Opportunities Will Match Challenges
The private equity (PE) and venture capital (VC) sector in India has undergone a major transformation over the past few years. First, it was an era before the Lehman crisis. The ‘India story’ was shining and some fund managers clinched deals at high valuations based on speculations rather than taking the actual fundamentals into account. Result? A host of investments went kaput, not reaping adequate returns, as desired.
The next phase — that began in 2008 after the collapse of Lehman Brothers, and continued till about 2012 — saw a slowdown in investments, with fund managers tightening their purse strings, and adopting a cautious approach towards new investments. While a part of the reason for this can be attributed to the global financial meltdown, back at home, the first round of investments in the early 2000 had left a clear list of winners and losers that threw the entire sector in a tizzy. On one hand, there were companies who failed to register growth and scale to the next level, on the other, there were fund managers who could not complete a full cycle of investment and exit.
Typically, a single PE/ VC investment cycle lasts for about five to seven years. After that, fund managers normally exit by way of trade sale, public listing, recapitalisation or secondary sale. Currently, we are at a phase when PE investors and venture capitalists have a clear understanding of the market — aware of both opportunities and challenges. So, does this mean that the sector has come of age? Well, the answer is both yes and no, as experts point out.
The alternative assets industry in India is still ‘small’. As per a report by industry tracker Preqin, assets under management across PE, VC, real estate, infrastructure, private debt and hedge funds stand at over $43 billion. There are around 221 private capital fund managers and 46 hedge fund managers based in the country currently.
While the numbers are ‘small’, it may be worthwhile to note that investors are increasingly recognising the benefits of exposure to alternatives. Today, PE and VC are among the most prominent asset classes, accounting for about 63 per cent of India-based investors.
“PE / VC will continue to be one of the important sources of funding for Indian entrepreneurs over the next 10-15 years,” says Nitish Poddar, partner and head of private equity at KPMG in India. “While this source of funding will principally be used as growth capital, I believe there will be alternative sources of capital that will also become prevalent such as structured debt and quasi equity,” he adds, indicating that PE investors will also play a crucial role in managing stressed assets going forward. “They are expected to participate in the turnaround story in partnership with Indian corporates.”
The PE / VC sector in India has evolved over a period of time from being minority stakeholders to holding controlling stakes; from being financial investors to graduating to the role of strategic advisors; and also from early-stage investors to funding acquisitions including pre-IPO deals.
“In the medium to long term, we expect PE firms and venture capitalists to wear the hat of ‘turnaround specialists’ for large Indian businesses that missed the innovation bandwagon and foreign corporations that intend to enter India,” says Pankaj Chopda, director at Grant Thornton India. Management buyouts and secondary transactions arising due to consolidations of portfolio companies are set to increase in the years to come, he says.
However, high valuations will remain a cause of concern for a while as too many funds are currently chasing the few quality deals. Even as investments are picking up in the country, not all of them are successful. This is prompting competition among fund managers too to clinch the ‘best deal’ in the market.
“Valuation expectation of Indian promoters has been and will continue to be a challenge, though in the recent times, I believe the expectations are getting aligned to realistic levels. Further, aggressive expansion plans that may not actually pan out can also deter investor money in some sectors / businesses,” says Poddar.
Echoing the same sentiment, Chopda adds: “Valuation, exits, regulatory environment, short business life coupled with long-gestation periods and limited fund life, dealing with promoters and lack of in-house talent to manage businesses will continue to be the challenges.
However, opportunities are huge as India’s long-term trend shows a stable and diverse economic growth. As per World Bank’s projection, India’s economy is set to grow at 7.3 per cent in the current fiscal and 7.5 per cent in the next — that itself prompts investors to look at India. Take 2017 for instance. It was a watershed year for the Indian PE and VC sector. “Investments grew significantly (65 per cent increase year-on-year) to a record high. Deals became larger and more complex and growth capital deals accounted for the highest activity and investment. It was also a great year for exits, which were almost 2x the previous high of 2016,” Vivek Soni, partner and leader for PE Advisory at Ernst & Young had earlier said.
“India will continue to be a tech entrepreneur breeding ground and the money will continue to flow into this space as internet commerce expands in the country,” says Poddar.
So, going forward, which sectors are expected to gain traction? Those that ride on a strong domestic consumption story will be the beneficiaries, say experts. These include areas such as internet commerce, consumer products, apparel and retail and healthcare among others.
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