Strategies For Realising Value By Deloitte

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  • This is the general approach to VC/PE investing: A fund generally takes money from third party sources, creates an investment fund and puts it use as equity in various companies and cashes out after some period through various exit routes. A VC would typically invest in companies which have a great idea or a great management team but lack the resources to grow to next levels. VC not only provides an investee company with capital, but would also mentor the entrepreneur to help identify the growth drivers and formulate future growth strategy of the firm. Once the investee firm has reached a certain size or the VC firm feels that the returns on its investment are adequate to exit, they would cash out.
  • When and how a VC exits is dependent upon a lot of factors. Increasing activities in the financial markets and inbound interest of foreign investors may present an opportunity for a VC to gain an acceptable upside on its investment. Growing transactions have also led to increased exits through M&A activities as compared to other routes by VCs in the recent years. When a VC believes that the investee company has reached a certain size that for the next level of growth, company needs additional capital that the VC is not able to provide, then it may approach a strategic or another financial investor who would can provide additional capital and sees value in the investee company to pay a premium for VCs stake. In some cases, VCs may also sell their investment to another portfolio company that could benefit from this collaboration or acquisition. It may also sell the investment to a competitor or a JV partner to enable access to technology, wider customer base or complementary product portfolio for its investee company. More popular route for exits across the world is the IPO route, which is considered most efficient by the VCs. They are a greater proof of market’s viability. Return potential is higher and liquidity concerns are also addressed. Regulatory issues also need to be kept in mind while deciding on the exit route. Some of the other exit options include buy-back of VCs stake by the entrepreneur or company management or merger with an existing listed company.
  • Significant investments from VC fund started in India around 2002-03. Since then the investments and exits have grown y-o-y. The graph shows the total number of PE exits from 2004 to 2007 and the number of exits through the IPO route. Remaining exits were through other exit options like strategic sale or sale to other financial investors. Though preferred to trade sale across the world, in India, exit through IPO hasn’t really picked up despite its benefits. This could be because of the smaller scale of the investee companies at the time of exit or also higher valuations offered by strategic investors for whom M&A is a faster route to enter a strategic market like India. In 2007, VC funds completed exits worth an estimated $1.5 billion via strategic sales or secondary transactions. Another 16 exits were through the IPO route. In the first half of 2008, another 6 exits by VCs have been seen through the IPO route given the unfavorable market conditions. Major exits are expected in 2009-10 when the investments made in the earlier years mature and the VCs would look at exiting. Some of the noticeable exits through IPO route are by Idea Cellular and the BPO giant Genpact. Idea Cellular raised $555 mn through its IPO and provided an exit option for its investors ChrysCapital, CVC, TA and Providence who collectively held a minority stake in the company. Genpact raised about $600 million in its listing on the New York stock exchange and provided rich returns for General Atlantic and Oakhill Capital who together held 60% in the firm.
  • Of the other options that have been more prominent in India are the strategic sales or secondary sales. These options provide the investee company immediate opportunity to grow by getting access to technology, market etc. For example, when Actis sold its 28% stake in Punjab Tractors to M&M, it helped in consolidation of the tractor industry in India. Similarly, when Google acquired YouTube for about $1.65 billion, value of Sequoia Capital’s investment in YouTube of $11.5 million reached a value of almost $495 million, that’s 43x times their investment in 2 years. What also helped was that Sequoia was one of the investors in Google too and its partner was on its board. There are also cases wherein a smaller VC fund sells its stake to a larger fund when the investee company grows to a size where in its capital requirements either grow in size or longer in term.
  • Some of the benefits and challenges faced in these exits options are discussed in these slides. In case of IPO route, though it is the most efficient route that prevents valuation issues and is fairly a transparent process, the market scenario would play a determining factor. Again unless an investor actually sells its shares in the listed company, an IPO is not an exit in itself. It however provides liquidity to the stock and provides option to the investor to sell its stake partially or as and when desired. Also for the VC, if any warranties and indemnities need to be provided by them to the underwriter of the IPO, it generally is an issue of concern for them. The entrepreneur on the other hand has additional duties to fulfill with additional regulatory requirements and at times undesired public scrutiny of his actions. However, the entrepreneur is also able to retain management control in the company.
  • On the other hand, strategic sale to a company or another investor is a longer process involving negotiations and possible restrictive covenants. The management of the investee company may also resist the sale for the fear of losing autonomy and future position in the company. It however provides an immediate and complete exit for the investor. The investor may also sell only partial stake. The entrepreneur may also gain in terms of getting access to resources.
  • Another exit route is the buy-out of the investor’s stake by the entrepreneur or the management of the company. This generally occurs when the company is either not able to live up to expectations/promises made to the investor or the entrepreneur sees higher future potential in retaining the control with himself. In this case, arranging for the capital to buy-out investor’s stake is a challenge for the entrepreneur. The investor may also lose on the valuation front in face of the resistance in exercising other exit options from the entrepreneur. Synopsis: While there are no defined rules for exits, the goal is to realize capital appreciation. An exit, however, is only justified when a true value proposition is identified, and everyone stands to benefit. What is critical is that the exit objectives are compatible among owners. Only then can it result in true value creation.
  • While there are no defined rules for exits, the goal is to realize capital appreciation. An exit, however, is only justified when a true value proposition is identified, and everyone stands to benefit. What is critical is that the exit objectives are compatible among owners. Only then can it result in true value creation.
  • Strategies For Realising Value By Deloitte

    1. 1. Strategies for Realising Value . October, 2008
    2. 2. VC/ PE Value Creation Model Value Identification <ul><li>Screening </li></ul><ul><li>Valuation </li></ul>Instill value based Management <ul><li>Strategy Evaluation </li></ul><ul><li>Business Planning </li></ul><ul><li>Performance Measurement </li></ul><ul><li>Mentoring </li></ul>Value Realisation / Exit Strategy <ul><li>When to exit? </li></ul><ul><li>Valuation </li></ul><ul><li>Likely Buyers….. </li></ul>Ultimate Aim: Value Enhancement
    3. 3. Exit Options <ul><li>The most popular ones: </li></ul><ul><li>Selling stake to strategic investors </li></ul><ul><li>Initial Public Offering (IPO) in India or overseas </li></ul><ul><li>Sale to any other private equity fund or venture capital fund </li></ul><ul><li>Secondary sale on stock markets (only for listed companies) </li></ul><ul><li>Merger with an existing listed company </li></ul><ul><li>Management / Company buy-backs </li></ul><ul><li>What drives Exit? </li></ul><ul><li>Sound Financial Markets </li></ul><ul><ul><li>Emergence of strong institutional participation (600+ FIIs, emergence of domestic mutual funds) </li></ul></ul><ul><li>Rapid growth in domestic and cross border M&A transactions </li></ul><ul><ul><li>Emergence of Indian corporates as strategic buyers </li></ul></ul><ul><ul><li>Large domestic markets are attracting global strategic buyers </li></ul></ul><ul><ul><li>India has emerged as the third largest M&A market in Asia </li></ul></ul>
    4. 4. Exit Trends <ul><li>Exit through IPO route: </li></ul><ul><li>The largest PE/VC-backed IPO came from Idea Cellular Ltd. ChrysCapital Management Co., Citigroup Venture Capital International Asia Ltd, TA Associates Inc. and Providence Equity Partners Inc. collectively had a minority stake in the company, which raised $555 million in total </li></ul><ul><li>Other notable IPO was from business process outsourcing giant Genpact, which raised approximately $600 million on the New York Stock Exchange. General Atlantic and Oakhill Capital together held 60% in the firm. </li></ul>Though IPO route is considered to be most efficient way of exit by PE/VC investors across the world, in India other options have been popular VC/ PE Exits in recent years
    5. 5. Exit Trends <ul><li>Sale to strategic buyers: </li></ul><ul><li>Many a times, merging or collaborating with a competitor or strategic partner is beneficial for the investee company </li></ul><ul><li>UK-based Actis Capital Llp. sold its 28% stake in Punjab Tractors Ltd to Mahindra and Mahindra Ltd and helped in consolidation of tractor industry in India </li></ul><ul><li>Sequoia Capital sold its 30% stake in YouTube to Google. Google which also had a video search engine capitalised on the social media aspects of YouTube, which has become the number one destination for videos online. </li></ul><ul><li>Sale to financial investors: </li></ul><ul><li>As the investee company grows, its capital requirements also grow. In such cases, it is common for smaller funds to sell their stakes to bigger investors who can provide additional funds for next level growth. </li></ul><ul><li>ICICI Ventures recently sold 10% stake in Subhiksha to Premji Invest </li></ul>
    6. 6. Initial Public Offering (IPO) Offering of investee company’s shares to public for the first time Benefits Issues PE/VC <ul><li>Fairly transparent process </li></ul><ul><li>No valuation issues – market linked </li></ul><ul><li>Higher liquidity – partial and on-demand exit possible </li></ul><ul><li>An IPO is not an exit in itself – An investor will only exit when it sells its shares in the listed company </li></ul><ul><li>Pre-IPO re-organisation of the investee company’s capital structure may impact investor’s legal position </li></ul><ul><li>Warranties and indemnities to be provided to underwriter of the floatation </li></ul>Entrepreneur <ul><li>Less fear of loosing management control </li></ul><ul><li>Higher liquidity </li></ul><ul><li>Additional regulatory requirements </li></ul><ul><li>Unwillingness of public scrutiny </li></ul>
    7. 7. Strategic Sale Sale of investee company’s shares to another company or investor Benefits Issues PE/VC <ul><li>Immediate and complete exit </li></ul><ul><li>Due to perception of synergy, buyer often pays a premium </li></ul><ul><li>Possible resistance from management team, concerned about their future positions </li></ul><ul><li>Long process </li></ul><ul><li>Negotiations with potential investors </li></ul><ul><li>The buyer may want to put restrictive covenants that might restrict the seller from participating in competition firms </li></ul>Entrepreneur <ul><li>Immediate access to technology, markets etc. </li></ul><ul><li>Injection of competent management </li></ul><ul><li>The buyer would be willing to inject more cash </li></ul><ul><li>May impact the ownership structure </li></ul>
    8. 8. Management Buyout The repurchase of the private equity investors’ shares by the company and/or management Benefits Issues PE/VC <ul><li>Immediate and complete exit </li></ul><ul><li>May not get the best valuations </li></ul>Entrepreneur <ul><li>Useful in case the company is not yet willing or ready for flotation/ trade sale, but whose private equity investors needs an exit </li></ul><ul><li>Arranging capital to acquire shares from investor </li></ul>
    9. 9. Put Option Company/ promoters to purchase the investor’s shares at a price pre-determined at the time of investment In general, extending a put option to circumstances where the company or promoter is not in default is quite difficult.. Benefits Issues PE/VC <ul><li>Minimum assured returns in case of </li></ul><ul><li>- Poor market conditions </li></ul><ul><li>- Default by promoters </li></ul><ul><li>RBI regulations prevents an Indian from buying shares from a foreigner at a price higher than one computed by its prescribed formula (market determined) </li></ul>Entrepreneur <ul><li>Put price will essentially be more than the market determined price otherwise the VC/ PE would rather find an alternative investor </li></ul>
    10. 10. To Conclude.. <ul><li>While there are no defined rules for exits and plenty of options to choose from, the goal is to realize capital appreciation </li></ul><ul><li>An exit, however, is only justified when a true value proposition is identified, and everyone stands to benefit. What is critical is that the exit objectives are compatible among owners. Only then can it result in true value creation </li></ul>
    11. 11. Copyright © 2008 Deloitte Touche Tohmatsu India Private Limited. All rights reserved. About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu, a Swiss Verein, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu and its Member Firms.

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