Beware! PE investment is a double-edged sword

Two recent unsavoury incidents highlight the plight of promoters and founders who rely too much on private equity (PE) investors.

In June this year, PE investors of Wealth India Financial Services, which owns Fundsindia.com — a popular mutual fund investment advisory website — ousted its co-founders CR Chandrashekhar and Sreekanth Meenakshi.

Differences of opinion cropped up between the PE firms — Inventus Capital, Foundation Capital and Faering Capital — and the promoters of FundsIndia.com on the way forward for the business.

As these PE investors held majority stake in Wealth India, they showed the door to the co-promoters.

Another (in)famous incident is the Cafe Coffee Day episode . In an alleged suicide note, VG Siddhartha — founder of Cafe Coffee Day, said that pressure from his PE partners and other lenders, as well as harassment from the income tax department, had become unbearable.

Also read:Bitter brew: VG Siddhartha’s tragic demise raises concerns about tax terrorism

While the veracity of this letter is yet to be confirmed, it has nevertheless brought out the grey side of PE investments. While in the FundsIndia case, the damage was restricted to promoters/founders alone, in the latter, retail investors have suffered collateral damage, as the share price has fallen sharply in the secondary market.

Gone are the days when investments made by PE players were considered safe bets and a win-win situation for both the promoters and the PE firms.

McKinsey’s recent report ‘Private markets come of age’, points out that the growth in private investments is influenced by a combination of factors, including investors’ need for higher returns as well as declining returns in other asset classes.

Hybrid instruments

Till now, the public and investors believed that PE investors enter a company with a three to 10-year horizon on expectation of a certain market-based return. In many cases, the promoter gives an exit option to these marquee investors, either through a buyback (at a predetermined price) or by going public through an initial public offering.

However, some of these deals, it appears, are not straight-forward equity infusions. They are hybrid instruments that contain both equity as well as debt components. Some PE investments are even debt products involving convertible debentures or preference shares. Such structures can sometimes be loaded in favour of the PE investors with a put option or a buyback clause requiring the promoters to buy back the security at a specified price and time. Problems arise when the promoters do not have the money to honour their commitments; such a situation forces them to sell other assets/properties or take loans to execute the deal.

The CCD episode suggests that SEBI should ask all listed firms to disclose the deal structure of PE investments that they receive. Besides, the market regulator should also mandate compulsory disclosures on any personal deals entered into by the promoters or through unlisted subsidiaries, to raise funds as in the case of pledging of shares.

Also, it should pass a diktat to all listed companies that henceforth, there should not be any hidden clauses in PE investments.

Role for MCA

SEBI should also escalate the issue with the Ministry of Corporate Affairs about the various deal structures, and if need be, push for legislation too.

PE funds should also be made to disclose the investors’ profiles, at least to SEBI.

In a liquidity-crunch situation, funds from any quarters are welcome, but they should be properly structured for the benefit of all market participants. That would be achieved only if the expectations on returns of PE investors are moderated.

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