How to open the tap of private equity funds

R. Balaji
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Businesses should not be a one-man show even if driven by an entrepreneur; the environment should be professional.

If you are an entrepreneur, even if a first-generation one, money will not be too hard to come by, if there is clarity on what you are going to do with it and how you are going to return it, say private equity investors.

Entrepreneurs need to look beyond just the money, when they are planning to look at private equity. PE funds have more to offer and promoters need to balance the need for money with the value-addition that such funds can bring in.

Expertise and brand value

For instance, there is the expertise – a PE looks at 100 business plans before committing to a couple of investments. That is a lot of knowledge that a fund representative brings on board for the welfare of the project. And then, there is the brand value a recognised fund brings in and the related benefits in terms of market credibility and attracting talent.

Participants at a recent meeting on private equity got an idea of what the funds look for and what the promoters should ascertain before choosing a fund – this is a partnership that they should enter into with a clear exit plan. As one fund manager put it, funds can be quite “intrusive” to protect the investors' interest. So the partners' roles and responsibilities should be clearly defined at the start, a process that could take several months.

To make for a happy relationship, there are a number of questions on both sides that need to be answered. Here are a few important ones and the answers they expect:

If it is a first-time entrepreneur without a proven track record, funds look for the promoter's commitment to the project. What has the entrepreneur brought in to justify expectations for more from others? Is there a growth plan, is the model scalable? Where is the company going to be in the next 5-7 years?

And, of key concern for the fund - is there a clear exit route? The life of a fund is about 5-8 years after the investors hope to exit with returns a few multiples of initial investments.

In India, private equity restricts itself to a minority stake and leaves the running of the company to the entrepreneur, so they bet safe – the money goes into companies in infrastructure, financial services, healthcare, consumer goods and education. However, others will just have work harder at convincing them.

Personal commitment

Personal commitment and impeccable character appear to come high on the agenda. Senior executives addressing a seminar on emerging trends in private equity organised by the Indo-American Chamber of Commerce and Industry were unanimous on this qualification.

Mr G.V. Ravishankar, Principal, Sequoia Capital India Advisors Pvt Ltd, says that when it comes to funding entrepreneurs who are just starting out, apart from the project fundamentals and potential for growth, Sequoia looks at the entrepreneur – is there ambition and drive to go the distance?

“What excites us is the energy they bring in, conviction in their idea and passion for business,” he says. Investors avoid situations where people are not willing to put in their own money.

A key difference between the US and India is that the depth of the market is low. So funds typically are comfortable addressing some sectors while they are yet to consider others, even if there are upsides. For relatively new areas, entrepreneurs need to “do a tremendous job of selling and make us see their view to buy into an idea.”

Mr Brahmal Vasudevan, Managing Director, ChrysCapital Inv. Advisors (I) Pvt Ltd, says the basic assessment is of the track record, history of growth and margins – not just of the top line but also profitability – and the promoter's capacity to think of where the company wants to be in three to seven years and a plan to achieve that goal. The second big thing is behaviour, according to him. Clearly, some behave better than others. There are the promoters who are willing to commit their personal wealth into the company and business. But there are also those who do the reverse. “In good times all are good.” But even in India there are bad times and it is then important to see how the promoters treat the minority shareholders, he says.

Professional environment

Mr Suresh Raju, Executive Director, TVS Capital Funds Ltd, says that other than concentrating on their niche in logistics, the fund believes the people involved in the venture are an important factor. They look for entrepreneurs who find it “difficult to sleep if there is a problem, people who move quickly and have the ability to work with other people.”

Businesses should not be a one-man show even if driven by an entrepreneur, the environment should be professional. The second rung of management should be in place for the company to continue even without the promoter, he says.

Mr A.S. Thyagarajan, Managing Director, Aquarius Investment Advisors (India) Private Ltd, says that character is the most important aspect they look for in an entrepreneur. As long as Aquarius Investments sees that the promoter can gel with it, shares its values, articulates what he plans to do over the next few years, shows the ability to change with the times and can attract the right personnel, “I thing we are interested,” he says.

Apart from the cash, what do the PE funds bring to the table? And what do the promoters need to look for?

High-end talent

The partners need to be culturally aligned. If there is no match, then they cannot work together. The funds bring in expertise, if the entrepreneur needs it, credibility and ability to attract high-end talent, says Mr Suresh.

For instance, TVS Capital Funds has the TVS group and Shriram Group behind it and that can give a promoter a lot of credibility and ability to attract high-end talent to the company. Such PE brings in an entire ecosystem and knowledge of ways to grow the company.

Mr Thyagarajan says the amount of knowledge available with PEs is huge. They study 100-500 companies each, before making a handful of investments and that knowledge is available free. But what the fund wants is not a share in the board level responsibility but a “share of the mind of the promoter.”

The fund can help promoters fine-tune expectations to reality either to think bigger or to scale down. The fund may, at best, monitor the plan to ensure the promoter sticks to it and not interfere with the running of the company.

Mr Vasudevan says it is important for the promoters to be clear on what they expect of the PE. Is it only money or more, in which case the partners need to clearly define their respective roles including a clearly charted exit route for the PE. What are the rights that the promoter is willing to give to the PE, board representation? Veto rights?

Mr Ravishankar says the fact that Sequoia is in the mix helps companies a lot. The brand is important because it is built on a philosophy, culture and track record. So, companies need to find out how the funds deal with the tough times, how much support do they give?

Due diligence

Promoters should look beyond the sales pitch. They need to talk to many people about the funds, look at the kind of investments they have made and the experience of those funded by them.

“Talking to more people is the start of due diligence,” he says.

Also, the age of the fund is important. A 3/4-year-old fund will want to exit early. But a fresh fund will wait 7-8 years.

Valuation will remain a contentious issue, feels Mr Thyagarajan. Aquarius never gets into bidding or pricing war. “If that happens, we walk out,” he says.

Mr Vasudevan says there is never a right answer to valuation. In over a decade, his company has done about 50 deals, exited about 35, and the best companies always continue to appreciate when PEs exit.

Entrepreneurs will continue to add value and make you wish you held on longer. But that cannot be helped because a fund life is only about 7-10 years and investors will commit their money to funds only if there is monetisation. So funds need to sell something.

There have been companies that PEs have held on to for 6-7 years and some they have exited in a couple of years. Usually, when the fund underwrites, it expects to make about three times the value in five years. If the incremental returns are not as expected, then that is the right time to sell.

(This article was published on January 24, 2011)
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