An In-Depth study of

Scope of Private Equity Funding in India

Submitted to: Doon Business School,

Dehradun

In Partial Fulfillment of Requirements For

Post Graduate Diploma in Management

Submitted By: Hemant Kandpal

Erp Id: 0171pgm109

Project Guide: Prof Sachin Kumar

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 CERTIFICATE – I

This is to certify that

The project report entitled

SCOPE OF PRIVATE EQUITY FUNDING

IN INDIA
Submitted In Partial Fulfillment of the Requirements
For the Degree Of

Post Graduate Diploma in Management

Of
Doon Business School Dehradun
By
Hemant Kandpal
Erp Id. – 0171pgm109
Has been prepared under my supervision and guidance.

Project Guide

Prof. Sachin Kumar

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 CERTIFICATE OF COMPLETION

This is to certify that the Final Project Report entitled “SCOPE OF

PRIVATE EQUITY FUNDING IN INDIA” submitted Dissertation of the
requirement for the degree of Post Graduate Diploma in Management at
Doon Business School, Dehradun, is work carried out by Hemant Kandpal
under my supervision and guidance.

Project Guide:
Prof. Sachin Kumar

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 ACKNOWLEDGEMENT

“Obstacles are those frightful things you see when you take -off for your
goals”

And with no exception, this was the condition when I started my dissertatio n
work. But in due course of time with the thorough guidance of my project
guide, it has been a success. Though the deepest gratitude can be felt inside
heart, but in words with deepest esteem I wish to thank my honorable guide
Prof. Sachin Kumar, for his enriching guidance, constant encouragement
and valuable suggestions while carrying out this dissertation.

And last but not the least I thank all my Professors and class mates, who
have directly or indirectly contributed in understanding the subject and
constantly encouraged me in carrying out the d issertation.

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Index

Chapter Particular Page

no.
1 Introduction 6-30
2 Objectives, Research 31-52
Methodology & Limitation

3 Sector Trend 53-54

4 Conclusion 55
5 Bibliography 56

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Chapter 1 - Introduction

Capital to a company is like life in human body. The companies engaged in the
traditional line of business procure necessary financial capital from the public issues,
financial institutions, commercial banks, mutual funds, lease financing, debt
instruments, hire purchase etc. But the companies face great difficulty while raising
capital for newly floated companies as at the initial stages of the business the risk is
very high and the return is uncertain.

Similarly, small-scale enterprises (SSE's) are also unable to raise funds because it is
highly risky venture, are less profitable and do not possess adequate tangible assets
to offer as security. So, they have two options left- either to raise capital through IPO
or to obtain loans. But most of the SSE's are unable to fulfill the listing requirements
in terms of sales and minimum size of share issues. Moreover, common investors
hesitate to invest in such companies even though the growth rate is high because of
high degree of risk involved. As far as loans are concerned, lenders charge relatively
high rate of interest to compensate for the high degree of risk involved.

The spectacular success of companies like GE, Microsoft, Federal Express, Infosys
and Reliance give a sense that new venture creation is a sign of future productivity
gains. So how such companies shall be financed?

The Private Equity market is an important source of funds for new firms, private
middle-market firms, firms in financial distress, and public firms seeking buyout
financing. Over the last 15 years it has been the fastest growing market for corporate
finance as compared to bond market, private equity and others. Today the private
equity market is roughly one-sixth the size of the commercial bank loan and
commercial paper markets in terms of outstanding, and in recent years private equity
capital raised by partnerships has matched, and sometimes exceeded, funds raised
through initial public offerings and gross issuance of public high-yield corporate
bonds.

Private equity is capital that is not noted on a public exchange. Private equity is
composed of funds and investors that directly invest in private companies, or that
engage in buyouts of public companies, resulting in the delisting of public equity.
Institutional and retail investors provide the capital for private equity, and the capital
can be utilized to fund new technology, make acquisitions, expand working capital,
and to bolster and solidify a balance sheet. Private equity comes primarily from

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institutional investors and accredited investors, who can dedicate substantial sums
of money for extended time periods. In most cases, considerably long holding
periods are often required for private equity investments, in order to ensure a
turnaround for distressed companies or to enable liquidity events such as an initial
public offering (IPO) or a sale to a public company.

1.1 What Is Private Equity?

The simplest definition of private equity is that it is equity – that is, shares
representing ownership of or an interest in an entity – that is not publicly listed or
traded. A source of investment capital, private equity actually derives from high net
worth individuals and firms that purchase shares of private companies or acquire
control of public companies with plans to take them private, eventually become
delisting them from public stock exchanges. Most of the private equity industry is
made up of large institutional investors, such as pension funds, and large private
equity firms funded by a group of accredited investors.

Since the basis of private equity investment is direct investment into a firm, often to
gain a significant level of influence over the firm's operations, quite a large capital
outlay is required, which is why larger funds with deep pockets dominate the
industry. The minimum amount of capital required for investors can vary depending
on the firm and fund.

The underlying motivation for such commitments is of course the pursuit of

achieving a positive return on investment. Partners at private-equity firms raise funds
and manage these monies to yield favorable returns for their shareholder clients,
typically with an investment horizon between four and seven years.

Private equity is a broad term that refers to any type of equity investment in an asset
in which the equity is not freely tradable on a public stock market. Private Equity
securities are the stocks in companies that are not listed on the stock exchange. The
private equity investment include leveraged buyout, venture capital, growth capital,
angel investing, mezzanine capital etc. Private equity funds takes the control
management of the companies in which they invest, and often bring in new
management teams that focus on making the company more valuable.

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1.2 Type of private equity funds
1. Leveraged Buyout: The PE funds provide capital for purchasing the
company or the controlling stake in it using debt and equity capital. As the
term leverage implies it involves using more of debt than equity. The buyout
can be Management Buy In (MBI) or Management Buy Out (MBO).

2. Angle Investing: It refers to investment in small closely held companies by

wealthy individuals, in which they generally have some operational
experience. They may have substantial ownership stakes and may be active
in advising the company, but they generally are not as active as professional
managers in monitoring the company and rarely exercise control.

3. Venture Capital: It refers to long term equity investment in novel

technology based projects which display potential for significant growth and
financial returns. It provides seed, start up and first stage financing to these
industrial enterprises.

4. Growth Capital: Growth capital is a very flexible type of financing. The

money borrowed under a growth capital line of credit can be used for any
corporate purposes. There are no requirements to provide invoices or other
backup material when borrowing under this type of facility, so administration
is simplified as well. Growth capital can be a beneficial way to extend a
company's runway between rounds of financing. The extra time can be used
to complete additional milestones that will raise the company's valuation, or

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 as insurance to ensure that all intended milestones are successfully
accomplished.

5. Mezzanine Capital: It refers to investment in those companies that have

already proven their viability but still have to raise money from the public
market. It is associated with the middle layer of financing in leveraged buy-
outs.

Private equity funds are the pools of capital invested by private equity firms. They
are generally organized as limited partnerships which are controlled by the private
equity firm that acts as the general partner. The limited partnership is often called
'Management Company'. The fund obtains capital commitments from certain
qualified investors such as pension funds, financial institutions and wealthy
individuals to invest a specified amount. These investors become passive limited
partners in the fund partnership and when the general partner identifies an
appropriate investment opportunity, it is entitled to call for drawdown i.e. the
required equity capital each limited partner contribute to fund on pro rata portion of
its commitment. All investment decisions are made by the General Partner which
also manages the portfolio. The normal lifetime of a fund is about 10 years. Over its
lifetime it make various investments and usually the amount invested in each
investment is not more than 10%.

General partners, who are responsible for fund management, are typically
compensated with a management fee i.e. a percentage of the fund's total equity
capital. In addition, the general partner usually is entitled to carried interest i.e.
performance based fee, based on the profits generated by the fund. Typically, the
general partner will receive an annual management fee of 2% to 4% of committed
capital and carried interest of 20% of profits above some target rate of return called
hurdle rate.

A variety of groups invest in Private Equity Market. Public Pension Funds and
Corporate Pension Funds accounts for 50% of the total market. Other investors
include Endowment Funds, Insurance Companies, Banks, Non-Financial
Corporations and others.

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1.3 The Organized Private Equity market consists of four players:

 Issuers - It refers to the companies that cannot raise or have opted to raise
capital through the private equity market for various reasons like to develop
new product and technologies, to make acquisition or to strengthen the
balance sheet.
 Intermediaries- It refers to the fund under management. Typically 80% of
the global private equity investment is managed by the funds on the limited
partnership model. Other intermediaries like Small Business Investment
Companies (SBIC's) accounts for a marginal share of private equity market.
 Investors- A wide variety of people invest in private equity funds. Public and
corporate Pension Funds accounts for 40% of global capital outstanding.
Endowment Funds and wealthy individuals, each accounts for approx. 10%
of outstanding. The other investors include insurance companies, investment
banks and non-banking financial corporations.
 Agents and Advisors - With the coming up of various private equity funds,
the role of agents and advisors are all more important. They act as information
disseminators. They perform two functions:
 They identify the potential private equity funds, evaluate them and provide
information to investors.
 They help funds raise capital. They often negotiate the terms on behalf of their
clients to obtain better terms.

1.4 Working of a Private Equity Firm

Fund Raising
PE firms raise "funds" which are made up of capital contributed by LPs (Limited
Partners). The LPs are typically made up of a range of large institutional investors.
These investors are either Pension Funds (i.e. CALPERS, etc.), Sovereign Wealth
Funds (i.e. Dubai's sovereign wealth fund, etc), Endowments (i.e. Harvard's
endowment), and many other large institutions. The PE firm can either go around
soliciting fundraising itself or, in the case of many of the larger PE firms, hire
someone (or have a branch of the own firm which specializes in this) who is an
expert at raising institutional money. PE firms have been known to have many

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different funds at once (the more successful the firm, the more funds they have going
at the same time). There are many restrictions of investment between and across
funds to prevent moral hazard.

For example, PE firms typically cannot make purchases of firms in Fund 1 with the
money from Fund 2 because this could be construed as a way to boost returns of
Fund 1 at the expense of Fund 2. PE firms would have an incentive to do this if they
were raising Fund 3 because Fund 1 returns would be the returns they would tout in
their investment pitch to potential Fund 3 investors. Funds can be massive in scale,
sometimes going as high at $10-20 billion in a single fund. One other thing of note,
and one which is constantly a source of debate, is the fact that the PE firm typically
has capital at risk for each fund. This mean they contribute a small portion to each
fund. The debate over this is intense but the explanation for why PE firms only make
up say 0.5% of each fund is because if they had any more invested in each fund they
would not be incentivized to act in the best interest of investors. Think about fund
size. Funds can be $10 billion. A PE firm does not have that type of capital. Thus
0.5% of the fund would still be $50 million. $50 million is a substantial equity
investment on the part of the PE firm and could make up somewhere around 5-10%
of the equity value of the PE firm. Compare that to CALPERS. If CALPERS makes
up 0.5% of the fund this is a fraction of CALPERS' worth. With over $200 billion
AUM (assets under management), $50 million is less than 0.025% of their total
assets.

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Annual Fees
After the money is raised a total pool of assets is gathered. Let’s say Fund 1 has $10
billion AUM. The typical private equity firm charges a 2% management fee on all
AUM each year. Thus each year Fund 1 generates a revenue of $200 million for the
PE firm without a single investment made. This may seem like a sham but, as will
be explained later, this doesn't actually disincentivize acting on the LPs behalf.
Moreover, funds of that size are only able to be raised by the most successful PE
firms.

Fund Length

Funds typically last 10 years. Thus investors are more or less guaranteed to get their
money back after the 10 years is up. This can be amended if the LPs agree for a
number of reasons (a few investments are still active and look to be sold in the next
year or two, etc.).

Screening Investments

The time period can be broken up into various stages. The first stage is the research
stage. PE firms, once they know how much money they have, begin looking for
opportunities in which they can put that money to work. They will survey hundreds,
if not thousands of companies to make sure they get the right company, the right
size, etc. There are a number of characteristics they are looking for:

 Historically stable Cash Flows

 Potentially low debt on balance sheet currently
 Potentially high cash reserves currently
 Good brand reputation
 Potentially Readily separable assets (for carve-outs etc)
 An industry not subject to rapid technological change (typically)
 Low cost producers
 Strong management team (better to have the existing team be strong but not
essential)
 Lower risk business

There are many others but these are the "main characteristics" that PE firms use as a
screen. Moreover, distressed companies may also be an option. However, there are
two types of distress (generally speaking). Distress caused by poor management in
a good company or distressed caused by simply being a bad company or in a

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declining market. If a PE firm sees a company which is characterized by the first
type of distress they will see a very attractive investment.

Once they see a company they like, they make the investment.

Investing

PE firms can either make an individual investment in a company or can enter into a
club deal ("joint" or "team" deals) involving two or more PE firms. The second type
of deal is most common for larger size companies. PE firms like to share the risk so
they can diversify their investments. If they want to buy a $10 billion company it is
best not to use all the $10 billion of proceeds from Fund 1 but split the deal 4 ways
for a $2.5 billion stake (they PE firm would ideally want the largest stake and thereby
be able to "control" the deal and thereafter the direction of the company in most
cases). Thus if this investment goes bad they may be able to make up for it if they
bought another $10 billion company at a 25% stake and sold said company 5 years
later for $80 billion for a gain of $20-$2.5 or $17.5 billion (theoretical obviously).

As noted by other answerers, the PE firm uses a combination of debt and equity to
buy a company. The equity portion is derived from the funds (and thus LP money)
themselves. Equity stakes can range from as high as >50% to a low as 20% (or even
10% in the PE boom of the 80s and 90s but this has largely not been the case because
PE firms which survived the bust know not to take too much risk because there is
always the next fund that needs raising). The size of the equity stake depends on the
riskiness of the company. Tech companies, for example, are in a riskier industry and
thus would probably have more of a 50/50 split between debt and equity. Industrial
companies, on the other hand, have more stable cash flows and thus could thrive on
an 80/20 debt/equity structure. The debt portion is made up of a number of tranches.
You will have the largest tranche made of secured debt (i.e. term loans with debt
holding fluctuating interest rates in the form of LIBOR + Xbps, amortizing in nature,
callable, lower total interest, secured by company collateral, non-trading, etc). Then
there is subordinated debt (i.e. bonds which have a fixed rate, non-callable for a
period of time, may be publicly traded, higher total rate, lower in capital structure,
not secured or secured by more risky assets, etc). You may also have some other
types of debt like junior subordinated or even convertible debt or maybe PIK debt.
It depends on how much debt is raised, the type of company, the market appetite,
etc, etc.

Since, the partnerships have finite lives, the private equity managers who serve as
general partners must regularly raise new funds in order to stay in business. In fact,
to invest in portfolio companies on a continuing basis, managers must raise a new

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partnership once the funds from the existing partnership are fully invested. The fund
raising-investment cycle last from three to five years.

The fund raising is very time consuming and costly exercise, involving presentations
to institutional investors and their advisors that can take from two months to well
over a year depending on the general partners' reputation and experience.

To minimize their fund-raising expenses, partnership managers generally turn first

to those that invested in their previous partnerships. In addition, funds are often
raised in several stages, referred to as 'closings', to get a favorable evaluation of the
fund by those that have already committed.

General Partners prefer investors that have a long-term commitment to private equity
investing. Because past investors are most familiar with a general partner's ability,
general partners face greater difficulties when experienced investors withdraw from
the market. For instance, insurance companies drastically reduced their
commitments to private equity in 1990 owing to concerns among the public about
insurance companies financial condition. More recently, IBM, a major corporate
pension fund investor, withdrew from the private equity market as part of a broad
reduction in pension staff.

SELECTING INVESTMENT

The success of private equity funds depends on the selection of right kind of
investment. General partners rely on relationships with investment bankers, brokers,
consultants, lawyers, and accountants to obtain leads; they also count on referrals
from firms they successfully financed in the past. Economies of scale apparently
play an important role in dealflow: The larger the number of investments a
partnership is involved in, the larger the number of investment opportunities it is
exposed to.

Partnership managers receive hundreds of investment proposals. To be successful,

they must be able to select efficiently the approximately 1 percent of these proposals
that they invest in each year. Efficient selection is properly regarded as more art than
science and depends on the acumen of the general partners acquired through
experience operating businesses as well as experience in the private equity field.

Investment proposals are first screened to eliminate those that are unpromising or
that fail to meet the partnership's investment criteria. Private equity partnerships
typically specialize by type of investment as well as by industry and location of the
investment.

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Proposals that survive these preliminary reviews become the subject of a more
comprehensive due diligence process that can last up to six weeks. This phase
includes visits to the firm; meetings and telephone discussions with key employees,
customers, suppliers, and creditors; and the retention of outside lawyers,
accountants, and industry consultants.

The private equity funds cooperate with one another through syndication especially
because of the restriction of a partnership fund that can be invested in single deal.
When deals are syndicated, the lead investor—generally the partnership that finds
and initiates the deal—structures the deal and performs the majority of due diligence.
While, the majority of later-stage venture capital and middle-market buyout
investments are syndicated, early-stage new ventures are more likely to be financed
entirely by a single partnership.

MANAGING INVESTMENTS

After investments are made, general partners are active not only in monitoring and
governing their portfolio companies but also in providing an array of consulting
services. General partners help design compensation packages for senior managers,
replace senior managers as necessary, and stay abreast of the company's financial
condition through regular board meetings and interim financial reports. They also
remain informed through informal contacts with second and third-level managers
that they established during the due diligence process.

General partners provide assistance by helping companies arrange additional

financing, hire top management, and recruit knowledgeable board members. They
also may become involved in solving major operational problems, evaluating capital
expenditures, and developing the company's long-term strategy.

They exercise due control by dominating the board of portfolio companies. Even in
minority investments, they appoint atleast one member on the board. The other
methods can be through acquisition of voting rights and by controlling the additional
finance requirements of portfolio companies.

The degree of involvement varies with the type of investment. Involvement is

greatest in new ventures—for which the quality of management is viewed as a key
determinant of success or failure—and in certain non-venture situations—for which
improving managerial performance is one of the primary purposes of the investment
(for example, leveraged buyouts). For these two types of firms, private equity
investors typically are also majority owners, so the investors have even greater

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incentive, as well as authority, to become involved in the company's decision
making.

Even when the degree of involvement is lowest—for example, when a partnership

is a minority investor in large private or public companies—general partners may
spend as much as a third of their time with portfolio companies. A partnership rarely
is a completely passive investor; an exception is the case of syndication, when other
partnerships may allow the lead investor to take the active role.

Exiting Investments

General Partners have an obligation to return the capital to limited partners within a
specified period of time based on contractual agreement. The three possible exit
routes are a public offering, a private sale, and a share repurchase by the company.

Public Offering- IPO is a win-win situation for both private equity fund and issuer
company. A public offering generally results in the highest valuation of a company
and, thus, is often the preferred exit route. The company management favors an IPO
because it preserves the firm's independence and provides it with continued access
to capital by creating a liquid market for the firm's securities. However, a public
offering, unlike a private sale, usually does not end the partnership's involvement
with the firm. The partnership may be restricted from selling any or a portion of its
shares in the offering.

Private Sale- It is preferred by general and limited partners as it provides payment

in cash or marketable securities and ends the partnership's involvement with the firm.
But the company's management dislikes the private sale to the extent that the
company is merged with or acquired by a larger company and cannot remain
independent.

Buyback of Shares by Company - The third exit route is a put of stock back to the
firm, in the case of common stock, or a mandatory redemption, in the case of
preferred shares. With puts of common stock, a valuation algorithm is agreed to in
advance. For minority investments, a guaranteed buyout provision is essential, as it
is the only means by which the partnership firm can be assured of liquidity.
However, buybacks by the firm are considered a backup exit route and are used
primarily when the investment has been unsuccessful.

Sale to another PE Fund- The general partners may liquidate their investments by
selling their stake to another private equity fund. General and limited partners
generally prefer this route as it provides immediate liquidation of their investments.

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GLOBAL SCENARIO
2006 turned to be a remarkable year for the private equity funds. Global mergers and
acquisitions received a big boost-topped to $3.8 trillion, a bump of 38% of which
20% was financed by private equity buyers. The large portion of the deals was
handled by Goldman Sachs and Citigroup. Goldman Sachs took the crown for
advising on the largest volume of global announced deals. It advised on $1.09 trillion
in deals, for a 28.6% market share.

Perhaps more surprising was last year's showing by Citigroup, which leaped from
fifth place in 2005 to second last year. Citigroup advised on $1.03 trillion in
transactions, claiming a 27.2 percent market share (Thomson Financial). Morgan
Stanley, which was number 2 in 2005, fell to 3rd slot in 2006, advising on $975 bn
in global deals for 25.7% market share.

In 2005, no single investment banker cracked the $1 trillion mark. Goldman Sachs
worked on the deals worth $951 bn, Morgan Stanley $720 bn and Citigroup $695
bn.

According to Private Equity Intelligence 2007, a record $401 bn was raised

worldwide in new commitments. A total of 612 new funds held a final close during
2006.US-focused funds continued to dominate the market, taking 63% of the global
share in terms of new commitments. Europe, managed to hold the second spot with
27% of all capital raised in last being committed to funds in this region. Asian and
rest of world funds also grew marginally, raising 5% more than 2005.

In total 311 US-focused funds raised an aggregate $252 bn, while 168 Europe-
focused funds raised an aggregate $108 bn. The 133 Asian and rest of the world
funds raised an aggregate of $41 bn.

Real estate funds continued to be increasingly popular with investors, while natural
resources and infrastructure funds have also been successful to great extent.

There were 175 buyout and co-investment funds raised, attracting an aggregate $204
bn during 2006, with $96 bn of this coming from just 10 mega-funds greater than $5
bn in size. Real estate private equity funds raised an aggregate $53 bn from 79 new
funds in 2006.In total 174 venture funds achieved a final close in 2006 collecting
$42 bn in new commitments, while 65 Fund of funds raised an aggregate $23 bn.

2006 was a remarkable year for mergers and acquisitions in general. Some of the
major deals in the last year are:

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  Equity Office Properties Trust, the US's largest publicly held office-building
owner for $36 bn by Blackstone Group.

 US hospital chain HCA Inc. for $33 bn by syndication of KKR, Bain Capital,
and Merrill Lynch Global Private Equity.

 Radio chain owner Clear Channel Communications for $27 bn by Bain

Capital and Thomas H. Lee.

 Electronics firm Freescale Semiconductor for $17.6 bn by Blackstone and

others.

 Natural gas pipeline company Kinder Morgan for $22 bn by Goldman Sachs
equity group, AIG equity group, a private investor.

 The acquisition of Harrah's, the world's number 1 casino company in $17 bn

by Texas Pacific Group and Apollo Management outbidding a strategic buyer
, the casino firm Penn National Gaming.

The PE firm hires an I-bank to help in the buy-out process which can take sometimes
longer than 18-24 months to complete. It typically involves a lot of negotiation.

PE Advantage 1 - Access to Capital Markets the PE firm can access this debt at a
significantly cheaper weight than the firm itself. Thus more debt can be added. I
won't go into the theoretical/practical aspects of why debt adds value to a firm (idea
= cost of debt < cost of capital) but suffice it to know that a company with 20% debt
is more valuable than a company with 0% debt in the eyes of the equity holders.

Post-investment Process

Once an investment is made the PE firm immediately sets to work maximizing the
value of the investment and preparing it for a future sale. If the management team
is poor then the team is let go and replaced. Typically, however, the management
team is seen as a valuable source of knowledge and their institutional knowledge is

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leveraged to make the company better. The PE firm will hone in on a number of
changes to be made:

1. Expanding into new markets: able to do so because the PE firm will hold a
portfolio of companies worldwide and can leverage its experience in other
markets with the company in question, something the company may not be
able to do itself
2. Efficiency improvements: the PE firm has vast experience in a number of
industries with improving a company because of the amount of firms it buys
and sells. Thus PE firms can add significant value to a firm by making its
processes more efficient, motivating workers more efficiently, negotiating
better deals with suppliers and customers, and a whole host of other changes
it can make. They can help to increase turnover of inventory, etc.
3. Creation of new products: PE firms have significant levels of talented
operating professions they can either use or reach out to. They know the
markets and help many companies develop new products/services to sell thus
creating value.
4. Improving investment efficiency: Many firms do not have a dedicated M&A
team or listen to banks pitching M&A deals without realizing the value added
to the company. PE firms can merge companies in their portfolio (which
happens a lot) or can make more thought out and shrewd investments because
of their experience and their own knowledge.
5. Better incentivizing management: Many times management is offered
significant equity incentives to improve a company which can be a very good
motivator given the heightened sales prices of many PE backed companies.
6. Improving management quality: PE firms not only take seats on the board and
thus can provide frequent, on-the-ground expertise and advice, but they
leverage contacts to get the best people possible to occupy the other board
seats.

PE Advantage 2 - Operational Improvement

Common Misconceptions

1. People decry the job cutting of PE firms. In fact, employment declines between
1-2% on average for all buyouts. This is insignificant. Compare this with the returns
they generate for pension funds (i.e. retired teachers, etc) and the value they add to
companies and the gains more than offset the losses.

2. Capital Expenditure is shoved aside for debt management. Capex does decline
but companies are not hurt by this. In fact, PE backed IPOs have outperformed the

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market by between 1-5% on average in the three years following their IPO compared
to most new IPOs dropping below their IPO price.

PE Advantage 3 = Tax Shield from Debt/Financial Engineering

This speaks for itself, but is less important now than it was in the 80s and 90s. With
the influx of PE firms, the IT’S now longer is sufficient enough a reason to undertake
an LBO. However, there is a significant value addition to a company from the tax
shield.

Sale

After improvements are made the PE firm surveys the market to look for the right
time to sell. Often times the market will be overall bullish and the PE firm can
achieve an expansion on the multiple it sells the company at over the multiple it
bought it at because of the market conditions.

1.5 HISTORY OF PRIVATE EQUITY

History of private equity Venture capitalists often relate the story of Christopher
Columbus. In the fifteenth century, he sought to travel westwards instead of
eastwards from Europe and so planned to reach India. His far-fetched idea did not
find favor with the King of Portugal, who refused to finance him. Finally, Queen
Isabella of Spain decided to fund him and the voyages of Christopher Columbus are
now empaneled in history. The modern venture capital industry began taking shape
in the post – World War II years it started with the establishment of American
Research and Development Corporation, formed in 1946, whose biggest success was
Digital Equipment. The founder of ARD was General Georges Dariot, a French-born
military man who is considered "the father of venture capital.” But it was in 1980
venture capital industry began its greatest period of growth with an investment of
USD 600 million. With the name including investment in Federal Express, Apple
Inc. and Genentech Inc.

he Private Equity Deal volumes show a continuous increase since 1996. It has
increased from $34 bn in 1996 to $137 bn in 2000. But it declined sharply in 2001
due to DOTCOM BUBBLE BURST. The Private Equity investments in the
upcoming Information Technology Sector declined to $72 bn in 2001. The PE
investments improved in the coming years with the strengthing of global economy.
The total PE deal volumes stood at $738.10 bn in 2006.

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SECTORAL ANALYSIS OF PRIVATE EQUITY DEALS

INDUSTRY VALUE ($ NO. OF DEALS

Billions)

Media & Entertainment 154.6 325

Industrials 99.9 513

Real Estate 85.2 100

Health Care 76.8 194

Retail 62.4 210

High Technology 60.7 372

Consumer Product & Services 56.2 448

Energy & Power 53.4 146

Financials 31.9 203

Materials 32.2 272

Total 738.1 3052

Top Ten Private Equity Dealmakers In 2018

Acquiring firms VALUE ($ NO. OF DEALS

Billions)

Texas Pacific Group Inc. 100 16

Blackstone Group LP 93.1 19

Bain Capital Partners LLC 84.8 12

Kohlberg Kravis Roberts & Co. 77.7 13

Carlyle Group LLC 71.9 32

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Thomas H. Lee Partners LP 64.6 7

GS Capital Partners LP 55.8 6

Apollo Management LP 48.7 9

Cereberus Capital Management LP 34.2 9

Merrill Lynch Global Private Equity 32.5 2

PRIVATE EQUITY IN INDIA

A decade ago, India did not figure in most investors definitions of "Asia"- or at least
not in a major way. During those times, the investors were attracted to destinations
like Indonesia and Thailand. Initially, private equity came into India in the form of
early stage/venture capital, particularly in the IT and IT-enabled services, and
telecom sectors.

It was telecommunications that ignited interest in India in March, 2005, when the
international private equity firm Warburg Pincus sold a $560 million stake in Bharti
Tele-ventures, India's largest publicly traded mobile telephone company. Warburg
Pincus has made $1.1 billion by selling off two-thirds of its 18% share in Bharti,
which was acquired at $300 million, made in stages between 1999 and 2001. The
shares, offered in the Bombay Stock Exchange(BSE), was consummated in a
breathtaking 28 minutes, which revealed to the world the depth and maturity of the
Indian equity market.

This deal ignited the interests of Private Equity firms not only within India, but also
around the world. Private equity investors from around the world are increasing their
bets on Indian corporates or making new ones. That includes big-name U.S. firms
like Blackstone Group, Texas Pacific Group, Kohlberg, Kravis and Robert's (KKR),
Carlyle Group and General Atlantic Partners, and Britain's Actis Partners. Local
firms such as ICICI Venture Funds Management Ltd. and Kotak are also stepping
up investments.

There has been a tremendous increase in the pace in which deals are being made. In
the first nine months of 2006, India saw 329 venture capital and private-equity
investments worth a total of $5.9 billion -- more than double the tally for 2005 --
with some 60% coming from foreign players, according to researcher Venture
Intelligence India. Private equity investment in India shot up by over 230 per cent in

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2006, owing to the growing interest of equity funds in domestic companies and high
returns from the stock markets here. Private equity fund investment in 2006 was
$7.46 billion, up from $2.26 billion a year earlier, according to industry tracking
firm Venture Intelligence. The size of deals is growing, too: from around $8 million
four years ago to an average of $25 million today.

The record for 2006 was set by Idea Cellular, which in November received $950
million from a clutch of investors including Providence Equity Partners,
ChrysCapital, Citigroup, and Spinnaker Capital. The second largest deal was the
$900-million buyout by Kohlberg Kravis Roberts and Co, one of the largest PE funds
in the US, for 85 per cent in Flextronics Software. Singapore's Temasek bought 10
per cent stake in Tata Teleservices for $360 million, Farallon invested $143 million
in Indiabulls Financial and Warburg Pincus acquired 27 per cent stake in Lemon
Tree Hotels.

A new benchmark may be on the horizon: Reliance Communications is in talks with

private-equity players such as Blackstone, Texas Pacific, and KKR to fund its $10
billion bid for cellular carrier Hutchison Essar.

Private equity emerged as the single largest investor class driving equity deals in
India in 2006, overtaking both foreign and domestic strategic investors. PE
investment in India also broke through the global average (20%) of investment as a
proportion of total merger & acquisition (M&A) deals by accounting for 28% of the
total deals in India by value, which touched $28.16 billion in 2006. Some of the
sectors that are of interest to the private equity firms recently are micro-finance and
real estate. They have also indulged in the purchase of stressed assets, from asset
reconstruction companies, who have acquired them from the banking system. The
purchase of OCM Textiles by Wilbur Ross from ARCIL is a case in this point.

While the traditional route for private equity firms is to buy a controlling stake in
struggling, mature corporations and then try to turn them around, in an emerging
economy such as India, these firms act more like venture capitalists. They look for
promising companies in industries ranging from tech to textiles and seek to give
them a boost, doing everything from injecting more capital for expansion to holding
the hand of management and providing strategic guidance.

Private equity investment in India shot up by over 230 per cent in 2006, owing to
the growing interest of equity funds in domestic companies and high returns from
the stock markets here. Private equity fund investment in 2006 was $7.46 billion, up
from $2.26 billion a year earlier, according to industry tracking firm Venture
Intelligence. Private equity deals were led by the technology sector with 87 deals for

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$1.47 billion, up from 46 deals for $434 million in 2005. Private investment in listed
companies fell to 22 per cent of total deals, from 34 per cent a year earlier.

There have been a few significant management buyouts in the recent past in the
Indian PE industry. Some examples are Actis' acquisition of significant stakes in
Nilgiris, Phoenix Lamps, Paras Pharma etc; Navis Capital Partners' acquisition of
Nirulas, ICICI Venture acquisition of controlling stake in Tata Infomedia, CDC's
Capital Partners acquisition of ICI India's industrial Chemical etc.

Some of the reasons for the heightened interest in the Indian economy are:

o The Indian stock market is comparatively liquid and transparent. The

Bombay Stock Exchange's benchmark Sensex index is up 42% since
January, spurred in part by IPOs for 15 private-equity-backed
companies that raised a total of $887 million. The Bombay Stock
Exchange has the largest number of listed stocks- 7000stocks.

o Another selling point is an abundance of family-owned companies.

Although Indian clans have traditionally been reluctant to give up
management control, the younger generation is often prepared to trade
away a chunk of the company in exchange for cash and some advice on
beefing up sales.

o India offers investors better trained managers and more corporate

transparency in the private sector.

o The Indian courts are a fairly reliable arbiter of investors' rights.

REGULATORY FRAMEWORK

The SEBI Regulations, among others, specify the investment criteria for venture
capital and private equity investors seeking to invest in Indian companies. A foreign
venture capital investor proposing to carry on venture capital activity in India may
register with the Securities and Exchange Board of India (SEBI), subject to fulfilling
the eligibility criteria and other requirements contained in the SEBI FVCI
Regulations.

Eligibility Criteria - For granting the certificate to an applicant as a Foreign Venture

Capital Investor, the Board shall consider the following conditions for eligibility:

 The applicants track record, professional competence, financial soundness,

experience, general reputation of fairness and integrity.

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  Whether the applicant has been granted necessary approval by the Reserve
Bank of India for making investments in India.

 Whether the applicant is an investment company, investment trust, investment

partnership, pension fund, mutual fund, endowment fund, university fund,
charitable institution or any other entity incorporated outside India.

 Whether the applicant is an asset management company, investment manager

or investment management company or any other investment vehicle
incorporated outside India.

 Whether the applicant is authorised to invest in venture capital fund or carry

on activity as a foreign venture capital investors.

 Whether the applicant is regulated by an appropriate foreign regulatory

authority or is an income tax payer; or submits a certificate from its banker of
its or its promoter's track record where the applicant is neither a regulated
entity nor an income tax payer.

 The applicant has not been refused a certificate by the Board.

 Whether the applicant is a fit and proper person.

The SEBI FVCI Regulations prescribe the following investment guidelines, which
can impact overall financing plans of foreign venture capital funds.

a) The foreign venture capital investor must disclose its investment strategy and life
cycle to SEBI, and it must achieve the investment conditions by the end of its life
cycle.

b) At least 66.67% of the investible funds must be invested in unlisted equity shares
or equity linked instruments.

c) Not more than 33.33% of the investible funds may be invested by way of:

(i) subscription to initial public offer of a venture capital undertaking, whose shares
are proposed to be listed.

(ii) debt or debt instrument of a venture capital undertaking in which the foreign
venture capital investor has already made an investment, by way of equity.

(iii) preferential allotment of equity shares of a listed company, subject to a lock-in

period of one year.

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(iv) the equity shares or equity linked instruments of a financially weak or a sick
industrial company whose shares are listed.

Apart from tax exemptions, one key advantage of registering under the SEBI
FVCI Regulations is that at the time of an IPO of the investee company, a SEBI-
registered foreign venture capital investor will not be subject to the one-year
lock-in period in respect of pre-issue share capital held by it.

FEMA REGULATIONS prescribe the manner in which a foreign venture capital

investor can make investments. A foreign venture capital investor, can through
SEBI, apply to the Reserve Bank of India (RBI) for permission to invest in an Indian
venture capital undertaking, a venture capital fund or in a scheme floated by a
venture capital fund. The consideration amount for investment can be paid out of
inward remittances from abroad through normal banking channels. Subject to RBI
approval, a foreign venture capital investor can maintain a foreign currency or rupee
account with an authorized Indian bank. The funds held in such accounts can be used
for investment purposes.

The FEMA Regulations prescribe the sectoral limits on foreign investments into
India. A company, which is inter alia engaged in the print media sector, atomic
energy and related projects, broadcasting, postal services, defence and agricultural
activities, must obtain the approval of the Foreign Investment Promotion Board or
Secretariat of Industrial Assistance, depending on the quantum of investment, before
issuing shares to a foreign venture capital investor situated abroad.

INCOME TAX ACT, 1961- The income of venture capital companies or funds set up
to raise funds for investment in venture capital undertakings is tax exempt, if they
are registered with SEBI and in compliance with Indian government and SEBI
Regulations. The income of such companies and/or funds will continue to be exempt,
if the undertaking in which its funds are invested, subsequent to the investment, gets
listed on a stock exchange.

Venture capital companies or funds are exempt from withholding tax in respect of
income distributed to their investors. The provisions of the IT Act regarding taxation
on distributed profits (dividend), distributed income and deduction of tax at source
do not apply to venture capital companies or funds.

PROCEDURE FOR ACTION IN CASE OF DEFAULT- The FIPB has the right
to suspend or cancel certificate of registration. Without prejudice to the appropriate
directions or measures under regulation 19, it may after consideration of the

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investigation report, initiate action for suspension or cancellation of the registration
of such Foreign Venture Capital Investor:

The board may suspend the certificate-

 contravenes any of the provisions of the Act or these regulations;

 fails to furnish any information relating to its activity as a Foreign Venture

Capital Investor as required by the Board;

 furnishes to the Board information which is false or misleading in any material

particular;

 does not submit periodic returns or reports as required by the Board;

 does not co-operate in any enquiry or inspection conducted by the Board.

The board may cancel the certificate-

 When the Foreign Venture Capital Investor is guilty of fraud or has been
convicted of an offence involving moral turpitude;

 the Foreign Venture Capital Investor has been guilty of repeated defaults of
the nature mentioned in the regulation 21; or

 Foreign Venture Capital Investor does not continue to meet the eligibility
criteria laid down in these regulations.

1.6 Venture Capital in India

Traditionally, the role of venture capital was an extension of the developmental
financial institutions like IDBI, ICICI, SIDBI and State Finance Corporations
(SFCs). The first origins of modern Venture Capital in India can be traced to the
setting up of a Technology Development Fund (TDF) in the year 1987-88. The
industry’s growth in India can be considered in two phases. The first phase was
spurred on soon after the liberalization process began in 1991. According to former
finance minister and harbinger of economic reform in the country, Manmohan
Singh, the government had recognized the need for venture capital as early as 1988.
That was the year in which the Technical Development and Information Corporation

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of India (TDICI, now ICICI ventures) was set up, soon followed by Gujarat Venture
Finance Limited (GVFL). In 1996, the Securities and Exchange Board of India
(SEBI) came out with guidelines for venture capital funds has to adhere to, in order
to carry out activities in India. This was the beginning of the second phase in the
growth of venture capital in India. There are a number of funds, which are currently
operational in India and involved in funding start-up ventures. The Indian Venture
Capital Association (IVCA), is the nodal center for all venture activity in the country.
The association was set up in 1992 and over the last few years, has built up an
impressive database.

1.7 Market Structure and Activities of Private Equity

Types of private equity activities in terms of the stages of corporate development,
where PE financing is called for:

1. Seed Financing: Providing small sums of capital necessary to develop a

business idea

2. Start-up financing: Providing capital required for product development and

initial marketing activities.

3. First-stage: Financing the commercialization and production of products

4. Second-stage: Providing working capital funding and required financing for

young firms during growth period.

5. Third-stage: Financing the expansion of growth companies.

6. Bridge financing: Last financing round prior to an initial public offering of a

company.

7. PIPE deals: A private investment in public equity, often called a PIPE deal,
involves the selling of publicly traded common shares or some form of
preferred stock or convertible security to private investors.

8. Leveraged Buyout (LBO): It entails the purchase of a company by a small

group of investors, especially buyout specialists, largely financed by debt.

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 9. Management Buyout (MBO): It is a subset of LBO whereby incumbent
management is3 included in the buying group and key executives perform an
important role in the LBO transactions.

1.8. Regulation of private equity in India

Though there is no formal legislation to regulate the activities of private equity in

India. Yet it is regulated by indirect legislation and norms. The inflow of foreign
equity capital under private equity withers through FII or FDI is restricted to
imposed investment limits on different sectors. Apart from this the foreign
investment under private equity is regulated by following to Acts:

 SEBI regulation Act 1996: It lays down the guideline for venture capital a
subpart of private equity. It contains norms for registration, obligation,
responsibilities, investment condition and restriction, investigation and
cancellation for venture capital funds.
 Foreign venture Capital funds regulation 2000: SEBI sets up Foreign
Venture Capital Investors (FVCI) Regulations in 2000 to enable foreign funds
to register with SEBI and avail of some benefits which are otherwise not
available under FDI route. Some of these benefits include no lock up of shares
held by registered investors and exemption from applicability of valuation
norms, thereby enabling investors to buy and sell shares in Indian unlisted
companies at prices they deem appropriate, upon mutual agreement between
buyers/sellers. However, they cannot invest more than 33.3 per cent of the
investible funds in shares of listed companies or debt instruments.

1.9. Key Players

 Qatar Foundation
 ICICI Ventures
 Barings Pvt. Equity
 HDFC-Temasek
 Infrastructure Leasing &Financial Services
 Henderson Global
 Sabre Capital
 Séquoia Capital
 Trident Capital
 Trinity Ventures
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1.10. Common Type of Risk while investing in Private Equity

 Funding risk: The unpredictable timing of cash flows poses funding risks to
investors. Commitments are contractually binding and defaulting on payments
results in the loss of private equity partnership interests. This risk is also
commonly referred to as default risk.

 Liquidity risk: The illiquidity of private equity partnership interests exposes

investors to asset liquidity risk associated with selling in the secondary market
at a discount on the reported NAV.

 Market risk: The fluctuation of the market has an impact on the value of the
investments held in the portfolio.

 Capital risk: The realization value of private equity investments can be

affected by numerous factors, including (but not limited to) the quality of the
fund manager, equity market exposure, interest rates and foreign exchange.

1.11. Factors influencing the investment in private equity

 Profile of the Respondents' Firms

 Size of the Firm in which investment is to be made.
 Growth Potential of the Product in the Market
 Expected Returns against investment
 Valuation of Firm Management
 Past Success
 Expertise in their field
 Assurance
 Regulatory Framework

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 Chapter 2 - Objectives, Research
Methodology & Limitation
2.1 Background of the Study
Today due to the economic ups and downs and the change in job market.
Entrepreneurship has gained market. A number of technocrats in India today plan
to setup their own shops and capitalize this opportunities. In today’s highly dynamic
economic climate with regular technological inventions, few traditional business
models may survive but margin lies more towards more innovative business ideas.
Today it is not the conglomerates that fuel economic growth but are the new SMEs
and other innovative businesses.
The bright reason for global economic growth today lies in the hand of the small and
medium enterprises. For example, in India SMEs alone contribute to almost 40% of
the gross industrial value added in the Indian economy. Whereas in the United States
55% of their global exports are supported by very SMEs with not more than 50
employees and 10% exports are generated by companies with 800 or more
employees.
There is a paradigm shift from the earlier physical production and economies of scale
model to new ventures with technological advancements providing services and
under process industry. To understand these impacts there is a need to analyze the
scope of private equity funding in India.

2.2 Need for the Study

 The study has been conducted for gaining the practical knowledge about
Private Equity Finance and to understand their scope in India.

 The study has been undertaken as a part of PGDM for the fulfilment of the
requirement of PGDM degree.

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2.3 LIMITATIONS OF THE STUDY

A study of this type cannot be without limitations. It has been observed those private
equity Finance are very secretive about their investments. This attitude is a major
hindrance for data collection.

2.4 Research Methodology

Research is a matter of gathering information from varying sources usually in
relation to a specific topic and for a specific purpose. The definition of research
includes any gathering of data, information and facts for the advancement of
knowledge.
The methodology of research adopted is causal research. Causal research, also
known as explanatory research is conducted in order to identify the extent and nature
of cause-and-effect relationships. Causal research can be conducted in order to
assess impacts of specific changes on existing norms, various processes etc. Causal
studies focus on an analysis of a situation or a specific problem to explain the
patterns of relationships between variables. Experiments are the most popular
primary data collection methods in studies with causal research design.

2.5 Literature Review

 VENTURE CAPITAL & PRIVATE EQUITY FINANCING IN INDIA

– By Rashmeet Kohli

Abstract: Venture Capital & Private Equity Financing are becoming increasingly
popular routes of foreign investment into India. These two asset classes have seen a
phenomenal growth in the past few years in the country and are expected to increase
further in the coming years. Before dealing with the private equity and venture

32 | P a g e
capital financing in India, this article endeavors to explain the concepts of Venture
capital and Private Equity (PE) as these two concepts are perceived to play into each
other's territory.

 THE GROWTH OF PRIVATE EQUITY FINANCING IN

INDIA
-By Dr. V. Santhi & Dr. Nanda Gopal

Abstract: Private Equity finance in India was known since nineties. It is now has
successfully emerged for all the business firms that take up risky projects and have
high growth prospects. The private organization which does not want to take finance
from the society may have their view on venture capital. It has potential to become
an important source for financing of small-scale enterprises (SSEs).Venture capital
finance is often thought of as ‘the early stage financing of new and young enterprises
seeking to grow rapidly. According to Pratt: There is a popular misconception that
high-technology is the principal driving factor behind the investment decision of a
US venture capitalist. Only a small minority of venture capital investments are in
new concepts of technology where potential technical problems add a significant
amount of risk to the new business development.

2.6 Private Equity Firms

The practice of multiple parties conducting business through a partnership is an
ancient one. Among the earliest commercial partnerships were ones formed to raise
money for seafaring ventures. The investors who stayed back home deemed it
appropriate for the people who actually captained the ships to receive a
disproportionate share of the spoils. In today’s private equity trade, the private equity
firms can be thought of as the ships, and the general partners as the captains who get
a disproportionate share of profits (if there are any). Private equity firms are groups
of individuals who come together to pursue private equity investments. While almost
all private equity professionals invest a portion of their own money, private equity
firms today primarily deploy capital on behalf of others. These firms tend to be
partnerships, similar in form to other private professional services firms, like law
firms, for example. A private equity firm today might range in size from two people
and a secretary to hundreds of investment professionals. The business model of a
private equity firm is as follows – raise capital from external sources, invest the
capital in a series of private equity deals, sell (or “exit”) those investments (often

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many years later), and return the proceeds from these exits to the external capital
partners while holding back 20 percent of the total profits for the partners of the
private equity firm. This 20 percent take is called carried interest. Carried interest is
the gravitational pull at the center of the private equity universe. The general partners
also earn substantial income from other fees, such as management fees and
transaction fees. Private equity firms usually raise capital for investments into a fund,
usually in the form of a limited partnership, which is a kind of fund that gives control
and a disproportionate share of the profits to the general partners, even though most
of the capital in the fund tends to come from external investors. As limited partners,
these investors have little control over how the fund is managed and agree in advance
to the lopsided profit-sharing agreement, as well as to the other fees.

When successful, a private equity firm can create a fortune for its founders. Here’s
a very simplistic example - let’s say a group of five general partners (often referred
to as GPs) raises a $500 million fund and invests it in a series of deals. When those
investments are finally all sold off, the resulting value is twice that of the fund - $1
billion. This means the fund has a profit of $500 million. As part of the profit sharing
agreement, the general partners keep 20 percent of this $500 million profit, equal to
$100 million. Assuming they all share equally in this windfall, each general partner
keeps $20 million. Nice work, if you can get it. This example doesn’t even factor in
the other potentially lucrative management and transaction fee streams available to
the general partners (to be discussed later). The fortune-building possibilities of a
private equity firm have led to the establishment of thousands of such firms around
the world. As recently as the 1970s, it was hard to count more than a few dozen
private equity firms, primarily venture capital and leveraged buyout groups located
in the United States. Now there are private equity firms both miniscule and enormous
in all the developed countries of the world and in most of the emerging markets. A
testament to the flexibility of the traditional private equity firm structure, these firms
pursue a vast array of strategies. A key similarity among all of them is fund structure:
a limited partnership presided over by a group of general partners. Who are the
general partners? They tend to be individuals who have been able to convince
investors that they will be skilled at investing capital in private companies, adding
value to those companies, and exiting the investments in a time and fashion that
maximizes profits for the investors. The skills needed by GPs are highly specialized.
They can be thought of as a set of competencies, not all of which are necessarily
possessed by single individuals.

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Key skills that groups of GPs must possess include:

 Deal sourcing – Private equity firms need to be skilled at finding attractive

investment opportunities, at generating great deal flow. This deal flow will
come from a network built up working in a particular industry, from
aggressively developing contacts among senior corporate executives. If Bob
the entrepreneur is thinking of selling his company, a GP wants to hear about
this first. A GP may argue that his or her deal flow comes from exhaustive
research into a particular industry, which unearths opportunities overlooked
by others. Today a large percentage of investment opportunities go through
intermediaries such as investment banks, who charge a fee to the seller, and
whose job it is to secure the highest valuation possible, often in auction-like
sale processes. Many GPs argue that they enjoy proprietary deal flow,
meaning they source opportunities directly with the potential sellers,
bypassing intermediaries. (Industry skeptics will tell you that many GPs
overstate the degree to which their deal flows are truly proprietary.)

 Research and due diligence – Before agreeing to do a deal, general partners must
painstakingly form a view on the future of a given industry or market, and
then on the potential of a particular company within that market. The GPs
must be able to deeply understand the inner workings of a potential portfolio
company and, based on that, determine the right price to be paid for the
company. Private equity GPs typically build elaborate models that tell them
how their investment in a company will fare, given a range of assumptions
about the future performance of the company. It may be that a company is
forecast to do very well in the future, but that the valuation of the company
currently offered to potential investors, according to the GP’s model, produces
a return for the private equity firm that is too low to be deemed acceptable.
(Many GPs will claim that their competitors pay too much for investments,
while they themselves exercise price discipline and hold out for investments
that stand a higher chance of producing better returns.) Before a decision is
made to invest in a company, the private equity firm must perform rigorous
due diligence on its financial health, on the state of the market in which it
operates, and on the backgrounds of the executives leading the company. GPs
often pay external consultants to do some or all of this due diligence work.
Failure to uncover an important weakness during the due diligence process
can result in an investment disaster for the GPs and their limited partners.

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 Financial engineering – This is a bit of jargon that refers to a dealmakers’
ability to masterfully structure an investment to his or her best advantage. A
good financial engineer will be able to rework a company’s balance sheet and
creatively apply capital-market products, most importantly corporate loans,
such that the equity provider is positioned to gain as much as possible from
the deal. GPs with experience in the financial markets often possess advanced
financial engineering skills. These skills are most important when a portfolio
company is being acquired, is itself making an acquisition or taking on new
debt, or is being sold through an M&A transaction or in an initial public
offering. Skeptics warn that many GPs have failed because they applied
sophisticated financial engineering in situations where the actual business
fundamentals of the company were not well understood.

 Operating skills – Once a private equity firm has made an investment in a

company, the GPs are charged with adding value to the company, or at least
monitoring it to ensure that its performance does not deteriorate. Many firms
include operating partners – executives who have experience running a
company in a particular sector. For example, a private equity firm that
acquires a chemicals company will often appoint a former CEO of another
chemicals company to run or oversee the new portfolio company. These
operating partners may simply be there to support the incumbent management
of the portfolio company, or they may entirely restructure the company,
starting with the firing of the incumbent management team. They may also
add new products, close factories, sell divisions and acquire new divisions. A
GP with purely investment banking-style financial engineering skills may not
have the wherewithal to effectively change the operations of a portfolio
company. Likewise, someone who, for example, was a senior executive at a
chemicals company for many years, may nevertheless not have the financial
engineering skills needed to structure the best investment result.

 Salesmanship – General partners must gain the confidence of many parties.

They must convince investors to sign up for lengthy commitments to private
equity funds. They must convince the management of potential portfolio
companies that they will make for valuable investment partners. They must
convince potential buyers on the public markets or in the M&A market that
their portfolio companies are worthy of lofty valuations. One finds no
shortage of charisma and self-confidence among successful GPs, personality
traits that result in their being entrusted with vast sums of capital for long-

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 term management, and help them sell investments for more than what was
originally paid.

Private equity firm hierarchies s vary from firm to firm. Typically the founding
partners are in charge and take the lion’s share of the economics. The other senior-
most partners – often called managing directors, partners, principals or general
partners – are almost always entitled to a piece of the lucrative 20 percent profit
share of the limited partnership called carried interest. A staff of supporting
investment professionals assist on generating deal flow, evaluating transactions and
overseeing portfolio companies. The titles, moving downward, typically include
vice presidents, associates and analysts. Private equity firms today have larger and
larger rosters of professionals charged with the managing the voluminous non-deal
aspects of the business. These professionals include chief financial officers, chief
operating officers, investor relations and communications professionals, general
counsel, human resources professionals, technology and capital markets specialists.
The addition of these back-office professionals is part of the institutionalization of
the private equity industry as it moves away from its scrappier boutique roots, where
historically a small group of GPs did everything themselves.

2.7 Private Equity Market Trend

Most private equity firms are in the business of managing private equity funds on
behalf of investors. The management of these funds, usually structured as limited
partnerships, involves a complex, staggered and years-spanning flow of cash from
the investors to the general partners to the portfolio companies, back to the general
partners and ultimately back to the investors. The long-term and illiquid nature of
private equity funds makes it difficult to measure their performance while they are
active. And because these partnerships are usually strictly private, it is difficult if not
impossible for outsiders to access meaningful information on individual funds.
Private equity is therefore often described as an opaque, non-transparent asset class.
Private equity funds are heralded by their supporters as vehicles that powerfully
align the interests of the general partners with the limited partners. Plainly put, GPs
have a huge incentive to maximize returns for the limited partners, because bigger
returns mean bigger carried interest payouts for the GPs. If the fund generates a loss
or a mediocre return, the GPs “don’t eat”. Skeptics point out that even loser funds
generate nice incomes for GPs thanks to payouts other than carried interest. That
said, GPs get into the private equity business with the hope of building fortunes
through carried interest. If things don’t work out well, the other fees associated with

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private equity fund management are nice consolation prizes, but not overly exciting
to ambitious GPs.

Private Equity limited partnerships are sometimes called blind-pool investment

vehicles, because the limited partners cannot “see” in advance what deals are going
to be done. The GPs themselves usually have no idea what the ultimate portfolio of
private equity investments will be, but must stick to the parameters codified in the
limited partnership agreement (LPA). If, for example, a limited partnership
agreement calls for the GPs to acquire power plants in the US, the GPs will get in
trouble if they instead end up investing in Chinese internet start-ups. Most private
equity funds are designed to make a number of investments over a specified amount
of time called the investment period (typically five or six years).

Most funds have rules against any one deal getting too much capital from the fund.
These diversification rules may stipulate, for example, that no one private equity
investment can receive more than 20 percent of the capital from the fund. Some
funds are created to do a single deal, but these will not be discussed here. A
discussion of the many kinds of private equity deals is further below, but in general,
a private equity fund is used to make equity investments in private companies. Debt
used in deal structures typically comes from other sources, such as banks. Here is
how a private equity limited partnership works, starting with a limited partner’s
decision to commit capital to the fund: When a limited partner, aka an investor in a
private equity fund, decides to invest, no money changes hands initially. Instead, the
limited partner agrees to commit a certain amount of capital to a limited partnership,
managed by the general partners. In doing so, the limited partner, or LP, signs a
legally binding commitment to contribute capital to the fund whenever the GP
requests it, up to the point where the LP’s size of capital commitment is reached.

For example, let’s say that a large (fictitious) institutional investor called Global
Opportunity Corporation (GOC) has agreed to invest with a private equity firm
called Rock Street Partners. Rock Street is raising a $1 billion private equity fund,
and GOC agrees to commit $100 million to the fund as a limited partner. The fund
eventually secures commitments adding up to $1 billion from GOC and additional
limited partners.

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Private Equity Investment In India In Past 5
Years
 PE/VC investments in India in 2018 witnessed a sharp increase in value on
account of some very large deals (12 deals of value US$500 million or greater,
including eight US$1 billion plus deals).

 In 2018, investments increased by 35% in value terms compared to 2017

(US$35.1 billion vs US$26.1 billion in 2017) and deal volume increased by
28% (761 deals compared to 594 deals in 2017). The growth was led by strong
pickup in buyouts and start-up investments.

 Notwithstanding the minor decline in 2017 buyouts are expected to be one of

the major trends of the Indian PE/VC sector in the years to come. We had
highlighted this in our report PE/VC Agenda India Trend Book – 2018,
released in early 2018. In 2018 there were 48 buyouts aggregating to US$9.8
billion, surpassing all the previous year highs and almost equal to the value of
buyouts in the previous three years combined.

 After record start-up investments in 2015 and subdued investments in 2016

and 2017, 2018 recorded a strong uptick in start-up investments on the back
of some mega deals that saw large venture capital investors like Softbank,
Tencent and Naspers deploy significant amounts of capital. On a Y-o-Y basis,
investment in start-ups increased 83% to US$6.4 billion compared to US$3.5
billion in 2017. 2018 was also the best year for start-up investments,
surpassing the previous high recorded in 2015.

 Growth investments, at US$12.7 billion, recorded a decline of 5% and saw

its share in the total investment pie decline to 36% compared to over 50% in
prior years. At US$3.9 billion, PIPE deals recorded a modest increase of 3%
in terms of value, impacted by volatility in the stock markets.

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 As the Indian market matures, PE/VC deals are becoming larger and more
complex. There were 76 deals of value greater than US$100 million in 2018,
aggregating to US$25.9 billion and accounting for 74% of total PE/VC
investments made in 2018 compared to 54 deals, aggregating US$18.7 billion, of
value greater than 100 million in 2017. The value and volume of large deals has
been progressively increasing over the past 4-5 years.

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 The largest deal during the year saw GIC, KKR, PremjiInvest and OMERS invest
US$1.7 billion in HDFC Limited for a 3% stake. This was followed by a
consortium of investors including Warburg Pincus, Softbank, Temasek and others
investing US$1.3 billion to acquire 28% stake in Bharti Airtel’s Africa business.
The largest deal in the Infrastructure and Real Estate asset class saw Macquarie
acquire tolling rights to select NHAI road assets for US$1.4 billion.

 From a sector point of view, most of the sectors recoded significant increase in
value invested. In 2018 11 sectors recorded over US$1 billion in investments
compared to seven in 2017. Notwithstanding the decline in deal activity in the
second half of 2018 following the liquidity issues faced by the NBFC sector,
Financial Services continued to be the top sector receiving US$7.5 billion in
investments across 141 deals, a 6% increase over 2017. This was followed by Real
Estate (US$4.5 billion across 49 deals), 10% decline compared to 2017 and E-
commerce (US$4.3 billion across 83 deals), 9% decline compared to 2017.

 Other sectors that recorded significant improvement in investments include

Industrial Products (US$1.6 billion across 21 deals in 2018 vs US$62 million
across 6 deals in 2017), Food & Agriculture (US$1.8 billion across 45 deals in
2018 vs US$364 million across 47 deals in 2017), Retail and Consumer Products
(US$1.9 billion across 41 deals in 2018 vs US$678 million across 36 deals in

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 2017), Education (US$843 million across 38 deals in 2018 vs US$253 million
across 20 deals in 2017).

Fund Raised

 2018 saw US$8.1 billion being raised across 51 fund raises by PE/VC funds, a
40% increase over 2017 and the highest ever. Similarly, the fund raise plans
announced stood at US$22.3 billion, which again is the highest ever. This further
reiterates the underlying trend, reflected in both investments and exits, of India’s
improving attractiveness for global PE/VC funds as the domestic PE/VC
ecosystem flourishes.

 The largest fund raise during the year saw Indospace (Everstone managed real
estate fund for building logistic parks) close its third fund at US$1.2 billion,
followed by Sequoia and True North raising US$695 million and US$600 million
respectively

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Monthly Trend of Private Equity in 2018

Recent Investment Trends

 Investments in Infrastructure and Real Estate by PE/VC funds in 2018 added

up to US$6.4 billion, accounting for 18.3% of all investments in 2018.

 In 2017 and 2018, Sovereign Wealth Funds and Pension Funds stepped up
their investments in Indian infrastructure and real estate, investing close to
US$2.9 billion of the total US$9.5 billion PE/VC investment in these asset
classes in 2017 and 2018.

 There were 76 deals of value greater than US$100 million in 2018,

aggregating to US$25.9 billion and accounting for 74% of total PE/VC
investments made in 2018.

 The share of large deals has been significantly higher over the past two years,
as compared to earlier periods, accounting for almost 2/3rd of all the value
invested. As a consequence, the average deal size has also been increasing.

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 Notwithstanding the minor decline in 2017, buyouts are expected to be one of
the major trends of the Indian PE/VC sector in the years to come.

 In 2018 there were 48 buyouts aggregating to US$9.8 billion, surpassing all

the previous year highs and almost equal to the value of Buyouts in the
previous three years combined.

 Credit investment has emerged as a viable alternative for PE/VC funds to

invest in the Indian market, taking advantage of a lower risk and an assured
return.

 PE/VC funds are better placed to structure credit transactions that are a win-
win for both the investor as well as the investee, which is not possible through
the regular banking channels, given various regulatory constraints.

 1Q18 recorded credit deals worth US$873 million across 15 transactions, the
second highest quarterly value of credit investment in the past four years.

 With large LPs investing directly in the Indian market, PIPE investments have
witnessed a strong growth, with majority of the investments flowing into the
financial services sector, which is considered by many investors to be a good
proxy for the India growth story. However, due to volatility in markets there
has been a dip in PIPE investment activity over the previous two quarters.

 While growth capital still continues to be the leading mode of investment by

value, its % share of overall PE/VC investments has declined to around a third
compared to earlier years when it used to account for more than 50% of all
PE/VC investments, primarily on account of the rise in buyout deals.

 After record investments in 2015 and subdued investments in 2016 and 2017,
2018 was a better year for start-up funding on account of large investments
made by Softbank.

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Key sectors For Investment

 Since 2017, Financial Services has emerged as a key sector of interest for
PE/VC investments, with investments made across all the varied business
models ranging from pure play banks to specialized NBFCs, small finance
banks, online credit platforms, insurance companies, and payment solution
companies. There has been a dip in activity off-late due to liquidity concerns
in the NBFC sector.
 Real Estate sector witnessed a significant interest from PE/VC funds in the
previous year and the momentum has continued into 2018, largely driven by
investments in yield generating commercial assets by large global funds like
Blackstone, Brookfield etc.
 With the closure of large Walmart-Flipkart deal which gave exit to many early
investors with healthy returns, there is a renewed enthusiasm in the Indian E-
commerce space as shown by the recent mega investments in Swiggy and
Byju’s.

Key Trends of Private Equity Investments In 2019

 February 2019 recorded US$2.6 billion in PE/VC investments, 51% higher

than February 2018 and 41% higher than the previous month. The growth was
driven by higher number of large deals (deals of value greater than US$100
million). February 2019 recorded nine large deals aggregating US$1.8 billion
compared to four large deals aggregating US$655 million in February 2018
and four large deals worth US$1 billion in January 2019. Softbank and
Carlyle’s US$415 million investment in Delhivery was the largest PE/VC deal
in February 2019 and also the largest PE/VC deal in the logistics sector ever .

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 By investment type, Growth investments, at US$1.2 billion, were 27% higher
compared to February 2018. PIPE investments recorded a rebound in
February 2019, emerging from a four year low of US$2.8 million recorded in
January 2019. At US$431 million, PIPE investments in February 2019 were
at their highest since level the past eight months.

 February 2019 recorded two Buyouts worth US$262 million, compared to

four Buyouts worth US$273 million in February 2018. Start-up investments
in February 2019, at US$156 million across 32 deals, were 52% lower
compared to US$325 million recorded across 31 deals in February 2018.

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  Credit investments in February 2019, at US$548 million, have been highest
in previous 12 months on the back US$350 million debt funding of ReNew
Power by Overseas Private Investment Corporation (OPIC), the US
Government’s development finance institution.

 From a sector point of view, Financial Services (US$712 million across 13

deals in February 2019 vs US$619 million across 13 deals in February 2018)
was the top sector followed by Logistics (US$470 million across four deals in
February 2019 vs one deal of US$2 million in February 2018). E-commerce
(US$35 million across five deals in February 2019 vs US$362 million across
nine deals in February 2018), which is generally among the top sectors
recorded a sharp decline in deal value.

Exits

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  Exits in February 2019, at US$472 million, were almost three times the value
recorded in February 2018. This was on the back of a partial recovery in open
market exits as the volatility in the stock markets decreased.

 There were four open market exits in February 2019 worth US$351 million,
more than three times the value recorded in February 2018 and highest in past
six months. There was one PE-backed IPO in February 2019 that saw
Goldman Sachs and Kuwait Investment Authority backed Chalet Hotels
Limited list on the bourses.

 The largest exit in February 2019 saw Bain Capital and GIC sell 5% stake in
Genpact for US$324 million.

 From a sector perspective, Technology was the top sector, primarily on

account of the large Genpact deal.

Fund Raised

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 February 2019 saw funds worth US$285 million being raised and fund raise
plans worth US$779 million being announced. US$250 million raised by
India Life Sciences Fund for its third fund was the largest PE fund raise in
February 2019.

Comparison of private equity in India with rest of the World

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 India attracts more than 2 percent of global private-market investment, two-
thirds of which goes to private equity.

 Since 2009, India’s economy (in nominal terms) has doubled in size. During
this period, private equity has increased fourfold, the syndicated loan market
and (non-private-equity) foreign direct investment (FDI) have remained
mostly flat, and IPOs have been a volatile source of capital at best.

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 Chapter 3 - Sector Trends

 Healthcare will continue to be a growing sector, with a shift towards the

deep vertical/specialized focus.
 In Fintech, while lending seems passes, 2019 will see the emergence of
insurance offerings and Wealth Management solutions targeted towards
India. Wealth management will see both offline and online players
compete for the same customer segment.
 There will be an emergence of new asset models. 2019 will see Land as
an asset model (cars and real-estate will continue to be hot, as the
market will move towards consolidation in these spaces)
 Drones will see revived a rejuvenation of interest with the new
Government regulations coming finally in place.
 We will continue to see the market adapt health-related products
targeted with healthy eating options, fitness for mind and body. The
market consolidation will not yet happen in 2019.
 Consumer brands will continue to see increased capital inflow in
Product plays. It remains to be seen if Brand only plays can find any
footing in India
 Cloud will continue getting increased adoption by Enterprises and SMEs
– much more room for SaaS startups to gain traction in India. Models
where product building happens in India and target global markets will
remain a hot favorite among investors

Other Market Trends

1. Content consumption will move towards video and audio content, with an
emphasis on 3-5m reading time for written content.
2. New models of distribution targeted at tier2 & tier 3 cities will emerge in
2019.
3. Mobile first models to stay relevant in this context.
4. AI/ML will become must-have standards in implementation, and will no
longer be differentiators in product offerings.
5. Voice as a layer will become a game changer
6. Micro-funds and institutional investors participating in the early stage will
continue to rise. In 2018, this percentage crossed 50% of the overall funding.
We believe this will continue to see a 10-15% increase in 2019.

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7. Venture Debt is seeing the surge, and we believe in 2019, this will become
more prevalent as an alternate model for funding.
8. Family Offices as an alternate channel for liquidity now directly investing
into growth stage startups is here to stay. We think the allocation towards
direct co-investment will see an increase in their allocation percentage set
aside for this asset class.

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Chapter 4 - Conclusion
The increased realization among Private Equity players that they will have to look
at India and China to drive their future growth shows that there will be increased
activity by private equity players in the coming years. The interest in the Indian
market is growing as the Indian market is clearly maturing, which will see more
players entering the fray, both domestic as well as foreign. It is more likely that
Private Equity firms will be targeting Small and Medium enterprises (SMEs). They
will primarily focus on Healthcare, Manufacturing and Retail Supply Chain that
would take India to the next level in the global economy.

As India's economy continues to open up, private-equity investors are starting to

diversify away from telecommunications and outsourcing. These days, health care,
food, real estate, travel, and more are heating up. And the opportunities are
expanding in newly deregulated industries such as cellular telecom and broadband,
airlines, and port infrastructure. It can be expected that with the deregulation of
several other industries like retail, etc., the investments by Private Equity firms is
likely to increase in a substantial way.

Even with the obstacles, India's compelling growth story forms a powerful
counterweight owing to a superior educational system, India boasts a talent pool of
more than 23 million young professionals, which is growing by nearly half a
million annually. Growth in the IT and outsourcing sector is expected to fuel
expansion in disposable income, by 8.5 percent each year through 2015.

As an expanding middle class of 250 million is exposed to western products and

culture, demand for consumer products will continue to explode. In September
2006, India recorded a monthly trade deficit in September of $5.33 billion, a
reflection of the country's hunger for imports. If current trends continue, India will
be among the world's three largest economies by 2050. International PE cannot
afford to miss out on what may be the world's most dramatic economic
transformation of the next decade.

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