The IVCA-PRIME PE/VC Directory was launched by Mr. U.K.Sinha, Chairman, SEBI in Mumbai on 7th July 2011. Click here for photos.
Private Equity Investments in India : Challenges faced by Investors
Sanjay K.Asher
Crawford Bayley & Co.
Ankit Paleja
Crawford Bayley & Co.

A. In the last 15 years, India has seen a lot of movement in the Venture Capital (“VC”) and Private Equity (“PE”) investment space. The year 2007 witnessed a steep rise in the number as well as the value of the Venture Capital and Private Equity investments in India and was considered as the golden year for investments in India. The total investments made by VC funds and PE investors in India between March 2008 and December 2013 was approximately USD 60 Billion. In the last five years, except for the year 2009 (being the year in which the effects of the global recession were felt in India), India witnessed a robust growth in the deal volumes of PE and VC investments in India even though the deal values were fluctuating. The Exits made by PE Investors during the period between March 2008 and December 2013 were approximately USD 28 Billion. Analyst and economist predict that the PE and VC investment space in India is continuously growing and there is still lot of potential for investments by PE Investors and VC Funds.
B. Though the PE and VC space in India is maturing, the Indian scenario does throw up various challenges for PE and VC Investors. PE Investors and VC Funds are exercising caution and do become very selective whilst investing in India.
C. At the outset of considering making any investment in India, a PE player looks for the right business segment, target company and product range. Indian markets are not deep enough for specialization. Though there is not enough market for niche and specialized products, investments in companies which have large volume sales do appear to be attractive. PE Investors and VC Funds also have the option of selecting a product which has gathered domestic goodwill.
D. Typically in India, there are intermediaries who act between the target companies and investors. There is a likelihood that there is a hunky dory picture shown by the intermediaries to the PE Investors and VC Funds of the target company. There have been cases in India where even the financial statements of the target company are beefed up to attract PE and VC Investments in the target company. Instead of just relying on the financial statements of the target company, PE Investors and VC Funds are now required to study the market for the products offered by the target company and to test its viability in the longer run. Data and information from industry peers do play a vital role in determining the health of the target company, its market capitalization, future growth and above all the valuation which a PE Investor and VC Funds may get at the time of an Exit in the future date. Comparison of the working capital requirements, capacity installation and capacity utilisation do give a broad indication in relation to the sales or revenues generated by the target company. A thorough due diligence of the target company conducted to a certain extent reduces the element of fraud. However, the risk of fraud can never be eliminated.
E. Every Promoter of the target company does play a vital role in attracting PE and VC investments. The role played by the Promoter of a target company is vital at all stages of investments i.e. (a) before the investment is made, (b) during the continuance of the investment and (c) at the time of Exit. Though, on paper, there are various rights which are made available to the PE Investor and VC Fund including the Exit right, however, in practical sense it is upto to the Promoter to allow enforcement or to disregard such rights. Therefore, investments preferably should be made in target companies with Promoters with a track record of extreme integrity. Also, often it is seen that there are material pecuniary relationships between the Promoters and the target company, which other than being related party transactions, is a mechanism by which the Promoters at times withdraw their equity contribution from the target company. Relentless and unaccounted transactions, perks and benefits made available to Promoters generally do not support a healthy investment environment. At times the complicated structures set up by the Promoters are not genuine and lot of attention should be paid by PE Investors and VC Funds to the inter se transactions before investments are being made. It is also not new to witness that the Promoters shareholding is a creation of ‘round tripping transactions’ and not genuine contributions. It is incumbent that all such shortcomings are identified and considered for the purpose of valuation and accordingly the further terms of the Investment are agreed with the target company.
F. The Board of Directors play a vital role in forming and implementing business plans which is framed in consultation with the PE Investors and VC Funds. The idea behind the framing of business plans is to ensure that identified ratios are with a view to provide an Exit to the PE Investor and VC Funds at the valuation as may be perceived by it. It is not new in the Indian context that instead of a professional diversified board of such as lawyers, chartered accountants, technical experts, the Board of Directors mainly consists of close knit family members who don’t (even if they can they don’t) exercise their discretion in governance of the target company. In fact, in certain small companies, the independent directors become so well known to the Promoters that they can hardly be said to be exercise independent judgement. Moreover, just like the companies abroad, the Board of Directors in India must physically meet once in 3 months to take stock of the situation and discuss serious issues instead of holding mere ‘coffee table talks’ or meeting for the purpose of enjoying ‘expensive lunches’ or ‘cashew nuts’. In the event, the Board of Directors is unable to meet, a Supervisory Committee of the Board members should be constituted which in turn meets at more regular intervals and prepares a report and submits the report to the Board of Directors, PE Investors and VC Funds. In order to ensure that adequate information is made available to investors, the minutes of meeting of the Board and its committees should be recorded more elaborately, which along with the other the books and accounts of the target company should be made easily available to the investors. Considering the recent cases of corporate fraud, it has become essential that PE Investors and VC Funds not just rely on the monthly statements provided by the target company, instead exercise their information rights to review books and other information and also their right to interact with senior officials of the target company to verify such statements.
G. Auditors of a target company are the only outsiders who have unrestricted rights to each and every book of account, including bank account statements and all documents which pertain to the financial matters of the target company. As a result of the role played by Auditors of a Company, the expertise which are possessed by them and considering the access given to them to all the books of the Company, in the event of any fraud or suppression or misstatement the Auditors shall be taken into confidence. It is therefore necessary that the Promoters or the target company does not exercise any control over the judgements and disclosures being made by the Auditors and the PE Investors and VC Funds are given unrestricted access to approach the Auditors of the target company to discuss matter of concern in relation to the financial statements of the target company.
H. Corporate Governance is relatively a new concept in India and is still under implementation and the significance of which is yet being understood by Indian players. PE Investors and VC Funds often witness the non-independence of the Board of Directors which leads to arbitrary and unfair decision making. Formation of recommendation committee (which recommends the independent directors) instead of the shareholders recommending the independent directors (which hardly can be said to be independent) helps to promote independence of directors rather than such directors being influenced by the Promoters. Further, various related party transactions which generally are less transparent do affect the valuation of the target company. If related party transactions are on arm’s length basis there should be enough checks and balance before entering into any such transaction to ensure that such transaction are genuinely on arms-length basis. A related party transaction with a customer or a supplier, after having entered into, cannot even be proved by forensic experts or internal audit checks as not to be on arms-length basis when the related party and such customer or supplier are hand in glove.
I. Above all the rights which are made available, a PE Investor or a VC Fund is often most interested in the right to Exit. Though, on paper, there are various rights which are made available to the PE Investor and VC Fund including the Exit right which are considered as fool proof and exhaustive in favour of the investor, however, in practical sense it is upto to the Promoter to allow enforcement or to disregard such rights. In the event such rights are not identified by the Promoter of the target company at the right time, the investor will be left to litigate. In the bargain, a PE Investor or VC Fund losses the valuation and the time and would have to settle for an Exit at a lower valuation than what was initially envisaged by investor at the time of making the investment. Therefore, an investor shall not only provide for such ‘Paper Tiger Rights’ to get an Exit at the right time, valuation and price, but instead should ensure that the structure of the transaction is such that it provides for an automatic remedial process which (a) fall within the four corners of law and (b) minimizes the requirement of litigation, and yet ensures a timely exit for the investors.
Despite of all the shams and scandals, PE Investors and VC Funds continue to make contributions to target companies in India. However, it is high time that strict checks and balances are brought in place by the PE Investors and VC Funds to at least safeguard the interest of their constituents. It also remains to be seen that whether the challenges faced by the PE Investors and VC Funds (a) have been addressed by the Companies Act, 2013 or (b) if addressed, to what extent will they be effective when put to test.

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