The Private Equity in emerging markets is still in its infancy compared to the more-developed
regions. However, the interesting growth prospects increasingly attract international
investors, in combination with a growing number of local PE firms. PE investors are especially
welcome in the emerging markets where capital shortages keep the valuations low as compared
to long term value creation.
Over the years, the role of PE funds, have been well documented, in fostering innovative and
competitive firms, and there now exists a broad consensus that a strong PE market is a
cornerstone for commercialization and innovation in modern economies. What is valid for
industrial countries should be even more important for emerging markets. The growth potential
is enormous and deserves capital to be exploited. Hence, policymakers should focus on the
creation of an adequate setting for a prospering PE market to support investments, growth,
competitiveness and entrepreneurial activities.
In a list of emerging markets; India leads the ranking of emerging market investment activity,
closely followed by China.
The global financial crisis affected the Indian economy less than anticipated, although it slightly
dampened our long-term economic growth of 8 - 8.5%, which is high compared to many other
countries. Economic development has remained stable, mainly due to India’s low dependence
on export revenues, an extensive domestic market of 1.2 billion inhabitants, and consumption
that has remained relatively resilient. Despite the difficult international financial situation,
domestic assets and companies’ steady revenues have kept investment levels high.
Growth has mainly been nurtured by the government’s extensive investments in infrastructure
development, particularly energy production. The rapid increase in public-private partnership
projects is also a new development. Favourable economic prospects and expectations of
attractive returns have stimulated private investors’ interest in India.
Private Equity in India offers huge opportunities. The increasing impact of private equity on
Indian business is a dual effect of indigenous factors such as an expanding domestic market
and globalization which would further scale up the PE Segment.
The Small and Medium Enterprises (SMEs) in India is an emerging segment and is looking at
various avenues for raising funds. For SMEs, PE investment could be an alternative and viable
source of financing. Apart from financial support, SMEs would also get exposure to global
management practices in operations, human resources management, financial planning,
reporting and investor relations. Such involvement would bring more accountability, transparency
and corporate governance. Sectors like back-end retail, logistics, infrastructure, power,
renewable energy, hospitality, transportation and telecommunication have gained favour
among the private equity firms. Even the Research and Development sector has caught
momentum. Initially, lack of capital to invest in R&D held back corporate India. Private Equity
capital is helping address this issue. Growth in R&D investments at PE-backed companies is
over twice that at their non PE backed counterparts.
Other new investment avenues with huge potential for PE investments are education and
agriculture sector in India. With an estimated US$40bn market for private institutions and a
CAGR of 8.6%, it is no surprise that PE & VC investors are looking to ramp up the investments
they have already made in Education-related companies. Even Microfinance and Clean
Technology are some emerging sectors for PE players.
Whilst the Private Equity opportunities in India are huge, so are some of the challenges that
Private Equity faces in the Indian landscape, including, lack of well established domestic
network of entrepreneurs, financiers, firms and research institutions; challenging operating
environment including family owned management practices at the smaller firms and a complex
legal system; tax environment and an innovative process to create a tax-efficient structure
for international investors.
Ideally, VCs are expected to be more involved with companies compared to PEs since they
invest in the entrepreneurial stage of the companies whereas, PEs invest during the growth
phase. However, very often in India, PE firms have to do a lot of handholding for companies.
This is because most of the companies in India are still building professional management.
Hence, in order to ensure management processes and governance, PEs step in to handhold
Deal sizes are smaller in India because companies are smaller. Average deal size is around $25
million. Though core sectors like infrastructure may need larger investments, PE firms are keen
on investing in this space because of long term value creation in India. Indian firms are mostly
promoter controlled. Promoters are hesitant to let go off their control, hence, PE firms normally
take minority stakes. As they say, it is more of “buy-in” than “buyout”. Besides, buyout market
hasn’t really picked up in India, as yet.
The main barriers to entry for PE's in India are complex regulatory issues relating to sector
investment and ambiguities in the Indian interpretation of the tax codes as well as the
regulatory costs. Moreover, what aggravates the problem is that there are multiple regulations
and little harmonization of guidelines across government agencies (SEBI, RBI, CBDT, Ministry
of Company affairs). As on date, there are no clear cut guidelines for Private Equity investment.
PE firms were viewed generally in the past as financial investors but are now expected to provide
much of strategic insight on various aspects of the business. PE firms are expected to come
up with best practices and help tighten operational aspects. Most PE firms believe that the
future lies in providing appropriate guidance to management teams so that the targets could
be achieved and the returns could be enhanced. To get strategic insights into the business,
PE firms access industry veterans and take them on as operating partners.
The PE industry is a relatively new concept in India having just less than a decade long history
in India. Even though returning Indians with prior experience in PE firms abroad are coming back
to India, most PE firm’s feel that they have to re-skill themselves to take up challenges in Indian
business scenario. They hope to overcome the challenge as the industry takes off in future.
Some PE firms feel that privatization is yet to take off in India owing to the fact that PIPE
financing still contributes almost 30% of PE investment in India. Ideally, partners do not expect
PE firms to invest in public equity.
The exit period in India has also increased because of slowdown in last couple of years. The
exit period, which typically was 2-3 years, has now increased to 4-5 years. Extended periods
have also led to PE firms providing a second round of financing in companies in which they have
already invested. Furthermore, the legal and equity protection rights are still evolving in India,
enhancing the concerns of PE firms about the inherent risks involved in investment projects.
Competition owing to ‘qualified institutional placements (QIPs)’ is another challenge for Private
Equity in India. Merchant bankers who advise companies on fund-raising options say companies
prefer QIPs over PE investment for various reasons. These include the need for giving board
representation to a representative of the PE firm if it is picking up a significant stake, which
is not mandatory in case of QIPs. Besides scrutiny of management decisions, PE investors also
tend to take a much longer time to invest through stringent due diligence compared with QIPs
which usually take place within a few weeks.
Besides giving listed companies the option to raise funds, QIPs also enable them to raise money
from foreign investors in the domestic market rather than going abroad and issuing shares in
international markets through depository receipts.
To sum it up, private equity has entered the economic mainstream and has gained a lot of
momentum over the past few years. Venture Capital/ Private Equity funding is a significant
percentage of our FDI inflow, and such funding should be nurtured and encouraged further
as it creates new ventures and new employment with the investment being made with a long
time horizon. VC/PE investments can significantly contribute to Forex reserves, reduce rupee
volatility and be one of the important factors contributing to financial stability. A simple, welldefined
and unambiguous regulatory regime can help the private equity industry to grow
further. IVCA continuously works with the policy makers and the Regulators to create a positive
environment for encouraging higher inflow of funds and for promoting Domestic fund raising.
The contractual nature of private equity funds in combination with the trend towards selfregulation
by industry groups suggests that the sophisticated players in the private equity
are themselves capable of disciplining opportunistic behaviour by fund managers and advisors.
This strategy ensures that possible rules and regulations are in line with both best practices
and standards applied in the world of private equity.
Everything said and done, to make the above happen; PE firms, in coordination with IVCA, have
come together along with the regulators to create specific regulatory provisions for the PE
industry. A right form of regulation will not only benefit the existing PE firms but also lead to
the growth of the PE industry by routing more PE firms to India.
The Indian Private Equity & Venture Capital Association