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Private Equity

PE investments in times of fear

M&A activity typically faces a downturn when the financial markets are unstable. The unprecedented fear generated by the ongoing global economic slowdown has directly affected public sentiment and the ability to raise funds from the capital markets. Currently, it is also very expensive to raise debt. Indian companies, which have been developing at a rapid pace, cannot afford to stall growth and must maintain the momentum generated over the past few years.

These companies need further growth capital, and given the regulatory hurdles around external commercial borrowings, Indian companies will look increasingly towards private equity (PE) firms to meet their capital requirements.

The last few years has seen enhanced PE investments in India, but there is speculation (and somewhat justified) on whether PE players will display continued interest in Indian companies. However, increased pressure of liquidity, declining internal accruals and the steep fall in valuations offer a good opportunity for PE funds to make investments.

To capitalise on these investment opportunities, Indian businesses need to become more competitive. It is important that these companies allay some usual concerns expressed by PE investors.

A survey conducted by KPMG revealed that PE firms are not always pleased with the corporate governance and financial/regulatory reporting standards of privately held Indian companies. Consequently, questions are raised about the management of these companies and most PE firms tend to approach the initial due diligence process with the mindset that that the target company may be full of land mines. Some PE firms have also encountered a deviation from contractually agreed positions and this has made them largely apprehensive about promoter commitments.

In contrast, given that private companies in India are primarily closely held family run organisations, the diligence is perceived by the Indian party as an “audit” of its business practices. Although keen to become associated with international PE firms, the success of a transaction is still largely determined by the ‘chemistry’ with the outsider. A huge emotional adjustment is required on the part of the Indian promoters to accept the deal process.

For these promoters, the dilution of their family equity means diluting control and this is something they still have difficulty in accepting. The typical Indian businessman values his independence and does not want any interference with the day-to-day management.

The fact that the investment benefits both parties is unquestionable and therefore it is necessary for both to align their interests. PE firms need to mould themselves to the ‘Indian’ way of business and address the cultural sensitivities of the country. It is always helpful to take steps that make the process less intimidating for the target.

Discussing the exit strategy (a very important part of the transaction process) with the target well in advance helps in establishing a good working relationship and providing comfort to the other party. Having a good (and preferably indigenous) team on the ground, one that understands the local functioning and can balance that with the corporate governance requirements of these international players, always helps to bridge the gap. Target companies also need to recognise that aside from the money, PE investors bring management strength and access to a huge international network and export market.

To sum up, the deal process requires effective communication between the parties. One hopes that the current downturn will be a learning experience for both the PE firms and Indian businesses. With India positioned to become the second most favoured investment destination in the world (reported by the United Nations Conference on Trade and Development in its World Investment Report 2008), one hopes that PE funds and traditional Indian businesses will learn to capitalise on each others strengths.

The market sentiments, voiced by world leaders, recently gathered in New Delhi for the India Economic Summit, was that despite the current crisis India will witness steady growth. This confidence finds merit in the FDI data released by the Union government for the period between April to September 2008, which recorded investments at $17.1 billion, a 137% increase from the corresponding period in the preceding year.

In the final analysis, how effectively Indian companies are able to co-operate with the PE firms and continue to make PE investments in India a profitable option for both parties will determine whether we are able to record the estimated annual growth of 7%. With general elections approaching, the manner in which the country handles the current period of turmoil will eventually set the tone for investments in 2009.

First Published in the Economic Times on December 19, 2008



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