PRIVATE EQUITY

THE ROLE OF PRIVATE EQUITY IN INDIAN MARKET

GROUP MEMBERS: MANALI CHHEDA MAYUR NAROLA NAFISA KURAWEDWALA PRERNA SUKHANI

PRIVATE EQUITY

Private equity is an umbrella term for large amounts of money raised directly from accredited individuals and institutions and pooled in a fund that invests in a range of business ventures. In finance, private equity is an asset class consisting of equity securities in operating companies that are not publicly traded on a stock exchange. Investments in private equity most often involve either an investment of capital into an operating company or the acquisition of an operating company. Capital for private equity is raised primarily from institutional investors. There is a wide array of types and styles of private equity and the term private equity has different connotations in different countries

TYPES OF PRIVATE EQUITY

Leveraged buyout The acquisition of a company using debt and equity finance. As the word leverage implies, more debt than equity is used to finance the purchase, eg 90 percent debt to ten per cent equity. Normally, the assets of the company being acquired are put up as collateral to secure the debt. Venture capital The term given to early-stage investments. There is often confusion surrounding this term. Many people use the term venture capital very loosely and what they actually mean is private equity Growth capital Growth capital refers to equity investments, most often minority investments, in relatively mature companies that are looking for capital to expand or restructure operations, enter new markets or finance a major acquisition without a change of control of the business Distressed and Special Situations Distressed or Special Situations is a broad category referring to investments in equity or debt securities of financially stressed companies

Mezzanine capital This is the term associated with the middle layer of financing in leveraged buy-outs. In its simplest form, this is a type of loan finance that sits between equity and secured debt. Because the risk with mezzanine financing is higher than with senior debt, the interest charged by the provider will be higher than that charged by traditional lenders, such as banks. Secondaries

The term for the market for interests in venture capital and private equity limited partnerships from the original investors, who are seeking liquidity of their investment before the limited partnership terminates. An original investor might want to sell its stake in a private equity firm for a variety of reasons: it needs liquidity, it has changed investment strategy or focus or it needs to re-balance its portfolio. The main advantage for investors looking at secondaries is that they can invest in private equity funds over a shorter period than they could with primaries

ADVANTAGES OF PRIVATE EQUITY

1) Funds gotten through private equity are crucial for the growth of industry and the development of innovative products. 2) Private equity funds are used for expanding working capital. 3) Private equity funds are helpful when it comes to facilitating mergers and acquisitions. 4) Private equity funds make a companys balance sheet stronger, and help it develop. 5) Private equity funds are a great way to obtain funds for small businesses and start-ups that have not been able to get loans or grants. 6) The general partner runs the company, so the investing partner, or the limited partner, cannot interfere in the management of the company.

DISADVANTAGES OF PRIVATE EQUITY

1)Since private equity funds are not open to investment on the stock market, anybody who wants to sell stocks of a private equity fund finds it difficult to locate a buyer. 2)There are certain transfer limits on private equity. 3)Most individuals cannot afford the high investments required in a private equity.

SEBI GUIDELINES

1.The Securities and Exchange Board of India (SEBI) issued its Regulations for Venture Capital in 1996, thus establishing the agencys authority over the funds, the limits on their activities, and incentives for them to finance and rescue troubled companies. There are no legal or regulatory differences between venture capital and private equity firms. The Government first permitted financial institutions (Industrial Development Bank of India, ICICI, and IFCI), commercial banks (including foreign banks), and subsidiaries of commercial banks to establish venture capital companies under guidelines issued in 1988. In addition, under current central bank regulations, banks investments in mutual funds catering to venture capital funding are considered to be outside the ceilings applicable to banks investments in corporate equity and debt. 2. Foreign venture capital funds have been permitted to operate in India since 1995. They may either hold the shares of unlisted Indian companies directly (up to a maximum of 25% of equity) or route their investments through domestic venture capital funds and companies. Before guidelines were issued in September 2000, direct exposure by offshore private equity funds in shares of unlisted companies was treated as a foreign direct investment and had to be approved in line with the Governments general policy on foreign investments. Indocean Venture Fund (now Indocean Chase), originally set up by George Soros and Chemical Bank in October 1994, was the first such overseas private equity fund.

3. The regulatory environment for the private equity industry was simplified in 19952000. Foreign institutional investors participated in the growth of the private equity industry through the foreign direct investment regulations of the Government and the simplified tax administration procedures under the Indo-Mauritius Double Taxation Avoidance Treaty. While the foreign direct investment route offered minimum investment restrictions for private equity funds, exit pricing and repatriation of capital were regulated by the Reserve Bank of India (RBI). To bring these capital flows under the regulation of the venture capital industry, new SEBI regulations were issued with simplified exit pricing and repatriation procedures for foreign investors. 4. Following amendments to the 2000 budget, the Government has allowed private equity funds pass-through status, meaning that the distributed or undistributed income of the funds is not taxed. To avoid double taxation, the income of a private equity fund is taxed only in the hands of the investor.

5. SEBI was also made the sole regulatory authority, and private equity funds must submit quarterly reports to it. In September 2000 SEBI announced the guidelines that now govern venture capital investment, based on the January 2000 recommendations of the Chandrashekhar committee on venture capital. After another set of amendments in April 2004, the following rules now apply:

(i) Foreign venture capital investors can invest in India without the need for approval from the Foreign Investment Promotion Board if they register with SEBI. (ii) Each investor in a venture fund must invest at least Rs500,000, and each fund must have at least Rs50 million in capital. (iii) A fund may invest in one company up to 25% of the funds capital. It cannot invest in associated companies of ventures that it finances. (iv) A fund must invest 66.67% (lowered from 75% in April 2004) of its investible funds in unlisted equity or equity-linked instruments. The remaining 33.3% can be invested in subscriptions to initial public offerings (IPOs) of companies or in debt instruments of a company in which the venture fund has already made an equity investment. (v) The April 2004 amendments removed the previous 1-year lockup period for IPO subscriptions. They also allowed investments within the 33.3% category in preferential allotments of equity shares of a listed company, subject to a 1-year lock-in, and in equity shares or equity-linked instruments of a listed company that is financially weak.

(vi) The removal of the profitability criterion as a listing requirement had an important effect on the private equity industry as it provided an exit mechanism for investors. To replace the profitability requirement, a firm would be delisted if it did not earn a profit within 3 years of listing. (vii) The acquisition of shares in a venture fund by the investee company or its promoters is exempt from the provisions of the takeover code and will therefore not mandate an open offer. (viii) Mutual funds may invest 5% of the capital of an open-ended scheme and 10% of the capital of a closed-ended scheme in a venture fund. (ix) In April 2004 the SEBI also removed some previous restrictions and allowed venture funds to invest in real estate companies, gold financing companies, and equipment leasing and hirepurchase companies registered with the RBI.

6. These regulations have significantly improved the regulatory environment for private equity funds operating in India, such as BTS India Private Equity Fund. In addition, they reflect the strong commitment of the Indian Government to support the provision of long-term equity finance to domestic entrepreneurial companies

PRIVATE EQUITY: HOW IT WORKS?

Private equity funds are set up as limited partnerships. These limited partnerships are controlled by private equity companies that are the general partner in the limited partnership. The private equity company encourages individuals and institutions to invest in the private equity fund. This way, the investors become limited partners, though the general partner controls the company management.

When the general partner thinks that a particular investment is feasible, it asks the limited partner to invest the amount it guaranteed. The general partner chooses the investment portfolio of the partnership, while the limited partner provides funds for investing. The limited partner, or investor, in turn profits through sales, mergers, recapitalization or initial public offering.

WHY INDIA??


Growing economy. policies.

 Changing government  Huge

potential. population. a bright future.

 Young

 Promise of

PRIVATE EQUITY IN INDIA

Indias private equity sector is moving to the big league. Fund sizes have increased dramatically from US $10 to US $25 million just a few years ago, to between US $400 million and US $ 1 billion today. Examples include the retail sector, where 50 percent FDI is now allowed in single brand products; the telecoms services sector, where the FDI limit has been raised from 49 percent to 74 percent. The private equity market in India, which attracted $2.2 in investment capital in 2005, will reach nearly $7 billion in 2010.

MAKING PRIVATE EQUITY WORK IN INDIA

India is becoming a powerful magnet for private equity investment. To realize its potential, however, private equity investors and Indian companies must recognize what each brings to the table. By some measures, India is poised to become the next big market in private equity. And there is certainly big interest: Well over 100 private equity funds are scouting for deals, making India the fastest-growing private equity market in Asia, with a 67 per cent compounded annual rate since 2002.

The survey gathered the opinions of nearly 150 global PE investors active in India, their local counterparts, and Indian entrepreneurs and executives. Among the highlights: Sixty per cent of survey respondents said the investment climate in India is more attractive than in Japan or South Korea, while 40 per cent agreed that India is more attractive than China. Over the coming three years, moreover, a majority anticipate that China and India will be on par as Asia's most attractive destinations for private equity investment. In general, India is perceived to be a friendlier investment environment than China, with survey respondents indicating that Indian businesses are less hamstrung by government regulations and have an easier time recruiting experienced managers.

They also say it is easier to negotiate and close a deal in India compared with China. For example, via a research it was found that 71 per cent Chinese corporate accounts suffer from a lack of transparency, compared to just half as many who said Indian companies' finances are difficult to track. In one important area, however, China is given an edge over India:Valuations are more expensive in India. Nevertheless, private equity firms are rolling out plans that reflect their confidence that India presents attractive opportunities. Among firms, three-quarters anticipate at least doubling the amount they invest over the next three years. There was broad agreement among PE investors and Indian executives who responded to the survey about which sectors are most appealing. But there was also consensus about bottlenecks that may diminish India's attractiveness.

Not surprisingly, poor infrastructure was the No 1 concern; 68 per cent of respondents described it as a "challenge" or "major challenge." More than 40 per cent thought that high asset values will continue to crimp opportunities for private equity. Also ranking high were worries about whether the supply of skilled workers can keep pace with the demand, as well as concerns that onerous government regulations could curb India's appeal. Whether India's young private equity market ultimately delivers on its promise will depend on how Indian companies and PE investors learn to capitalise on each other's strengths. Indian executives will have to discover what these deep-pocketed newcomers can do help their companies flourish. For their part, private equity firms should be willing to invest patience as well as cash in cultivating relationships.

BENEFITS OF PRIVATE EQUITY

1. Private Equity boosts the Indian economy 2. Private Equity funding provides long term perspective Profitability 3. Private Equity-backed companies generate foreign exchange earnings 4. Private Equity-backed companies create well-paying jobs 5. Private Equity catalyzes innovation in the economy

PRIVATE EQUITY CAPITAL IS MORE THAN JUST MONEY

Apart from providing capital, Private Equity investors provide strategic and operational guidance to the companies they invest in. Their strategic input is more than just financial monitoring. Eighty percent of the top management at PE-backed companies interact with their investors on a weekly or monthly basis. PE Investor contributes to various business operations of a company, like Strategic Decision making, Financial Advise, Recruitment and Marketing. Private Equity for Indian companies can create enormous growth opportunities to compete in the global market and boost the growth of Indian Economy.

CASE: PRIVATE EQUITY CAPITAL IS MORE THAN JUST

MONEY

Blackstone bought 50.1 per cent of the 70.1 per cent stake held in Gokaldas by the Bangalore-based Hinduja family. The Hindujas still continue to have management control. The Executive Director of GEL says that, Acquisitions are the easiest way to grow as we dont need to reinvent the wheel, a bigger company will boost its bargaining power while negotiating contracts with buyers.

CONTD.

Hindujas are also clear that it would not have been possible for their family to go to the next orbit of growth on their own. Blackstone, being a large US private equity giant, has the experience to infuse the necessary capital, process know-how, industry networking and management specialists.

THE OPPORTUNITY

All the leading international PE Funds have been active in India in recent months; they include the Blackstone group, Goldman sachs, Warburg Pincus, the Carlyle group, Kohlberg Kravis Roberts & co (KKR), Citigroup and Actis capital, besides two leading funds from Singapore, GIC and Temasek holdings. In 2007-08, nearly 400 PE deals were struck by these international funds, aggressively buying into companies showing promise in sectors like information technology, biotechnology, healthcare, telecommunications, media and entertainment and real estate and retailing.

Goldman Sachs, the US finance major, is now beefing up its presence in India and looking at various options, including setting up an asset management company, a brokerage unit, wealth management division and a commodities outfit. It is also keen on setting up a non-banking finance company. Besides American and Europe PE majors, other smaller private investors are also striking smaller deals, especially in the real estate and hospitality sectors. (Pragnya, a Mauritius-based PE fund, invested $40 million in real estate projects in India.)

But many private Indian business groups have also set up private equity funds and venture capital funds. They include the Anil Dhirubhai Ambani group, the Aditya Birla group and the Future group. INDIAS largest commercial bank, State Bank of India, has also entered the PE segment The Insurance Regulatory and Development Authority of India allows even insurance companies to invest up to five per cent of their investible corpus in VC funds that invest in infrastructure projects. The private equity industry in India is at a key inflection point. Investors the world over are increasing their allocations on India. The robust economy, supportive government, and recent industrial reforms could see several hundred billion dollars channeled to the newly opened infrastructure sector alone.

IMPORTANCE OF PRIVATE EQUITY

Five years ago, entrepreneurs ran family owned businesses & looked to the next generation to take over the business. It was very difficult for private equity players to invest as entrepreneurs were reluctant to relinquish control of their business. Now increasingly second generation family members accept that ceding control of part of the business is not a bad thing; PE investment provides additional capital & brings additional business expertise & improved governance. Richard Laing, Chief Executive, CDC 2008 outlook

without PE funding, company.

Investments by stage

33% 63%

would have developed the same way would have existed

PIPE buyout 22% 36% 4% 3% 15% 20% other early stage growth stage late stage

4%

would not have existed

ROLE OF A PE INVESTOR
Main contribution of PE investor to business operations
strategic direction

financial advice Main contribution of PE investor to business operations

Recruitment

Marketing

0%

20%

40%

60%

80%

PRIVATE EQUITY INVESTMENTS IN INDIA

Total

FDI : USD 30 Billion Private equity : USD 6 Billion till June/July 2008 Real estate sector : USD 10 Billion

Private equity investments in India (USD Million)

500 000 1500 1000 500 0 1996 1999 00 005

Private equity investments in India (USD Million)

VALUE ADDITION TO THE INVESTEE COMPANY

Higher

returns exports

Higher

Innovation

REASON FOR UNDERPERFORMANCE OF PE

Low Standards of Corporate Governance Limited Legal Recourse Dysfunctional Capital Markets

SOLUTIONS

RETHINKING THE APPROACH - Go local - Add value - More discerning deal selection - Creative exit strategies - Improving access to public equity markets

LOCAL GOVERNMENTS MUST PROMOTE EMERGING MARKET DEVELOPMENT - Protecting shareholder rights - Promoting sound corporate governance standards. - Liberalizing investment restrictions for local institutional investors. DEVELOPMENT FINANCE INSTITUTIONS MUST PROVIDE LEADERSHIP - Training for fund managers - Financing that attracts additional investors - Assist with policy and regulatory reform - Support creative new initiatives

CASE STUDY
WARBURG PINCUS-BHARTI

One of the most reputed PE firms of US Investments worth more than $ 26 billion In more than 100 Companies Presence in US, Europe & Asia One of the first PE investors in India

Positive Macro Factors Sector

National Telecom Policy encouraging  Domestic Private Investment  Foreign Direct Investment Competition to Fixed Line Service Providers  High Installation Fees  Order Backlog Mobile Telephony considered as a status symbol Markets were Price Elastic No Player having Pan-India presence Telecommunication is a pre-requisite for Growth

Negative Macro Factors Sector

Lack of Regulatory Clarity Economic viability of Telecommunication Project Restriction on Licenses Monthly Fixed License fee to government No investor interest No clarity on Exit route Bharti having presence only in North India

Landmark Transaction
The Deal equaled one third of total PE investments in India till date PE investments in India were only 0.2% of total GDP FDI was only about 1% of GDP First Investment done banking upon the India Growth Story Foreign Exchange fluctuation was a matter of concern Investment in Unorganized Sector Investment in a privately owned company

WP Information Gaps
Bet on forecasts Loss making business Entering as a minority stakeholder Ambiguity in Government Policies Fragmented Sector Cost efficiency Mobile telephony was still a Luxury among Indians Business model based on Cost-Volume-Pricing

Shareholder Value & Corp Governance

Think Big !!! BT- Initial Suboptimal Strategy Bell North WP -Change in Plans Pan India Presence Growth Plans !!! BT - Management Approach to build business from scratch WP - Time sensitive: Growth by Acquisition Restructuring the corporate structure BT- Adhoc structure WP Buy back stakes to reduce to conflicts of interest Inclusion of Strategic Partners - SINGTEL

Exit

CONCLUSION
Private equity funds

are an excellent investment options for venture capitals and other organizations looking for long-term investment in projects that will bring in good returns. not open for public trading and not affordable to minor investors and individuals. a private equity fund is a good option for small business owners who have not been able to source funds for their start-ups or long running business from any other source.

However, they are

Forming