Retail participation in Private Equity

There has been a lot of press in recent times about the surge in retail participation in Private Equity in India. I recently got a call from my Relationship Manager at my bank who wanted to check if I would be interested in investing (a minimum of INR 1 Million) into a Private Equity fund floated by a reputed business house. What was shocking was the complete lack of knowledge about the product, the risks it posed and the liquidity window for the fund. He kept insisting that my investments would grow at about 25% every year and I could pull out the money after 5 years. There was pretty much little else he knew - nothing about how NAVs would be calculated and how frequently, and what would be modus operandi for providing liquidity, what type of companies would be invested into and how would they be monitored and how would the carry be shared with the GP (was the hurdle rate 10% at an individual deal level or at a collective fund level).

I did find out that he was getting incentivized 2% of the money raised as his commission. Apparently with mutual fund commissions having dried up (because of SEBI's ruling), there are a lot of banks that are peddling these products to almost anyone and everyone.

Hmm... this got me thinking about the great ULIP scam in the earlier part of this decade. Every bank (under the garb of bancassurance) sold unwitting customers an investment cum life insurance product called ULIP which was, guess what, intended to make everyone (except for the customer) happy. With an administrative fee that ranged from 30-60% on the first year premium (half of which rolled back to the banker as incentive) and a steady trail of 8-10%, it sure did make money - but not for the customer. I must have been one of the biggest suckers - for inspite of being a retail banker, I got sold this product by one of my fellow bankers who promptly quit (after collecting his big, fat bonus). The worst part of it was that I could not surrender the product for 3 years because of a lock-in clause - so I had to throw good money after bad money, to get some of the good money back.





Cutting back to the chase, I am not against improving retail participation in Private Equity funds. But I am against it first time investors investing into first time funds without understanding the risks and the time horizon associated with it. To top it all, there is no one to regulate this - I am not sure if this falls under the purview of SEBI. I feel strongly that there ought to be a strong regulation to improve disclosures and ensure that there exists a certain level of mandatory disclosures upfront and on an ongoing basis before investors can plonk down their money.

Investing into Private Equity is far far riskier than investing into a listed stock or even into a close ended mutual fund (where one can cut one's losses and pull out the money should things go wrong) and one has the ability to monitor NAV's at regular intervals of time. Putting money into a blackbox which promises a high return.

This presents more than ever a case for a "smart intermediary" like a mutual fund - who can pool in the capital and add the smartness that is ever so required. This is critical when there are already increasingly strident voices from the existing LPs on making money in India.

Would love to hear other's views on this...

~Varadha
(varadha.r1@gmail.com)

GPs and the art of progressive reporting

If one were to go back to the fundamental reasons for the blossoming of private equity as an industry, the tightened regulations that were the aftermath of the Enron/worldcom tragedy would certainly be paramount. The other day I ran into someone who runs a small cap company in NYSE (which has a Mcap of < $ 300 mn). He estimated the direct cost of reporting/compliance alone to be in excess of $ 4-5 million. Anyone, of course, would tell you the level of reporting sophistication in India (barring a few like Infosys) is still some way off the international standards.

Ask any GP in India, and one of the foremost things he would talk about is how his PE fund has been working with the promoters of portfolio companies to improve governance, compliance and sophistication of reporting. However, unlike in the West, where the industry has evolved to a level where reporting standards amongst PE firms have been templatized (also partly due to the fact that most of the portfolio companies are public companies being taken private and hence are used to a much higher reporting standard in any case),

This in particular is a problem for LPs, (like Fund of Funds, Endowments and the likes) who I presume must have uniform reporting standards, irrespective of their geographical allocation. I have of course, met a couple of "Indian LPs" and they seem to be far more forgiving in their ask for information (which is not necessarily a good thing in the long term).

This brings me to the following questions :

• Can there be different reporting standards for different geographies in PE ?
• How does one have a smooth upgrade in the quality of reporting without being too stifling at the beginning and too lax in the end ?
• How do you capture “significant, material intangibles” in a templatized form ? For eg., expected attrition amongst senior management, materiality of pending law suits, forex risk etc.

It would be interesting to hear the voices of a few LPs on this.

~Varadha

PE in India - time for consolidation

It has truly been a long time since I posted. I have avowed to myself that I shall post at least once a week. It has been a truly enriching experience over the last three years being a part of what hopefully, is still a sunrise (and not enroute to a sunset !) industry.

Wanted to bounce off a thought that has been gnawing my mind for the last six months. Having met different constituents of this spectrum - LPs, Investment Bankers, Promoters and fellow PE funds, I tend to believe that the PE industry in India is on the cusp of a large shake-out. Listed below are top reasons why :

Gap in skill sets : There are just way too many funds focussed on "passive capital". I would have thought this would have changed post the financial melt down. Truth is, the ones who missed the India bus earlier, seem to have gotten even more aggressive in deploying cash. All my dear investment banking contacts tell me that with all the free money sloshing around in the Western markets getting directed to "Emerging Markets" (what else !). I seriously think the time has come for BRICS -II. Goldman, where art thou ? May be a SMAT (Srilanka, Mexico, Argentina, Taiwan). Takers, anyone ?

Lack of focus/segmentation: I am yet to see more than 6-8 funds that pridethemselves on their focus - geography, verticals or deal types (venture, growth, buy-out, restructuring). Everyone's favourite sector seems education, healthcare and all else where India's per capita consumption is woeful. Where are the proprietary deal flows, where is the ability to construct a deal (and not study an IM for its pros and cons), where is the network of relationships ?


Impending battle for exits: This is going to be fun to watch. All the excesses from 2007 and 2008 have resulted in PE invested companies being valued at astronomical valuations (favourite whipping boys being retail, education, aviation where there is no evident route to a profitable scale-up with the exception of a honourable few). Case in point, a company that was invested into by a PE fund was valued at Rs. X in Jan '09 when the PE fund sold their stake to a counterpart. Now, I hear the going value is Rs. 2 X with hardly a change in fundamentals. Basic laws of economics point to the fact that in any free market arbitrage opportunities vanish fairly quickly. Hopefully, it would happen here as well.


Forward integration by LPs: if your friendly Mutual Fund told you that he did nothing with your money all year long and knocks off 2% off the corpus as ostensible "management fee", would'nt you be mad at him ? Ironically in an immature market like India, it does not take one too much of an effort to hire a couple of smart traders and generate a return of 15-20% from public markets. If so, what is the big deal in getting a 25% IRR from an illiquid asset class over a 5-7 year time period.

Ever increasing fund sizes : Funds are doubling their corpus every three years. Surely, the economy is not growing at 25% to justify doubling of deal sizes in the same segment(s) all else being equal; or is it ? This game has to stop - I have not seen Mutual Funds being proud of their corpuses - as far as I remember, they have been proud of their performance (historical returns). Why should it be any differnet in the PE industry.

Would love to read from others their thoughts and moot points.

~Varadha