“Isn't it funny how day by day nothing changes, but when you look back, everything is different...” ― C.S. Lewis
These words of wisdom from C.S. Lewis seem to resonate not only with individuals but even with institutions. Specifically here I am referring to private equity (PE) firms/investors. There is a lot that has changed since I first began my association with this fraternity in 2007.
Then bullishness was in the air, with the Indian financial markets regularly making new highs. Young PE funds empowered with newly raised capital were competing with each other to get the best deals done quickly. Investing in deals would lead to celebrations, and investors would talk with parental pride as to how their investee companies were gems, and they were lucky to have invested in them at a reasonable valuation. Come 2015 and it seems a different world. The euphoria is now replaced by wisdom, which comes with experience, encompassing learning from own successes and failures and that of others as well.
To understand the changes in the PE investors’ approach, let us look at the different aspects of investing which have changed.
Elaborate promoter check: Even in 2007, PE investors would do checks on the background of promoters; however it was not absolutely critical. To give a perspective, if it was a compulsory 20 marks question in a 100 marks paper then, now it is a compulsory 60 marks question. The scope has changed from mere quick background check and educational qualifications, public perception, etc. The promoter’s knowledge and vision for the business, ability to achieve his goals and willingness to share jointly created wealth with stakeholders are now the critical checkboxes. As the MD of one of the most successful funds in India told me,“Essentially we are backing the promoter and his team. We have realised that there will be challenges on the path and all things will not work out. However, if you have a great guy at the helm, he will sail through and emerge a winner”
Scrutinising regulatory risk: Another aspect which has changed in magnitude is the reservation to regulatory risk. Earlier investors would use innovative structuring to find ways around legal strictures to ensure that the word of the law was followed. Now there has been a move towards the spirit of the law, albeit not universally so. Additionally, bitter past experiences where PE firms lost significant returns on their investments due to government or political changes, amendments in regulatory guidelines etc, have made them scrutinise the implications of these possibilities.
Entering at the right valuation: Earlier, often PE deals would become ‘auctions’ where the highest bidder won. It was usual for investors to compete on pricing - which unfortunately led to winners’ curse for those who bought stakes in companies at steep valuations. Now, it is very common to be asked the valuation expectation in the initial stage and investors are rejecting deals if they find the expectations to be too high. Even after doing significant work, taking a liking to the sector and specifically the company, investors are telling no to deals beyond a certain price point. The more recent outlook is that “No deal is a must-do. If you do a must-do deal, you typically end up losing money!” This itself is a game-changer. There is a desire to do good deals but there is no desperation or fear of losing out on a good deal.
Being focused: Their experiences over the years have made PE investors more knowledgeable and selective. Funds are clear about their sector preferences and more often than not, have a ready view on the sector. One will now get a quicker response, and if it is one of those also ran sectors or companies, it will be a quick denial. As the MD of a leading mid-market fund told me, “Jo learning karni thi woh sab humney picchley saalon mein kar li!”
A matter of time: In 2007, it was common for funds to offer non-binding term sheets in one or two meetings, with very limited information and deals would normally close within three-four months. Today, PE investors take their time in closing a deal, they try and understand every aspect of the company and thus the pre-deal work has increased enormously. As a banker, I must admit that this is at times exasperating. However, it is probably one of the best things that has happened to the industry and will augur well for this fraternity in the long run. On the flip side, the sense of skepticism and risk aversion are much more than possibly warranted of equity investors. Let me add, as an investor I believe these are virtues- but only to an extent.
Parting thoughts:
On a final note, I would like to quote Charles Darwin who said, “It is not the strongest or the most intelligent who will survive but those who can best manage change”
From an investing perspective, PE investors have made significant changes which should bode well for them in the long run. However, the process of evolution will need to continue with changing times. Also, they would need to do their bit to improve their image and trust.
May they continue to evolve, help their portfolio companies prosper and create wealth for all in the process!
(The author is a member of the financial sponsor group at ICICI Securities. Views expressed are personal)