Contractual risks in pe invsts dr. kishore - prmia
Dr. Kishore N.K.M.Com., ACS., MDBA., Ph.D., LLBBEKEM Infra Projects Private LimitedContractual RisksinPrivate Equity Investments
Scheme of discussion:• PE and related investments• Investment strategies of PE• Process of PE and Fund’s Life cycle• Valuation Methodologies of PE• Contractual Risks in PE Investments:– Liquidity Preference Rights– Equity Ratchet Rights• Risks in Pre and Post Money valuation• Risks in 20 Pressure Clauses of PE• Brief case study on PE investment• Recent statistics of PE
Private Equity – Broadly Defined• Technically refers to any type of equityinvestment in an asset in which the equity is notfreely tradable on a public market.• Therefore, PE is:– Less liquid– Long Term in nature
Introduction to private equity"Angel" "Growth""HedgeFunds"Seed 1st Round2nd & 3rdRoundEmergingGrowthLeveragedBuyoutsMezzanineDebtDistressedEquityDistressedDebtHedge FundsAge ofCompany0 years 0-1 year 1-3 years 3-10 years 10-50 years 10-50 years 10-50 years 10-50 years 5+ yearsStage ofCompanyIdea Prototype1st generationproduct2nd or 3rdgenerationproductEstablished,slow growthEstablished,slow growthStressed Stressed PublicPublic orPrivate?Private Private PrivatePrivate orPublicPrivate orPublicPrivate orPublicPrivate orPublicPrivate orPublicPublicEquityRequirement$0.2-0.5m $1-2m $2-5m $5-20m $10 - 250m $10 - 250m $10 - 250m $10 - 250m N/AReturnExpectations70%+ 50-70% 50-60% 40-50% 25-40% 20-30% 30-50% 30-40% 20%"Venture Capital" "Buyouts" "Distressed Investing"
Angel Investors• Angel investor is typically a wealthy individual• Often with a technical industry background• Able to judge high-risk investments• Invests in early stage companies up to Rs. 50 lacs• Expects investment through IPO or subsequentfinancing rounds
Financial VCs• Most common type of VC• Is an investment firm, capital raised frominstitutions and individual investors• Being formal VC funds, have limits on size,lifetime and exits• Are entitled to carried interest• Fund size ranges between Rs. 100 crores toRs. 50,000 crores• Exits from IPOs, mergers & acquisitions, andselling on stock exchanges
Strategic VCs• Typically a small division of a largetechnology company• Invests in companies whose success mayincrease revenue growth of the VC• May not concern only about the return oninvestment• May provide investees with valuableconnections and partnerships• Usually takes a back seat role in funding
Why Angels Invest• The Person– Familiarity with the integrity and abilities of the management teamOR– Friends, Family & Fools• The “Cause”– The company is doing something that contributes to a social causethat is meaningful to the angel…• Curing cancer, improving the environment– The company is targeting a market segment in which the angel hasexperience and insight• Perceived BIG opportunity– The Angel perceives the technology to be disruptive and doessome cursory due diligence that confirms his / her suspicions
Private Equity – Corporate Finance StrategiesFinance type StrategyLeveragedBuyoutAcquisitions of operating companies that are financed withequity and debtGrowth Capital Expanding companies in need of capital to finance highgrowth or acquisitionsTurnaround Acquisitions of underperforming businesses or businesses inout-of-favor industries in need of either financial oroperational restructuring
Private Equity – Venture Capital StrategiesFinance type StrategyEarly Stage Companies that are in the process ofdeveloping business plans, products /services have been developed and aremarketed to a limited number ofcustomersLate Stage High growth companies, nearingprofitability
Private Debt – Financing StrategiesFinance type StrategyMezzanine Investments in subordinated debt issued by operatingcompanies; frequently issued in conjunction with a buyoutacquisition and with equity kickers attached, such as warrantsor options in order to enhance returnsDistressed Debt Investments in public and private debt securities that aretrading at discounts to par value due to financial stress of theunderlying companyInfrastructure Investments used to finance the construction orenhancement of distribution networks for electricity, waterand gas, and certain transportation assets such as toll roads,bridges and tunnels
Process of PE fund(1) Raise Capital(2) EvaluateMarket Segments(3) GenerateDeal Flow(4) Select InvestmentCandidates(5) Negotiate andStructure Investments(6) NurturePortfolio Companies(7) Liquidate / SellPortfolio Companies
Private Equity Fund LifecyclePeriod ActivityFund raising(6 – 18months)The first phase of a fund’s life cycle is thefundraising period, during which a fund ismarketed to potential investors who commitcapital. Capital commitments from investors areessentially promises to fund future investments asa fund manager identifies them.InvestmentPeriod(5 – 6 years)Once fundraising is complete, the fund closes andbegins its investment period, which typically lastsfive years. During the investment period the fundmanager calls capital from commitments providedby investors to make investmentsRealizationPeriod( 5 – 8 years)After the investment period, the fund enters therealization period, which lasts five to eight yearson average. During the realization period,investments are sold or liquidated, and proceedsare returned to the investorsPrivateEquity
Valuation methodologies• Price of recent investment• Earnings multiple• Net assets• DCF or earnings (of business)• DCF from investment• Industry valuation benchmarks
Price of recent investment• Since the previous investment wasmade recently, the same price may beadopted for the current investment aswell• The validity of the valuation obtained inthis way is inevitably eroded over time.• To adopt price as above, background tothe previous transaction and investmentmust be evaluated (such as volume,rights, strategic considerations etc)
Evaluation of previous investmentand business• Performance and prospects of the businessagainst the assumptions / terms of previousinvestment• Extent of compliance with the terms andconditions of investment documents• Present business environment, includingtechnical, market, economic, legal andregulatory, in comparison with previousinvestment
Earnings multiple• Is applying an earnings multiple to theearnings of the business to derive thevalue of the business.• This methodology is appropriate forinvesting in established businesseswith identifiable stream ofmaintainable continuous earnings• The earnings figures for a number ofperiods may be averaged using aforecast level of earnings or applyinga sustainable profit margin to currentor forecast revenues.
Essentials to apply earnings multiple• Multiple should be appropriate,reasonable, and commensurate with theearnings growth prospects of theunderlying company.• Earnings should be adjusted for thesurplus assets or excess liabilities andother relevant factors to deriveenterprise value for the company• This methodology may even be appliedto companies with negative earnings ifthe losses are considered to betemporary and one can identify a level ofnormalized maintainable earnings
Various multiplesMultiple ApplicabilityP/EPrice / Earnings of comparative company may be used. It signifies theprice market is willing to pay for the Company based on its earnings(EPS). Theoretically the company can be purchased at the MPS on thestock exchangeEV / EBITEV, Enterprise Value, is the sum of net worth and net financial debt ofthe Company. EV / EBIT indicates the multiple of EV for the totalearnings of the CompanyEV / EBITDAEBITDA is the total cash earnings of the Company.EV / EBITDA indicates the multiple of EV for the total cash earnings ofthe Company
Caution required while applying multiplesMultiple CautionP/EP / E is a market based approach.Market capitalization of a quoted company may not reflect the value ofthe Company but only the price at which ‘small parcels’ of shares areexchanged.The comparative companies should be similar in terms of businessactivities, markets served, size, geography and applicable tax rates.EV / EBITThis multiple ignores the benefit of depreciation, particularly in case ofassets depreciated for accounting purpose over a limited period butpractically have a longer economic usable value.EV / EBITDAThis multiple removes the impact on the value of depreciation of fixedassets and amortization of goodwill and other tangibles. The need ofreplacement of highly depreciable assets, need for expending additionalamounts to be amortized over a limited period have to be factored in.
Net assets• This methodology involves deriving thevalue of business by reference to the valueof its net assets• This is likely to be appropriate for a businesswhose value derives mainly from theunderlying value of its assets rather than itsearnings. Ex., property holding companiesand investment businesses.• This may also be appropriate if return onassets is inadequate and greater value canbe realized by liquidating the business andselling its assets
Caution required while applyingNet assets method• Contingent assets and liabilities mayalso be included while valuing assetsand liabilities of the Company• An appropriate marketability discountshould be applied to arrive at arealistic value of the assets• The value of the redeemableinstruments, if any, should bededucted to arrive at the availablevalue of the assetsNetAssets
DCF from the underlying business• Discounted Cash Flow (DCF) methodologyinvolves deriving the value of a business bycalculating the present value of expectedfuture cash flows• Is flexible as it can be applied to any streamof cash flows or earnings• This methodology may be applied forbusinesses going through a period of greatchange, such as a rescue refinancing,turnaround, strategic repositioning, lossmaking, or is in its startup phase etc.
DCF from the investment• Unlike the DCF from the businessearnings, this methodology applies DCFtechnique to the expected cash flows fromthe investment itself.• Where pricing for the return on theinvestment or floating Initial Public Offer(IPO) is / to be agreed at the time ofmaking investment, this is the appropriatemethodology.• Is particularly suitable for valuing non-equity investment in instruments like debt,mezzanine debt etc since the value of suchinstruments derives mainly from theinstrument-specific cash flows and risksthan of the underlying business as a whole
Caution for applying DCFmethodology• Cash flow forecasts, estimation of terminalvalue, and selecting risk-adjusted discountrate should be appropriate• Ideally DCF based valuations should beused as a cross-check of values estimatedunder market based methodologies andshould be used in isolation of othermethodologies only under extreme caution
Industry valuation benchmarks• Industry specific valuation benchmarks are usedas per the prevailing practice of the industry• Examples: price paid per bed for hospitals, priceper seater for BPO, price per head for schools,price per subscriber for cable-television, mobile,internet companies etc• These industry norms are based on assumptionsthat investors are willing to pay for turnover ormarket share and that the normal profitability ofbusiness in the industry does not vary much• This may be used as a sense-check of valuesproduced using other methodologies
EXIT OPTIONS:• IPOs• Mergers & Acquisitions• Management Buy-out• Sale to Another Fund• Buyback by Promoter/ Company• Stock MarketEXITOPTIONSAVAILABLETOPRIVATEEQUITYFUNDSDuration of Private Equity/ Venture CapitalInvestment normally ranges from 3-7 yearsIn case of Buyback by Promoter/Company , the value atwhich PE Fund would exit is IRR or market-based and ispre decided at the time of investment on a certain valuation
Popular Investment instruments of PE(For issue to PE by investee companies)Equity shares at a premium Traditional pricing. Ratchet rights may not beinvolvedOptionally Convertible PreferenceSharesECB guidelines apply and foreign PE / VC maynot find it attractive.Pricing can be in favour of PE. Ratchet rightsmay be stipulated.Fewer no of equity shares (withdisproportionately higher votingrights) and substantial portion inPreference sharesMarket pricing. Deal in favour of PE. Votingcontrol is provided to PE with the differentialvoting rights. (Present version of newCompanies bill bans DVRs)Cumulative CompulsoryConvertible Preference Shareswith participating rightsProspective pricing. Participating rights inresidual income. Very popular instrumentand widely used in the recent past.Mix of Equity + convertible equitywarrants + preference sharesMultiple convertible instruments. Very complexto structure. Pricing can be manipulated as perthe agreement between the parties.Debentures convertible into equityshares at the time of IPO at theIPO pricePricing can be fair and neutral. Comfort to PEwith the periodical interest cash flows andcomfort to Investee Company with the non-equity control by PE (till conversion into equity)
Contractual rights andcorresponding risks in PEinvestments
Liquidity Preference• Liquidity preference right applies forliquidation, merger, acquisition,takeover, sale of asset of company,IPO, or any other exit• If company is liquidated the PEinvestors (holding liquiditypreference rights) will be entitled toget their money back in 1 or moremultiples as per the liquiditypreference right(ex: Invst x 1; invst x 1.5; invst x 2)
Liquidity Preference distributionPE InvstRs lacsPE %shareholdingLiquiditypreferXLiquidity prefamtdistributed#Capital sharedistributed*Totaldistributed2500 5% 1 2500 575 30752500 5% 2 5000 450 54502500 11% 1 2500 1265 37652500 11% 2 5000 990 59902500 26% 1 2500 2990 54902500 26% 2 5000 2340 7340Liquidity preference distribution if liquidity realization is Rs. 14000 lacs# PE invst x Liquidity Pref* PE shareholding % x (Liquidity realization – Liquidity pref amt distributed)
Liquidity Preference distributionPE InvstRs lacsPE %shareholdingLiquiditypreferXLiquidity prefamtdistributed#Capital sharedistributed*Totaldistributed2500 5% 1 2500 275 30752500 5% 2 5000 150 54502500 11% 1 2500 605 37652500 11% 2 5000 330 59902500 26% 1 2500 1430 54902500 26% 2 5000 780 7340Liquidity preference distribution if liquidity realization is Rs. 8000 lacs# PE invst x Liquidity Pref* PE shareholding % x (Liquidity realization – Liquidity pref amt distributed)
Liquidity Preference distributionPE InvstRs lacsPE %shareholdingLiquiditypreferXLiquidity prefamtdistributed#Capital sharedistributed*Totaldistributed2500 5% 1 2500 100 26002500 5% 2 5000 0 45002500 11% 1 2500 220 27202500 11% 2 5000 0 45002500 26% 1 2500 520 30202500 26% 2 4500 0 4500Liquidity preference distribution if liquidity realization is Rs. 4500 lacs# PE invst x Liquidity Pref* PE shareholding % x (Liquidity realization – Liquidity pref amt distributed)
Liquidity preference equationsLiquiditypreferenceamount to PELiquidity realization amount xPE % shareholding x liquiditypreference numberCapital share onliquidation% PE shareholding x (Totalliquidity realization – liquiditypreference distribution amount)Total distributionto PE onliquidationLiquidity preference amount +capital share distributionAmount availableto othershareholdersLiquidity realization amount –total amount distributed to PE
Anti-dilution price protection provision(Equity ratchets)• Ratchet is the structure of resetting(adjustment) of equity price and sharesallocations depending on subsequent equityallotment price, future performance of companyor the rate of growth etc.• Anti-dilution price protection gives PE thebenefit of reduced effective price per share ifthe company issues its shares at a lower pricein a later round (down round)• Later round price is considered as lower if it islower than the share value projected to prevailat the later round price
Types of equity ratchets• Weighted ratchet anti-dilution price protection• Narrow based weighted average anti-dilution priceprotection provision• Broad based weighted average anti-dilution priceprotection provision• Full ratchet anti-dilution price protection
Nature of ratchets• Weighted ratchet: The resetting allotmentprice is lowered to a price that is aweighted average of the price at whichthe company issued shares valuing thecompany at the pre-adjusted price. It hastwo sub-types viz., narrow basedweighted average ratchet and broadbased weighted average ratchet• Full ratchet: The resetting allotment priceis lowered to the lowest price, that islower than PE’s purchase price,regardless of the number of sharesissued (but not weighted average price)
Kinds of weighted average ratchets• Narrow based weighted ratchet: Narrowbased weighted average anti-dilution priceprotection provision might include onlyequity share capital and convertiblepreferred shares then outstanding• Broad based weighted ratchet: Broad basedweighted average anti-dilution priceprotection provision includes equity sharesoutstanding and issuable upon conversion,warrants, convertible debt, options and anyother contingent right to equity shares orequity share capital
Share price adjustments with RatchetsInvestorNo ofsharesAllotprice Invest amtBefore adj %shareholdingAfter adjno of sharesAfter adj %shareholdingPromoters 10,00,000 80 8,00,00,000 64.52% 10,00,000 63.73%PrivateEquity 50,000 125 62,50,000 3.23% 69,095* 4.40%New Invst -1 2,00,000 90 1,80,00,000 12.90% 2,00,000 12.75%New Invst -2 3,00,000 85 2,55,00,000 19.35% 3,00,000 19.12%Total 15,50,000 12,97,50,000 100.00% 15,69,095 100.00%Share price adjustments with weighted average ratchets* Rs. 62,50,000/90.45; Rs. 90.45 = (Sum invst amt of PE + NI 1 & 2)/(Sum of no. of shares to PE, NI 1& 2)
Share price adjustments with RatchetsInvestorNo ofsharesAllotprice Invest amtBefore adj %shareholdingAfter adjno of sharesAfter adj %shareholdingPromoters 10,00,000 80 8,00,00,000 64.52% 10,00,000 63.55%PrivateEquity 50,000 125 62,50,000 3.23% 73,529* 4.67%New Invst -1 2,00,000 90 1,80,00,000 12.90% 2,00,000 12.71%New Invst -2 3,00,000 85 2,55,00,000 19.35% 3,00,000 19.07%Total 15,50,000 12,97,50,000 100.00% 15,73,529 100.00%Share price adjustments with Full ratchets* Rs. 62,50,000/85; Rs. 85 = Lower of Allot price to PE, NI 1 & 2)
Ratchet flow chartPE 1 invests@ x priceCompany(Equity Issuer)Proposal forFollow on IssueIf issue priceis > x,no ratchetIf issue priceis < x,ratchet kicks-inReset the price:Sum invst amtPE 1 + new sharesReset the price:PE 1 invst amtLowest new issue priceWeighted FullTotal eligible shares to PE 1 @:PE 1 invst amtReset price as aboveRatchet exercise completes; PE investor gets additional shares
Ratchets in connection withbook value of equity sharesIn addition to the ratchets connected with down-rounds, ratchets are alsostructured in connection with book value of equity shares. While ratchets offormer type protect the control interests of PE investor, the latter protects themonetary interests of the PE investors even if no down-rounds are made. Thefollowing is one of the practices to structure these kinds of ratchets.• Optionally convertible cumulative participating redeemable preference shareswill be issued at premium to equal the determined value at the time of PEinvestment for the equity shares of the Company.• The intrinsically prevailing value of the equity share will be arrived at at the endof each year• If share value as in 2 is greater than in 1, no ratchet kicks-in; If share value as in2 is lower than in 1, no ratchet kicks-in.• As per the ratchet, either of the following two or a mix of the following two will beeffected at the option of the PE investor:i) for the payable preference dividend amount, PE investors will have to be allotted equityshares at value that will compensate the PE investor in value terms for his totalinvestment and this dividend receipt.ii) Convert the preference shares into equity shares at the relevant valuation as on the dateof opting for conversion
Pre-money and post-money valuation• The following are the two valuationconcepts in connection withcomputing the % of shareholding aPE gets for its investment in thecompany:• Pre-money valuation• Post-money valuation
Pre & post money valuation equationsPre-moneyvaluationPost money valuation – PEinvestmentPost moneyvaluationPE investment / PE ownershippercentage or Pre-moneyvaluation + PE investmentShare price Pre money valuation / no of premoney shares; orPost money valuation / no ofpost money sharesNew sharesissuedPE investment / share priceTotaloutstandingsharesPre money shares + newshares issued
Pre money and post money valuation- illustration - 1Pre moneyvaluationRs. 100 croresInvestmentamount proposedRs. 25 croresPost moneyvaluationRs. 125 croresPE’s percentagesharesRs. 25 / 125 x 100 = 20%
Pre money and post money valuation- illustration - 2Post moneyvaluationRs. 100 croresInvestmentamount of PERs. 25 croresPre moneyvaluationRs. 75 croresPE’spercentageshare25 / 75 x 100 = 25%
Rights and Risks associated with20 Key Pressure-Clausesin PE investments
1/20 Key pressure clauses of PE investmentDividend Rights:• Dividend policy of the investee company during theperiod of PE investment is influenced by PE.• The dividend policy is formulated in a tax efficientway• Usually, on account of taxation, PEs do notencourage periodical dividend payments• PE investor holds an overriding right to veto thepayment of any dividend.
2/20 Key pressure clauses of PE investmentNature (kind) of shares for PE investors:• PE investors usually invest in either Equity orpreference depending on the legal provisionsprevailing in the host country• Since ratchet rights have to be accommodated,generally PE investors prefer convertible preferenceshares over equity shares. However, since veto rightsare available only for equity shareholders, PEs preferto hold a mix of preference and equity.• PEs also prefer to hold golden shares (with additionalrights).• Differential Voting Right (DVR) shares are consideredin India. However, the new companies bill prohibitsissuance of DVR shares.
3/20 Key pressure clauses of PE investmentLiquidation Preference:• Liquidation preference accords a right to thePE investors to receive certain amount ofthe realized amount out of liquidation of theCompany in preference to othershareholders.• This preference amount may be equal to theamount of the original amount invested bythe PE investor or a multiple of it.• In India liquidation preference rights may notbe possible on equity shares and hence PEinvestors prefer ‘cumulative participatingpreference shares’
4/20 Key pressure clauses of PE investmentRedemption Rights (Equivalent to sell-back right inIndia):• PEs demand that the Company shall buy back itsown shares from investors. PEs insist that theother shareholders (usually promoters) shouldnot participate in the buy back scheme therebyfacilitating their shares to be bought back by theCompany.• Valuation of the buy back of the shares is subjectto the guidelines issued by the competentauthorities.• Alternately and / or simultaneously, as per theterms of the investment agreement, promoterswill have the obligation to purchase the sharesfrom PE investor at a price to yield the requiredrate of return
5/20 Key pressure clauses of PE investmentAnti dilution (Price protection ratchets /Price protection rights):• PEs hold anti-dilution protectionrights to protect the value of their stake inthe Company if new shares are issued ata valuation which is lower than that atwhich they have originally invested. Suchsubsequent or follow on issue round istermed as ‘down round’.• These rights are termed as ratchetrights. Ratchets could relate to price offollow on issue price or valuation of theequity share even in the absence of asubsequent equity issue.
6/20 Key pressure clauses of PE investmentRight of first refusal (ROFR):• ROFR right provides that if anyshareholder (usually promoter) intends todispose of shares, such shares must befirst offered to the PEs (if ROFR right isheld) at the same terms and conditions theshares are intended to be sold.• These rights ensure that the promotersdo not sell their shares to persons whomPE would not like to be shareholders of theCompany.• These rights also ensure that the promotersdo not sell their shares at unusual terms totheir preferred persons
7/20 Key pressure clauses of PE investmentDrag along (Bring along) rights:• A drag along provision creates an obligationon the other shareholders (usually promoters)of the Company to sell their shares to apotential purchaser if and when PEshareholder votes to sell its shares to thepotential purchaser• These rights will be useful in the context of asale where potential purchasers intend toacquire substantial majority (usually 100%) ofthe shares of the Company in order to avoidhaving responsibilities towards minorityshareholders after the acquisition.
8/20 Key pressure clauses of PE investmentTag along (Co sale) rights:• A tag along provision creates an obligationon the other shareholders (usuallypromoters) of the Company to ensure thatthe potential purchaser agrees to purchasean equivalent percentage of PE’s shares atthe same price and under the same termsand conditions.• This right may have the effect of making theshares more difficult to sell.
9/20 Key pressure clauses of PE investmentPre-emption right :• Preemption is the right of PE investor toparticipate in a financing to the extentnecessary to ensure that, if exercised, itspercentage ownership of the Company’sshares will remain the same after the financingas it was before.• In Indian term sheets, it could even meanrights of PE to decide whether certain itemscan be taken up by the Board or GeneralMeeting in the agenda.
10/20 Key pressure clauses of PEinvestmentRepresentations:PE investors insist on representations from the issuer Company(and from the Promoters) to be included in the investmentagreement / term sheet confirming about the informationdisclosed and that the deal (investment by PE) is subject tothe facts, information, statements furnished by way ofrepresentations.Representations are also stated as recitals. Recitals usuallyform part of the agreement. PE investors prefer to includethe representations in the agreement rather than in recitalssince as per the legal interpretation, recitals are consideredas jointly agreed upon statements / situations than a coverto the other party.If any representation is found inaccurate subsequently, PE willhave a right to initiate corrective action includingaccelerating the investment as per the terms of theinvestment.
11/20 Key pressure clauses of PEinvestmentWarranties:PE investors insist on warranties from the issuer Company (andfrom the Promoters) to be included in the investmentagreement / term sheet to provide the investors with acomplete and accurate understanding of the currentcondition of the Company and the past history so that theinvestors can evaluate the risks of investing in the Companyprior to investing in the Company.The warranties typically cover areas such as legal existence ofthe Company, financial statements, business plan, assets,liabilities, material contracts, employees and litigation.If any warranty is is found inaccurate subsequently, such anevent will be considered as breach of the agreement andthe PE will have a right to be reimbursed for the loss /expenses etc with an additional right to rescind theinvestment agreement itself.
12/20 Key pressure clauses of PEinvestmentConsent Rights:PE investors normally hold consent rights which provides thatthat certain actions cannot be taken by the Companywithout the consent of the PE investors or of a majority %(as specified)These consent rights need not confine to only board agendaitems
13/20 Key pressure clauses of PEinvestmentBoard Seats:PE investors will require a right to nominate one or moredirectors to be appointed on the Board of the investeeCompany.PE investors may also require a right to appoint a BoardObserver who can attend all Board Meetings but will notparticipate in any board decisions.
14/20 Key pressure clauses of PEinvestmentInformation Rights:PE investors will require right to receive information on a regularbasis concerning the financial condition and budgets alongwith a general right to visit the company and examine itsbooks and records.
15/20 Key pressure clauses of PEinvestmentRegistration Rights:These are specific only to USA since SEC requires theregistration of the securities to be eligible for offering forpublic sale (Offer for Sale). The registration processinvolves the Company providing significant informationabout its operations and financial condition which can betime consuming and expensive.In India this clause is non-existent. However a correspondingclause to this in India is that PE investors insist that theCompany do not recognize PE investors under promotergroup and also should endeavor to avoid PE investors beingrecognized as promoters under law. This will help PEinvestors not to be subject to the lock-in requirement of thepromoters’ shares at the time of IPO of the Company.
16/20 Key pressure clauses of PEinvestmentConditions Precedent:Term Sheet / Investment agreement of PE investors will includea full list of conditions to be satisfied before investment willbe disbursed.Usually Conditions Precedent to signing of the investmentagreement and Conditions precedent to releasing of theinvestment amount to the investee Company will beseparately laid down clearly in the term sheet and theinvestment agreement respectively.Conditions to be fulfilledin advance
17/20 Key pressure clauses of PEinvestmentTranche Disbursements:PE investors will have a right to release the investment amountin one or more tranches (stages / phases) dependant onachievement of targets or milestones claimed to beachieved in the business plan of the Company.While the investment price may be determined at the time ofsigning of the investment agreement itself, the investmentamount is structured to be released in tranches (stages) toensure that the Company is growing as per the growthguidance issued by the Company / Promoters.
18/20 Key pressure clauses of PEinvestmentExit Options / Rights:PE investors will reserve right to exist in various ways including:- Initial Public Offer (IPO)- Offer For Sale (OFS)- Merger- Take Over- Strategic Sale
19/20 Key pressure clauses of PEinvestmentNon Compete Clause:PE investors will require the promoters to sign non-competeagreements so that the promoters will not nurse theirinterests to promote and develop other companies whichmay eat in to the business of the investee Company orwhich may stand competition to the investee company.Usually the Non-Compete agreements will carry a tenure ofabout 5 years from the date of investment.Cant
20/20 Key pressure clauses of PEinvestmentSpecial Audit:PE investors will require the Company’s financials to be auditedby a special auditor usually appointed by them in addition tothe statutory auditor of the Company.The costs of the audit and the audit fee for the special auditorrhave to be borne by the Company.Special Auditor submits his audit report to the PE investor witha copy of the audit report to the Company. In addition to theusual financial audit, he may also comment on the status ofthe compliance of the conditions of the terms and conditionsof the investment agreement signed by the Company withthe PE investor.
Pros and Cons of Private EquityAdvantages for Company Disadvantages for CompanyFaster Growth More complex accounting andreportingUnsecured Finance Investor veto rightsEmployee ownership (in the caseof MBO)Accountability to investorStrengthens financial position Investor’s involvement in boarddecisionsFacilitates obtaining other formsof financeRestrictive covenants formanagers / operationsFunding is committed until exit(unlike bank loans)Warranties to be given bypromoters / companyManagement and relationshipadviseInvestor’s objective / motive isexit at good return
Challenges to PE in IndiaArea ChallengeValue ofPrivate Equity-Important to be an active investor to understand thevalue add from PE-Must trade-off value, growth and risk-Analyzing the relative merits of a potential non-PEinvestment-No relevant experience to guideMarketconditions-Developing business plans and best practices forprivately held and family run Indian firms-Questions of global competitiveness-Discarding what is irrelevant and possibly damaging forIndian companiesExit Strategy -Market and business tolerance for public offerings-Family business reluctant to relinquish control-Inevitability of an Initial Public Offer (IPO)Others - PE sponsors more susceptible to volatility in the globaldebt market-Increased regulations-Lower IRR on existing PE portfolios
Case study on PEInvestment andassociated risks
CLSA Private Equity Investment in AparIndustries LimitedApar Industries Limited:USD 250 million Apar is the largest player in transformer oildivision with 50% market share. It is second largest player in thealuminium power conductor business with 25% market share. Itis largest exporter of aluminium power conductors from India..The PE Investor:Credit Lyonnais Securities Asia (CLSA) is Asia’s leadingindependent brokerage and investment group. It is active inequity broking, capital markets, mergers and acquisition, assetmanagement services, and private equity investmentsInvestment vehicle:CLSA CLSA PE Limited, Hongkong Aria InvestmentsPartners Shinny Limited, Mauritius
The PE Transaction:Private Equity investment:In September 2005, CLSA Private Equity was issued 3,445,978 shares as 5.4% cumulativecompulsory convertible preference shares with participating rights for Rs. 185 per share.Convertible on 11thOctober 2006 into equity shares resulting in 14.21% equity stake of Rs. 10each at a premium of Rs. 175 per share• Number of shares: 3,445,978• Converted into equity on 11-10-2006: 3445978 equity shares of Rs. 10 each with a premium ofRs. 175 each• Market Price of Share (MPS): On date of conversion (pre-bonus): Rs. 246; Post-bonus : Rs. 188;Highest till Jan 2008 (post-bonus): Rs. 450;• Bonus issue on 18-Jan-2007: 1:3 ratio; Initially issued: 3,445,978 + bonus: 1,148,659 =4,594,637Rights & Risks:• Board seat (Directorship) to be reappointed during the currency of the Investment Agreement• Right to appoint observers; Right to call for special audit;• Identified material adverse events;• Obligation on Company and Promoters to ensure exit by way of strategic sale / FPO• Tag along and drag along rights• Information rights• Pre-emptive rights• Anti dilution rights (read implied ratchets)
Recent Key statistics related toPE investments
PE Investments versus FDIInvestment 2002 2003 2004 2005 2006 2007PE 1,050 865 1,479 2,424 7,520 17,273FDI 5,035 4,322 6,051 7,722 19,531 45,455PE Investments in India: FDI & GDP(amount in US $ mio)PE investments versus GDPValue 2002 2003 2004 2005 2006 2007PE Investment 1,050 865 1,479 2,424 7,520 17,273GDP 495,651 575,245 666,305 778,666 873,659
Most active international players in 2007Fund manager Nationality Firm Type Deal value(US $ mio)Temasek Holdings Singapore Govt affiliate 3,152.2CVC International US Bank private equity arm 2,057.8Goldman Sachs US Bank private equity arm 1,883.0Blackstone Group US Independent VC / PE firm 1,136.8India Equity partners US Independent VC / PE firm 1,098.9AIF Capital Hong Kong Independent VC / PE firm 1,008.2Macquarie Bank Australia Bank private equity arm 1,000.0Avenue Capital US Independent VC / PE firm 717.8Carlyle Asia US Independent VC / PE firm 701.0Dubai InternationalCapitalUAE Investment Company 637.8
Most active Domestic players in 2007Fund manager Nationality Firm Type Deal value(US $ mio)ICICI Venture Funds India Bank Private Equity arm 1,106.5New Silk Route Advisors India Independent VC / PE firm 443.0IL&FS Investment Managers India Independent VC / PE firm 324.6Beacon India Advisors India Independent VC / PE firm 273.2IDFC Private Equity India Bank Private Equity Arm 268.8Indivision Investment Advisors India Independent VC / PE firm 217.0UTI Venture Funds India Independent VC / PE firm 156.6Zeus Inframanagement India Independent VC / PE firm 127.5Jacob Ballas Capital India Independent VC / PE firm 119.3ChrysCapital Management India Independent VC / PE firm 117.9
Select PE transactions in 2007Investee Ind Amt $mn% InvestorsComputer Age Mgmt services Computerrelated90.0 Advent Intnl Corp / South East AsiaVenture Investment (SEAVI)ICSA (India) Computerrelated22.0 Goldman Sachs (Asia)Infotech Enterprises Computer 63.9 13.0 General Atlantic LLCDivya Sree Developers Construction 100.0 TPG-Axon Capital LLCJaypee Infratech Construction 815.3 ICICI Venture Funds Mmgt Co.Punj Lyod Construction 198.7 Avenue Capital / Blackstone / DKROasis / Kingdom capital / Warburg PincusSoma Enterprise Construction 102.9 India Reit Fund AdvisorsHeritage Foods Consumerproducts8.9 Carlyle Asia IndiaBGR Energy Systems Electronics 32.6 4.0 Citi group Venture Capital IntnlHavell’s India Electronics 112.1 11.2 Warburg Pincus IndiaSudhir Gensets Electronics 65.0 15 GE Commercial Finance; Goldman SachsAK Capital Services Fin services 9.1 13 Global Technology Investments LLCAnand Rathi Securities Fin services 22.7 19.9 Citi group Venture Capital IntnlAngel Broking Fin services 37. 12.5 IFC (world bank group)ARCIL (Asset Reconstruction) Fin services 13.7 9.2 Ankar Capital Management LLCBombay Stock Exchange Fin services 79.8 8.0 Atticus Mgt LLC; Caldwell Asset Mgt,Urbana Corp
(contd) Select PE transactions in 2007Investee Ind Amt $mn% InvestorsCDSL Central Depository Fin services 4.1 5.0 Croupier Private Equity PartnersCenturian Bank of Punjab Fin services 41.6 5.3 ICICI Venture Funds Mgmt CompanyCity Union Bank Fin services 18.7 12.5 Argonaut PE, Blue River Capital, FMO(Netherlands Devpt. Fin Company)Delhi Stock Exchange Fin services 10.3 20.0 Kuwait Privatization Project Holding Co.,New Vernon PE, Noor Financial Invst Co,Passport CapitalFuture Capital Holdings Fin services 23.5 10.0 Och-Ziff Capital Mgmt GroupHDFC Fin services 649.9 5.6 3 Logi CapitalICICI Bank Fin services 598.3 2.9 Dubai International CapitalIDFC Fin services 185.9 10.0 Khazanah Nasional Bhd.India Infoline Investment Fin services 76.4 22.5 Orient Global Pte.Karnataka Bank Fin services 36.2 5.0 IFC (world Bank)Karvy Stock Broking Fin services 44.0 IFC (world bank)Magma Leasing Fin services 15.0 FMO Netherlands Devp. Fin Corp.M&M Financial services Fin services 6.6 1.4 Chrys Capital Mgmt. CoMahindra Forgings, Mauritius Fin services 4.9 10.0 Promethean Investments LLPManappuram General Finance &LeasingFin services 11.8 30.0 India Equity Partners; Sequoia CapitalLimitedNational Stock Exchange Fin services 345.0 15.0 General Atlantic; Goldman Sachs; SAIFPartners
(contd) Select PE transactions in 2007Investee Ind Amt $mn% InvestorsReligare Enterprises Fin services 15.6 5.0 Merrill Lynch Global Principal Inv.Shriram Transport FinanceCompanyFin services 82.1 5.7 Infinite IndiaSKS Micofinance Fin services 11.3 IDFC Private Equity Co.Spandana Spoorty InnovativeFinancial ServicesFin services 12.0 Blue Ridge Capital; IFC; UTI VentureCapital Funds Mgmt. Co.YES Bank Fin services 48.6 5.0 Khazanah Nasional Bhd.Intelenet Global Services IT 200.0 100.0 Blackstone Advisors India; IntelenetGlobal Services Mgt. TeamRT Outsourcing Services IT 7.9 Motilal Oswal Venture Capital AdvisorsV Soft IT 10.4 iLabsAnsal Properties – SPVs Infra 29.4 49.0 IL&FS Investment ManagersB. Seenaiah & Company Infra 38.4 7.0 Amansa Capital Pte; IDFC; L&T CapitalCompany; L&T Infrastructure Finance;Lehman BrothersIndu Projects Infra 33.9 Citigroup Venture Capital Intnl.KMC Constructions Infra 35.0 Baring Pvt Equity; ICICI VenturePatil Infrastructure Holdings Infra 56.7 26.0 One Equity PartnersRamky Infrastructure Infra 28.3 13.5 IL&FS Invst Managers; Sabre CapitalSea King Infrastructure SKIL Infra 500.0 26.0 Future Capital HoldingsSubhash Projects Infra 61.4 20.0 Citigroup Venture Capital Intnl.
(contd) Select PE transactions in 2007Investee Ind Amt $mn% InvestorsAparna Constructions Real Estate 100.0 JP Morgan Asset MgtDLF Assets Real Estate 400.0 DE Shaw India Advisory ServicesDLF Assets Real Estate 200.0 Lehman BrothersEmaar MGF Land Real Estate 100.0 1.5 JP Morgan Asset Mgt; & othersQVC Realty Real Estate 100.0 IL&FS Investment ManagersShriram Properties Real Estate 100.0 Infinite IndiaVatika Group Real Estate 254.8 10.8 Beacon India Advisors; GoldmanSachs; Wachovia CapitalFirstsource Solutions Services 22.442.06.04.5Galleon Partners;SUN GroupApollo Hospitals Ent Health 103.5 12.0 One Equity Partners LLCFortis Healthcare Health 20.0 3.2 TCK Advisors (Trikona Capital)GVK Biosciences Health 25.5 Sequoia CapitalMax Healthcare Institute Health 74.0 IFC (World bank)Great Offshore Shipping 40.8 5.0 Carlyle Asia IndiaQuipo Infrastructure Equip Infra renting 34.0 31.0 GIC Special Invsts Pte; IDFC PEVandana Luthra Curls &Curves (VLCC)Health care 11.3 Indivision Investment AdvisorsBharti Artel Telecom 2013.5 5.0 Temasek Holdings Advisors IndiaBharti Infratel Telecom 1000.0 10.0 AIF; Citigroup; Goldman Sachs; IndiaEquity Partners; Dubai Invst Corp; etc
(contd) Select PE transactions in 2007Investee Ind Amt $mn% InvestorsDish TV India Telecom 63.0 4.9 Indivision Investment AdvisorsHutchison Essar Telecom 25.0 IDFC Private Equity CoReliance Telecom Telecom 346.5 5.0 DA Capital; Fortress Capital; GalleonPartners; GLG Partners; HSBC PrincipalInvsts; New Silk Route; Soros FundTata Sky Telecom 56.5 10.0 Temasek Holdings Advisors IndiaGokaldas Exports Textiles 165.0 70.1 Blaackstone Advisors IndiaMudra Lifestyle Textiles 3.3 SIDBI Venture Capital; SBIS. Kumars Nationwide Textiles 82.0 10.0 Citigroup Venture Capital IntnlBLR India Transport 11.3 31.0 Reliance Private EquityDRS Logistics Transport 22.7 Kotak Investment AdvisorsFirst Flight Couriers Transport 26.7 27.7 Temasek Holdings Advisors IndiaOcean Sparkle Limited Shipping 18.0 India Equity PartnersReliable Autotech Shipping 4.6 17.0 BTS Investment Advisors PrivateAdani Power Utilities 229.6 8.0 Tano India AdvisorsKVK Energy & Infrastructure Utilities 26.0 Old Lane, LPLanco Amarkantak Power Utilities 8.0 5.8 International Finance Corporation (IFC)Moser Baer Photo Voltaic Utilities 100.0 CDC Group; GIC Special InvestmentsPte; IDFC PE, IDFC Company
Select PE transactions in 2008 (first-half)Investee Ind Amt $mn% InvestorsAshoka Buildcon Construction 180.3 15.6 IDFC PE Co.Nagarjuna Construction Construction 50.0 3.2 Blackstone Advisors IndiaICOMM Tele Telecom 12.4 Tano India AdvisorsParag Milk Foods Food items 14.1 Motilal Oswal Venture CapitalMahindra & Mahindra Fin service Fin services 105.6 11.2 Standard Chartered Private EquityTotem Infrastructure Infra 7.4 Aquarius Investment Advisors (India)Mahindra & Mahindra Manufacture 172.4 3.7 Goldman Sachs (India) LLCMaithan Ispat Manufacture 18.5 IL&FS Investment Managers; Orix CorpShakti Pumps (India) Manufacture 0.2 9.1 MayfieldAnil Printers Media 7.4 Tano India AdvisorsApollo Hospital Enterprises Medical 13.9 1.9 Apax Partners India AdvisorsGland Pharma Medical 30.4 3 Logi CapitalHealthcare Global Ent Medical 20.0 Premji InvestParabolic Drugs Medical 7.0 BTS Investment Advisors Pvt.Sai Advantium Pharma Medical 20.0 12.0 ICICI Venture Funds Mgmt. Co.Punj Lloyd Upstream Metals 30.0 12.0 IFC (world bank)DLF Assets Real estate 450.0 Symphony Capital
Select PE transactions in 2008 (first-half)Investee Ind Amt $mn% InvestorsMaytas Properties Real Estate 153.3 Infinite India Investment ManagementVaishnavi Group Real Estate 28.0 Actis Capital LLPShriram EPC Services 3.5 1.1 Asiabridge Fund, Bessemer VenturePartners, Chrys Capital Mgmt. Co., ICICIVenture Funds Mgt. CompanyAditya Birla Telecom Telecom 640.0 20.0 Providence Equity PartnersBharti Infratel Telecom 250.0 2.5 KKR AsiaTV 18 Home Shopping Network /HomeShop 18Telecom 10.0 25.0 SAIF PartnersReid & Taylor (India) Textiles 209.6 25.4 GIC Special Investments Pte.TVS Logistics Services Transport 25.1 Goldman Sachs (Asia)ACME Tele Power Utilities 100.8 3.4 Jacksons Heights Investments, MonsoonCapital LLCKLG Power Utilities 50.1 20.0 TPG Growth, LLCShree Maheswar Hydel Power Utilities 24.0 Henderson Equity PartnersSophia Power Utilities 403.8 37.5 DE Shaw India Advisory Services
Select PE Exit transactions in 2007Investee Amt $mnDeal%Seller InvestorNagarjuna ConstructionCompany Ltd16.4 2.1 ICICI Venture FundsMgmt. Co. LtdIndian investorsPunj Lloyd Ltd 54.5 2.2 Standard Chartered PE;Temasek HoldingsChinese InvestorsGodrej Beverages 53.9 51.0 Godrej & IL&FS The Hershey Co. (US)MTR Foods Ltd 100.0 Aquarius Invst;JP Morgan PartnersOrkla ASA (Norway)Federal Bank Ltd 10.6 2.2 IFC (world bank) Indian investorsSharekhan 118.2 85.0 General Atlantic; HSBCPE; Intel IndiaCitigroup VC IntnlNIIT Ltd 48.4 10.0 Intel Capital (India) Indian investorsGammon Infrastructure 17.9 3.5 Och-Ziff Capital Mgt Co. Gammon CoolingPVR Ltd 3.2 3.7 ICICI Venture Funds Calderys (Finance)Sintex Industries 256.4 25 Warburg Pincus Indian investorsApollo Hospitals 30.3 5.3 Temasek Holdings Indian investorsAurobindo Pharma 23.2 2.5 Standard Chartered Indian investorsSubhiksha Trading 18.6 5.0 ICICI Venture Funds Prudential ICICITrinethra Pvt. Ltd 76.8 90.0 India Value Funds Aditya Birla
Select PE Exit transactions in 2007Investee Amt $mnDeal%Seller InvestorNew Delhi Television 7.7 General Atlantic Prannoy & Radhika RoyWelspun India Ltd 5.0 4.3 ICICI Venture Funds Indian InvestorsDeccan Aviation 104.6 20.0 Deccan Aviation, ICICI Kingfisher Radio; UBOcean Sparkle Ltd 18.0 APIDC Venture Capital India Equity Partners