. Some of the high profile exits in 2010 were Credit Suisse PE Asia from Shree Ganesh Jewellery House, Trikona Trinity from IL&FS Transportation Networks, ChrysCapital from Hathway Cable, JP Morgan Partners from Jubilant Food Works and Temasek from Infinite Computer Solutions India.

Buy-back of shares/ put option

PE investors often contractually agree to exit through a mutually agreed internal IRR pursuant to a buy-back of shares. The buy-back process will need to adhere to the guidelines laid down in the Companies Act, 1956 – read with the Private Limited Company and Buy-back of Securities Rules, 1999, in cases of private limited companies and unlisted public companies and the Sebi (Buy-Back of Securities) Regulations 1998, in cases of public listed companies. According to the prescribed thresholds, there can only be a buy-back of 25% shares of the company in a given year and the debt equity ratio post buy-back cannot exceed 2:1. In addition, the buy-back of shares is permitted only from a securities premium account or from free reserves of the company. Though a buy-back of shares is not the conventional mode, for PE it is interesting to note that recent studies have shown that the maximum number of exits over the past 10 years have occurred pursuant to buy backs.

An alternate exit mechanism is pursuant to a put option. Recently, the Reserve Bank of India (RBI) has taken a view that a put option is not legally valid and will be treated as external commercial borrowings (ECB). In RBI's opinion, a sellback right, or a put option, to foreign investors may amount to one-to-one derivative deals and provides an investment instrument with the flavour of debt, rather than equity. With such a view presented by the RBI, an exit strategy has become a dilemma for foreign PE investors as the put option is often the most favoured exit option. In such event, if an investor is not being provided with an appropriate exit option, its entire rationale for the investment is placed in jeopardy.

Sale to strategic or trade buyers

The difference between strategic buyers and trade buyers are many, but the most significant one is their approach to acquisitions. While strategic buyers intend to buy, hold and develop a target because of synergies or a long term strategy, trade buyers are in the business of buying low and selling high. A sale is often preferred for the reason that it provides certainty of valuation or timing. However, the investee company management may resist due to fear of takeover by a competitor and dilution of their independence, and they often attempt to carve out competitor sales from among the permitted transfers.

A PE investor may also sell to another PE buyer (usually referred to as a secondary buyout). This type of exit appears to have developed for various reasons. For example, with PE investors increasingly engaging in niche areas (and not being sector agnostic), non-specialist investors have begun to sell to more specialist firms. Investors may also wish to reduce their deal life in an investment so they can explore other exciting opportunities. It is also possible that a PE investor may exit when both the management and the investor believe that a larger PE investor may add value to a company. The difficulty that a PE seller typically faces in such secondary buy-outs is that the incoming PE seeks strong warranty and indemnity protection, while the exiting PE would like to restrict its exposure.


The first half of 2012 is expected to be fairly tough for PE investments. Not only will exits take a lot of PE fund manager's energy and bandwidth, but the choppy capital markets and fluctuating growth may affect exit valuations significantly. Reports anticipate that nearly 800 deals made through 2007 that remain in PE fund portfolios are the likeliest prospects for exit in 2011 to 2012. Following several years when exit volumes were low relative to the number of new deals being done, 2010 was generally a record year. PE funds unwound positions in 120 companies last year for considerations of approximately US$5.3 billion. PE funds seeking exits in 2010 were able to avail from among several healthy exit options, including sales to strategic buyers and through a growing secondary sale market. Unfortunately, the correction and choppiness in the capital markets has resulted in this not being too effective an exit route.

The shortage of exits during the recession has led to a backlog of mature companies ready to exit and now, as economies are stabilising, exit activity is starting to flourish though with an emphasis on buy backs, strategic sales and trade exits. As 2012 began, the outlook for PE, though optimistic, remains shrouded in some uncertainty. Buyers and sellers are finding it hard to agree on valuations, and the public markets are anemic. With growing uncertainty in the global financial markets and a resilient Indian economy, Indian PE firms are now making a step change in the way they approach their investments and ensuring that they remain somewhat sector agnostic and spread their investment right. However, the smart investor stays focused on the end game i.e., managing his investment, securing a good exit and attempting to ensure a good return on capital.

Shardul S Shroff
  Shardul Shroff, managing partner with over 32 years of experience, is considered a leading authority on corporate governance, infrastructure, projects and project finance, privatisation and disinvestment, mergers and acquisitions, joint ventures, banking and finance, capital markets and commercial contracts. He regularly counsels boards and directors on corporate governance matters and actively participates in the Independent Directors Dialogue.

He is actively involved in the formulation and drafting of various important economic legislations and company law reforms in India. He has also been on a number of high-powered committees appointed by the Government of India, including committees on various legislations. He has served as a member on FICCI's M. Damodaram Committee, the high powered Naresh Chandra Committee (2nd Committee) (2003) and the high powered JJ Irani Committee (2006) that deliberated on the principles of corporate governance with reference to the new Companies Bill 2008.

He is the chairman of CII National Committee on Legal Services and the associate president of Society of Indian Law Firms (SILF). He is also the recipient of 'National Law Day Award' from the President of India for his unique contribution to the field of corporate law. He was recently awarded as the 'Best Corporate Lawyer of India' at the LegalEra Law Awards 2011-12. Also, he has been honoured for his 'Outstanding Contribution to the field of Law' by Chambers and Partners at The Chambers Asia-Pacific Awards 2012.

Raghubir Menon
  Raghubir Menon is a corporate and PE partner at Amarchand Mangaldas, New Delhi. He is an expert on matters pertaining to private equity, mergers and acquisitions and joint ventures. His wide experience includes mergers, acquisitions, disposals, joint ventures and reorganisations. He represents investment banks and commercial banks, private equity funds, multilateral agencies and strategic corporate clients on a variety of domestic and cross-border transactions.

Raghubir Menon has advised many private equity and venture capital funds across the full range of their operations and activities and has extensive experience in matters pertaining to fund formation, onshore and offshore structuring, registration with regulatory authorities in India, and transaction management from the term sheet until closing. This includes working closely with regulators such as the Reserve Bank of India (RBI), the Foreign Investment Promotion Board of India (FIPB) and the Securities & Exchange Board of India (SEBI), and structuring incentives and sharing of the 'carry' for fund managers.

Prior to Amarchand Mangaldas, he worked with White & Case, in London and Singapore, for five years. Raghubir Menon has a Bachelors in Law, BA, LLB (Hons), from National Law School of India University, Bangalore. He enrolled at the Bar Council of Delhi in 2011 and is a qualified solicitor (England & Wales).

Rishi Anand
  Rishi Anand, senior associate, Amarchand Mangaldas, is in the corporate practice group at the firm. His experience includes private equity, mergers, acquisitions, disposals, joint ventures and reorganizations, with extensive experience in matters pertaining to fund formation, onshore and offshore structuring, registration with regulatory authorities in India, and transaction management. He has represented investment banks and commercial banks, private equity funds and corporate houses on the full range of their operations and activities.

Prior to Amarchand Mangaldas, Rishi Anand worked with eminent law firms in Singapore and China. At Amarchand Mangaldas, Rishi Anand has represented various Indian and overseas clients, on a range of corporate-commercial transactions, involved in diversified businesses. His scope of experience comes from advising on a range of transactions including public and private buyouts, mergers, demergers, share swaps, asset purchases, restructurings and spin-offs, involving listed as well as closely held Indian companies. He has a broad sector experience and has worked closely with Indian regulators while navigating complex deals in India.

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