Future of private equity in India may be a pipe dream

The business column I write for The National every week is really tough for me. This week was no exception. I learned about private equity 101 and talked to about half a dozen players in Mumbai and Bangalore. No one would speak on the record and it was all very interesting. I turned in the piece after my deadline and Rupert, my editor, tried to be gracious about it. Next week, I start again.

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Future of private equity in India may be a pipe dream
Shoba Narayan
Last Updated: Feb 20, 2011

Last week, after a record year, Sequoia Capital India’s four founding partners shocked the subcontinent’s private equity world by quitting abruptly to re-start their own firm, WestBridge Capital Partners, which, they said, would invest in publicly traded companies.

Since 1991, when the Indian financial market opened up, the country has spawned a rich entrepreneurial culture that is reminiscent of Silicon Valley in the US. Rather than go abroad to make a living and make money, today, 95 per cent of Indian engineering graduates prefer to stay home and set up shop. The increasing number of start-ups require financial capital and professional expertise, all of which has created a sub-culture of private equity firms. According to a report by the Confederation of Indian Industry and KPMG issued last year, there are about 135 domestic and 137 foreign private equity firms operating in India today. Together, they have made about 1,500 private equity deals since January 2006, bringing in US$32.5 billion (Dh119.37bn) in investments. This activity has been accompanied by some volatility, the latest of which has been the Sequoia surprise.

The local media have linked the founders’ exits to newfound interest in Pipes – private investments into public equity. “Sequoia’s exit shows Pipes getting hotter,” said The Times of India.

That may well be but it could also be something as simple as non-competition agreements, forcing these erstwhile private equity players into new terrain.

Sources close to Sequoia say there is no non-compete agreement or any restriction on how the four founders, Sumir Chadha, KP Balaraj, SK Jain and Sandeep Singhal, can invest in the future.

The quartet, meanwhile, are going back to their roots — they founded WestBridge Capital Partners with the help of the Khemka business family in 2000 before it became Sequoia India.

One industry veteran makes the case that such sudden and dramatic changes in top management occur only in the Indian operations of foreign PE houses. “Why do managers leave non-independent businesses?” he asks. “They never get a part of the wealth creation; they don’t own a piece of the global business.”

So is the future of Indian PE homegrown independent firms? The plethora of entrepreneurial activity, investor confidence, and the spate of high-profile management exits, would seem to suggest so.

According to Venture Intelligence’s India Roundup 2010, private equity firms invested $7.97bn over 325 deals in India during the 12 months ending in December, compared with $4.06bn across 290 deals during the previous year, putting PE activity back to 2006 levels after a volatile period.

According to KPMG, over the past three years, venture capital and PE investments were the equivalent of 33 per cent to 72 per cent of the total equity raised from primary markets.

In the secretive world of Indian private equity, there are two starkly divergent points of view with respect to the future.

One investor (and Sequoia falls in this camp) says he is going to put the bulk of his investments in illiquid public companies since most entrepreneurs are taking their companies to the public markets very easily.

Too much money and too few companies to invest it in, he says.

Not true, says a source in a rival firm. Private equity is the future of Indian entrepreneurial activity, given the entry barriers to public markets. Look at the growing size of recent initial public offerings (IPOs), he says.

The fact that IPOs have become progressively bigger shows companies have to be large or unique for the market to pay attention to them.

“But there are tons of great companies that are neither large or unique. That’s where private equity firms come in,” the source says.

The entry barriers to public markets might be high but the barriers to foreign private equity firms are higher.

Given its fiscal deficit and current-account deficit, the Indian government ought to make itself attractive to long-term investors. But it is not doing so.

The message from the government is “we take our business offshore”, said one private equity player, who wished to remain anonymous.

Thanks to double taxation rules and complicated regulations, the government makes it almost impossible to set up an alternative asset business in India.

“Why can’t they simplify the tax structure and bring a level of stability to it?” laments one venture capitalist, who also declined to be named. “What is the tax rate? Who gets taxed and who doesn’t? You can’t have changing goalposts and that, too, with a retroactive effect.”

Even after they set up shop and make investments, PE firms have to contend with recalcitrant management.

During the slowdown of 2009, PE firms identified deviations from agreed business plans as the single biggest challenge they faced post investment, according to a KPMG report.

Entrepreneurs and promoters failed to appreciate the professionalism, business model changes and corporate governance that PE companies brought in (or imposed, depending on your point of view), given that they were minority shareholders.

Pipes may provide the silver lining. With India seeking $14bn in private sector investments for infrastructure projects over the next three years, Pipe deals will probably become vogue.

In the end, this may be India’s saving grace as PE investors bring their professionalism and governance requirements bear on the quagmire of large-scale public projects.

With the economy galloping at 8.6 per cent growth, there is room for all kinds of investments.

If only the government would co-operate.

Shoba Narayan is a journalist based in Bangalore and the author of Monsoon Diary