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Contents
• Why do companies need funds?
• When is equity financing preferred?
• Forms of Private Equity Funding
• Recent Trends
• General Process
• Valuations
• Structures and Instruments
• Exit Options
• Advantages and Disadvantages
• Important factors for consideration
• PE at crossroads…
2
Why does a company need funds?
• Plant & Machinery
• Land & BuildingCapital Expenditure
• Fund Based
• Non Fund BasedWorking Capital
• Term Loan RepaymentRetiring Debt
• Vertical – New Product Lines / New Segment
• Geographical – Operations in International MarketsExpansion
• Leverage Buy-out
• Management Buy-outAcquisition Finance
3
When is equity financing preferred?
Equity Financing
Over leveraged
Inconsistent cash flows
Difficult to meet interest commitments
Ideal for start ups
4
Forms of Private Equity Funding
Ideas
Micro
Business
SME’s
Mid - Large
Business
Mature
Business
Incubation
Funds by
Promoters
Family &
Friends,
“Angel” Investors &
Venture Capitalist
Venture Capital,
Private Equity
& Mezzanine
Capital Markets /
Private Equity
& Mezzanine
Buy Out Funds/ Capital
Markets
Stages of Business
Types of Private Equity Funds
5
Recent Trends in PE
Volume Value (US$ Bn)
HY1 09 HY2 09 HY1 10 HY2 10 H1 11 HY1 09 HY2 09 HY1 10 HY2 10 H1 11
PE 89 117 125 128 203 1.78 1.66 2.95 3.28 5.09
QIP 5 49 26 30 4 2.02 6.59 2.56 3.66 0.65
Total 94 166 151 158 207 3.80 8.25 5.51 6.94 5.74
Source: Grand Thornton Deal Tracker
6
Recent Trends in PE - Performance of various funds
8
• Expansion / growth capital accounts for 46% of total deals of 2011
• Big trends for 2011 was surge in start-up/early stage deals from 18% of total in 2010 to 33% of total in
2011
Source: Economic Times on 6th January, 2011
Angel Investor
• Provides „seed funding‟
• Usually affluent individual providing capital for business start-ups
• Different from venture capitalists
• Limitation on amount of money that can be raised
• Bear high risk
• Require very high return
• Investment holding period of <5 years
9
Venture Capital
• Typically occurs after seed funding stage
• Subset of private equity
• Venture capital consists of investing in equity, quasi equity and/or conditional loan in order to
promote unlisted, high risk or high tech firms driven by technically or professionally qualified
entrepreneurs.
• Finance companies that have demonstrated extraordinary business potential
• The risk anticipated is very high
• Follow the concept of “high risk, high return”
• Year 2011 is record year for early-stage Venture Capital investing
– Deal values & volumes at all time high
– Euphoria around e-commerce, across mobile, internet and related verticals
– Evident from recent deals of InMobi, Fashionandyou, Snapdeal
– Exit in MakeMyTrip touted as poster deal for domestic venture industry
– JustDial , One97 Communications and others lining up for exit over coming months
11
Venture Capital
Sector
Early Stage
Key Driver -
Innovation
Investment
& Exit
Success
Majorly in
emerging sectors
Funds start up
& early expansion
Highly skilled
professionals,
scientist &
innovators with
innovative
business idea,
new product &
new technology
Upto $10 mn, exit
through strategic
sale or IPO
High mortality rate
& few great
success
12
Private Equity
• Equity investments in relatively mature, primarily unlisted companies requiring growth capital
• An asset class that involves value enhancement and high returns generation by sharing business
expertise of the Investor complementing the Entrepreneur
• Typical value additions from the PE Fund House could include Strategy Formulation Financial
Formulation, Expertise and Global/Domestic Networks (including other investee companies)
• Offer greater opportunity to exercise control over investments as compared with other passive asset
classes like equities, mutual fund, real estate, commodities, fixed income
– Active involvement and influence on the company, including board seat
• Each investment is backed by an investment thesis which plays out over a period of 3 to 5 years
• Private Investment in Public Entities (PIPES)
14
Growth Stage – Private Equity
Sector
All growth sectors
Growth
Stage
Investor funds at
growth stage of
the company
Key Driver -
Innovation
Capacity expansion,
new products, new
geography etc.
Investment
& Exit
From $5 mn to
$500 mn, exit
through IPO
Success
Few failures &
great success
15
Buyout Funds
• Globally most important strategy of PE; though not a very prevalent strategy in India
• Generally buyout‟s done at matured stage of business
• Mature companies with leading market position, active management team, strong cash‐flow
• Taking a controlling stake in the company through leveraged buyout (LBO) or through management
team alongside the PE fund (MBO)
• PE funds provide capital for expansion, promoters‟ / corporate divestures, succession issues…
• Development of a business plan over 4 to 6 years in order to add value
• Revenue growth + Margins improvement + deleveraging = added value
17
Transactions (Illustrative)
18
Company Financial Investor Value (US$ Mn) Type
Flextronics Software Systems Kohlberg Kravis Roberts & Co. 900 LBO
GE Capital International Services (GECIS)General Atlantic Partners, Oak
Hills600 LBO
Phoenix Lamps Actis Capital 29 MBO
Nilgiris Dairy Farm Actis Capital 65 MBO
WNS Global Services Warburg Pincus 40 MBO
Infomedia India ICICI Venture 25 LBO
Nirula‟s Navis Capital Partners 20 MBO
Gokaldas Export Blackstone 165 MBO
Paras PharmaceuticalsActis Capital
Sequoia CapitalN.A. MBO
Mezzanine Debt / Structured Product
• Mezzanine financing is provided by mezzanine funds and sometimes hedge funds
• Finance as Debt instrument / structured product like partly or optionally convertible instruments etc.,
immediately subordinated to equity
• Mezzanine financing might include, besides coupon bearing debt, an equity sweetener as well
• Considered as debt instrument with very high yield which at times in substitution of equity
• Returns generated by the fund are
– Interest ‐ fixed rate or fluctuate along an index (e.g. LIBOR) OR a pre agreed IRR
– Upside potential through Equity
• Illustrations:
19
Sector focused funds
• Real estate funds
– Focus on investments in real estate and real estate intensive businesses
• Infrastructure funds
– Roadways
– Port projects
– Railway projects
– Power projects
– Telecom
– Logistics
20
Key Differentiators
Particulars Stage Level of risk Assessment Focus Investment Size
Angel Investors Very Early Very High Mostly Technology < $ 1 Mn
Venture Capital Early High Mostly technology < $ 10 Mn
Private Equity Growth Moderate Diversified > $ 10 Mn
Buyout‟s Mature Moderate Diversified > $ 50 Mn
Mezzanine All stages Moderate Diversified > $ 5 Mn
21
» Identify target
Investors
» Share
Information
» Follow-ups
» Promoter
Meetings
» Plant visits
» Negotiate
valuations and
other terms of
the
transaction
» Due Diligence
» Definitive
Agreements
Stage
Process
PreparationInvestor
IdentificationTerm Sheet
Final negotiations
and Closing
Timing
4-6 weeks4-6 weeks3-5 weeks3-4 weeks Total Time
14 – 21 weeks
Sign NDAs Sign Term Sheet Sign Definitive Agreements
» Understanding
and evaluating
historical
performance
» Recast of
Historical
numbers; if
needed
» Preparation of
IM and
Projections
» Industry
Overview
» Pre & Post
Closure
formalities
General Process
22
Structures and Instruments
Primary Investment
• Involves fresh infusion of capital in the company against issue of fresh shares to augment future
growth
• Ideal for growth companies
Secondary Investment
• Involves payment to existing shareholders of the company
• Could be either on account of buying out or providing some liquidity to existing shareholders
• Ideal when promoters wants to cash out (fully or partially) or buyouts
24
Structures and Instruments
Private Equity Investment
Primary Investment
Direct EquityConvertible
Preference Shares / Debentures
Warrants / Options
Secondary Investment
Equity Purchase / Earnouts
25
Exit Options
• Modes of exit
– Initial Public Offering (IPO)
– Exit via M&A
– Sale to another investor
– Secondary sale on stock markets
– Buy Back / Call / Put Option
• Three important pillars
– Valuations
– Timings
– Restrictions, if any to exit
Nature of Exit2009 2010
Volume Value (US$ Mn) Volume Value (US$ Mn)
Initial Public Offering 2 31.64 15 502.22
M&A 18 157.97 40 1,238.13
Open Market 69 1,390.10 76 1,448.54
Secondary Sales 8 78.17 18 160.85
Buyback 6 500 15 1,695.32
Total 103 2,158 164 5,045
Source: VCEdge
26
Advantages
• Fills funding gaps for long term capital
• No interest cost. Seeks return through capital appreciation rather than immediate and regular interest
payments
• Adds value because, apart from funding, PE contribution includes:
– Financing expertise and strategic management support
– Networking and Global Integration
– Confidential as compared to IPO or even debt funding
– Independence of the capital markets volatility
• Positive signaling effects to the market:
– Debt, IPO
– M&A
– Employees, Suppliers and Customers
– Increases Industry Visibility
• Corporate Governance
• Relatively less expensive fund raising exercise in comparison to IPO
27
Disadvantages
• Raising Private Equity finance is demanding, time consuming; at times the business may suffer if
promoter devotes more time for the transaction
• Depending on the investor, promoters may lose a certain amount of power to make management
decisions
• Will have to invest management time to provide regular information for the investor to monitor
• Might create conflict or differing opinion in long‐term strategy due to pressures of EXIT from the
investor
• The cost of complying with regulations could be relatively higher
• Non‐alignment of Interest of fund manager on the board and entrepreneur could hamper the growth
of company
28
Important factors for consideration
Growth Potential
Market Positioning
Management Bandwidth
Historical Performance
Competitive Scenario
Industry Trends
Project Period
Stage / Sector / Structure
Returns
Exit
29
• PE operating in a challenging environment today
• Difficult fund raising environment
• A large number of India focused funds were raised during 2004-06. Many of these are due to raise their
next fund
• Funds with dry powder putting monies to work in environment beset with intense competition
• Tremendous competition amongst funds to win deals resulting in bid war
• Expensive entry valuation continues to frustrate
• Investments by real estate funds have reduced - slowdown in sales & high borrowing cost continue to
plague the sector
30
17,828Announced
2011
2,024Raised
16,853Announced
2010
4,111Raised
Value of funds raised and announced ($ Mn)
Particulars 2010 2011
Funds Announced 52 51
Funds Raised 10 25
Number of funds raised and announced
PE at Crossroads…
Source: Economic Times on 6th January, 2011
31
• Deep inventory of future exits in the PE pipeline
– PE exits will take a lot of PE manager‟s time, energy and
bandwidth
– Approximately 68% of PE deals made through boom years of
2006-08 remain in PE funds‟ portfolios
– Now reaching the upper end of their investment holding periods,
many of these holdings should soon be coming up for sale
– PE exits account for only 20% of PE activity in 2011, indicating
strong potential for M&A transactions in the coming years. Also
reflected in increased preference towards exit through M&A route.
More than 100% rise in instances of exit through this option in
2010 over 2009
• Funds will look to learn from past and spend greater time on deal evaluation and make investment
decisions based on merits rather than sentiments
• PE firms also expected to spend considerable time on their portfolio management as holding periods have
been stretched
Source: Economic Times on 6th January, 2011
PE at Crossroads… (contd.)
• Motivation for PE players to provide high yield debt finance continues to grow. Such endeavors
undertaken to cater to all investment needs of promoter, debt & equity
• Increased activity in PIPES deals
– Volatile capital markets in 2011
– Conventional fund raising options for listed companies not available
– New Takeover code provides a boost for PE funds
– Greater number of listed companies expected to source growth capital needs from PE
• Early stage investing is in the limelight & will continue to gain momentum
• Deals in cloud computing, clean technology, online commerce and technology enabled services such as
mobile & online advertising, analytics and data management business will continue to attract Venture
Capital funding
• Strong growth potential for Venture Capital, Buyout funds and Pre-IPO / late stage placements
32
PE at Crossroads… (contd.)