Era of Private Equity Funding

“Opportunity with the attendant risk brings promoters and investors together for creating value. In a growth hungry economy with a scarce funding environment, PE offers yet another resource for fueling the economic engine”

- Kalpana Jain, Deloitte Touché Tohmatsu India Private Limited

About Private Equity Funding

There is no universally agreed definition of private equity. Different academic studies and private equity associations in various economies have defined private equity differently depending on the activities they engage in those economies.

Private equity funding means to raise the share capital for any private company or public company through investors who want to invest their money in business that has potential of growth and where investors gets handsome return on Investment. Private Equity is a source of investment capital from high net worth individuals and institutions for the purpose of investing and acquiring equity ownership in companies.

An important company metric for these investors is earnings before interest, taxes, depreciation and amortization (EBITDA). When a private-equity firm acquires a company, they work together with management to significantly increase EBITDA during its investment horizon (typically between four and seven years). A good portfolio company can typically increase its EBITDA both organically (internal growth) and by acquisitions.

Why Private Equity Funding??

Ø When we think about raising the fund for the business or requirement of capital for starting new business we always think of Banks. We always think that bank is the good options for raising the funds. But it is rarely easier to take loan from Bank and even the enterprise should have sufficient assets to mortgage. But in PE funding there will be no mortgage of assets rather investor will be given the share in the assets of the company.

Ø It was suggested that for many Indian investee companies that, private capital provides the means by which they can get mentoring and advice such services are not provided by banks and sometime in some situation expert advice only can give ways to survive. For example, one major company had the option of an IPO, yet preferred private capital because someone knowledgeable would be assigned and available to provide mentorship and advice.

Ø There was an opinion that three in five companies would rather just have the money and not the advice, though one participant described a breed of entrepreneurs who are looking for a private equity firm that can help as required

Difference between Private Equity, Venture Capital and Hedge Funds

Ø Presently there is lot of ambiguity surrounding the concepts of private equity and alternative investment channels like venture capital and hedge funds.

Ø Venture capital is a subset of private equity and refers to equity investments made for the launch, early development, or expansion of a business. It has a particular emphasis on entrepreneurial undertakings rather than on mature businesses. Private equity and venture capital terms are used interchangeably.

Ø Private Equity funding are generally used for funding to all sectors, while Venture capital is used for mainly for IT Industries, Life Science.

Ø Private Equity provides funding for the amount up to $500 million for growth Stage Company and venture capital provides funding up to $10 million for start-up and early expansion of the business.

Ø Hedge Funds differ from private equity firms in terms of their time-to-hold, liquidity, leverage and risk tolerance and desired rate of return of the two types of funds. Hedge funds seek a quick flip of their investments with the average length of their investments being 6-18 months, whereas private equity firms stay invested for around 3-5 years.

Ø Companies entered for Venture Capital are Google, Just dial, Naukri.com, Tutor Vista, Yahoo, Bazee.com and many other companies.

Ø Companies entered for Private Equity are Pipavav shipping, Flipkart.com, Jain Irrigation Pvt. Ltd., Café Coffee Day, Neo Sports, Lavasa Corporation Etc.

Types of Equity based on the Stages of Business

Types of Private Equity based on Market Structure and Activities

Types of private equity activities in terms of the stages of corporate development

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.

Exit Strategies in Private Equity

Private equity investors usually have an investment horizon of 5-7 years and plan to exit after that after making a substantial profit on their investment. There are many exit strategies that private equity investors can use to offload their investment. The main options are given below:

1.   Initial Public Offer (IPO)

One of the common ways is to come out with a public offer of the company, and sell their own shares as a part of the IPO to the public. As the case may be, they may sell their shares immediately, or sell the shares allotted to them after the company gets listed and the shares start trading on the exchange. Stock market flotation can be used only for very large companies and it should be viable for the business because of the costs involved.

2.   Strategic Acquisition

Another alternative is strategic acquisition or trade sale, where the company they have invested in is sold to another suitable company, and then they take their share from the sale value. This is one of the most popular exit routes for private equity funds. The buyer will usually have a strategic advantage in acquiring this business as they both may complement each other. For this reason, the buyer will often pay a premium to acquire such a business.

3.   Secondary Sale

In a secondary sale, the private investors will sell their stake in the business to another private equity firm. This can happen for many reasons, for example, the business may require more money which is not in the capacity of the current equity fund. Or, the business may have reached a stage that the existing private equity investors wanted it to reach and other equity investors want to take over from here.

4.   Repurchase by the Promoters

This is also a successfully used exit strategy, where the management or the promoters of the company buy back the equity stake from the private investors. This is an attractive exit option for both the investors and the management.

5.   Liquidation

This is the least favorable option but sometimes will have to be used if the promoters of the company and the investors have not been able to successfully run the business.

Benefits of private equity

Ø Companies who go for Private Equity funding can easily meet its finance requirement. Private Equity is ideal way to get to finance.

Ø Sometime private equity fund provider not only provides funds but also they provide Expert Advice that can be helpful to the company in decision making.

Ø Corporate Governance

Ø This method raising the fund is far easy and less complex than to IPO and this method is relatively less expensive fund raising exercise.

Ø Through this method company can meet its long term capital requirement as in this investment is generally made for 5 to 15 years

Ø If the company has opted for PE Funding then also it can easily get the other source finance as the proportion debt is less than owned fund.

Limitations

Ø Raising Private Equity finance is demanding and time consuming as the investor would check the position of the company with 360° so as to protect his investment from un necessary risks

Ø  Depending on the investor, promoters may lose a certain amount of power to make management decisions because the investor would acquire the Shares of the company.

Ø Company will have to invest management time to provide regular information for the investor to Monitor the performance of the company

Ø As the company has to follow many regulations and cost of complying with them can be relatively higher.

Situation in India regarding Private Equity

India‘s economic growth over the past decade has attracted unprecedented foreign direct investment (FDI). Much of this FDI has consisted of investments by private equity (PE) firms, out of total investment PE firms responsible for over $ 50 billion of total FDI in 2005–2012. There has been phenomenal growth in the value of private equity investment in India over the past decade. With an expanding domestic market and additional opportunities brought by globalization, the impact of private equity on Indian business is likely to increase further in the coming years. In comparison with China, Philippines, Indonesia, and Vietnam that have given favourable returns in the same global economic environment.

Successful private equity deals in India

Ø Flipkart.com one of the largest E-commerce website of India has raised Fund of $200 million from the clutch of private equity. The money was raised from South African technology group Naspers Ltd and private equity funds Tiger Global and Accel Partners. All the three companies are existing investors in the Bangalore-based firm, which will use the funds for building and strengthening technology capabilities and bolstering its supply chain

Ø There are many more companies who raised the fund through private equity in a decade like Pipavav Shipping, Bharti Airtel, ABG, Punj Lyod, Pantaloons, and Snap Deal among others.

Ø In 2008 Lavasa Corporation also went for Private Equity through Axis Bank of Rs. 250 cr. By taking stake of 2.5%

Ø Another notable PE success story lies in the NBFC field. The ‘Shriram Transport Finance Corporation’, a vehicle finance company opted for private equity capital from Chrys Capital and TPG Newbridge in 2005. It helped the company build a global outlook.

Ø Seeing the growth of PE Funding many banks also started providing such services as investor bankers like Axis Bank, Standard Chartered, Citi Bank and many more.

Conclusion

We can understand the importance of the finance for any company and PE Funding completes the requirement of the finance. With the increase in the industrialization and globalization need of finance will increase and PE Funding can effortlessly provide the finance.