Exits have always been the ‘holy grail’ for private equity, especially so in India. Out of more than $80 billion that have been invested in the Indian market over the last decade, it is reported that only about one-third of the investments have found an exit route. An article in a business journal had likened the Indian PE situation to that of Abhimanyu (Mahabharata warrior) valiantly entering the ‘Chakravyuha’ (enemy’s circle of defence) without having a clear idea of the mechanism to exit the same.
From our experience, there isn’t one specific formula for creating profitable exits, but surely a disciplined investment process coupled with an active engagement with the portfolio firm and alertness to every possible exit avenue, helps.
If I put it in a simplistic equation form:
Exits = f (Ability & Willingness of the Promoter & Business) + X
Let’s take the most critical point first—i.e. “ability and willingness to pay” of the promoter. Ability is relatively straightforward since it involves assessing the promoter’s capacity based on set financial metrics. Assessing the willingness to pay is the not so easy part; it essentially boils down to backing the right people. Determining whether a specific person or organisation is the right one involves subjective analysis and there is no set answer. And whilst there may not be exact methods of measurement, one can try to assess the intent, by understanding the past behaviour/ experiences of a person’s dealings vis-a-vis other stakeholders, JV partners, banks, etc to understand his/her track record. More often than not, these provide strong tell-tale signs since human behaviour can be conditioned in the short term but it’s not easy to change the underlying nature and sustain a false image over long periods of time. The second part of the puzzle is ability of the business to create a profitable exit.
Again, going back to the basics of investing - it is all about what value you pay to come in as an investor. You have to obviously pay a premium as a consideration for the value that has been created by the promoter. But if someone expects a significant portion of the future upside to be considered into the entry valuation itself, then that’s something to pause and think about. It’s absolutely critical to align the interest of the promoter and PE investor in terms of generating the upside and then sharing it on realisation. This approach ensures that you are not putting yourself into a big hole at the start, from where you need to first come out (i.e. get to par value) and then grow (i.e. generate upside).
In a competitive market, this philosophy could cost you deals, but that’s where the discipline of investing comes in. You have to be clear of the price that you are willing to pay for a business based on your own fundamental conviction and not because someone else is putting a higher value on the same. Based on past learnings and some pearls of wisdom from my mentor in private equity, I have come to follow a few golden rules relating to exits:
Exits do not happen automatically
Exits do not happen automatically; they have to be crafted, which means one has to be nimble in taking alternative approaches as per the evolving market conditions. I remember of an incident about six years ago, just after the global financial crisis, when we changed our strategy in an investment by shifting from a marquee, but unlisted situation into a listed entity. Looking back, if we had not acted in a swift manner, we might have still been stuck in that company.
Be always ready
Once the portfolio company’s core business and internal systems are well in place, one has to always be in a state of readiness to orchestrate an exit. This is especially true, if you are thinking of an IPO as a possible mode since market windows are much shorter now, given our link across global markets. We kept one of our companies ready (for example, doing quarterly audits, regular connect with the market participants, PR, etc) for almost three years when we were planning an IPO. Those actions helped us in consummating a successful IPO in the nick of time, just before the market window shut for almost five years.
‘Bird in hand’
Whilst the motto propounded by Gordon Gekko in Wall Street may have been “Greed is good", the rules in private equity are a little different. In the sense, hunger for growth is good, but you need to be open to encash your investment whenever an opportunity knocks rather than wait endlessly for a better deal. About five years back, we faced such a dilemma, when a corporate sponsor offered to buy us out of an investment, whilst we were really keen on an IPO. I am glad that we eventually accepted the buy-back since the IPO of that company never happened. And yes, we had our misses too in some situations, which also taught some valuable lessons.
Have built-in flexibility
When it comes to exit, build in sufficient flexibility in your commercial arrangement so as to be able to utilise any of the potential modes of exit. Private equity by its nature is illiquid and you are never going to be able to predict perfectly the exact manner in which your exit could come about. You can only position yourself to take advantage of the possible avenues that open up at a given point in time. Over the course of last eight years, we have been able to exit 26 investments by keeping our options open and thereby, using almost all possible exit strategies—IPOs, strategic sales, secondary sales, buy-backs and swaps.
Think of yourself as a partner
This is not only an exit-related point but more applicable to our entire philosophy of investing in private equity situations. We have always thought of ourselves as a JV partner to the promoter, rather than his financier. That is when you create a deeper relationship and which in turn, creates a bedrock of conducive environment for the exit. Whilst it’s nice to have generated and distributed real cash to our investors across the above-mentioned exits, we have also created enduring partnerships with some high quality entrepreneurs in the country. That is an equally important takeaway for us.
My thoughts on the subject of exits are clearly not gospel, but more of a sharing of experiences based on what I have seen and what has worked well for us over the last decade in private equity.
Coming back to our initial equation, it would be extremely presumptuous on my part to not acknowledge the role of ‘X’ factor in exits. Some may call it luck and some, the hand of God—whatever the name, ultimately you also need help from a power, greater than your own.
May that force be with you!
Prasad Gadkari is a Partner – Private Equity at IDFC Alternatives. Views are personal.
(As told to Ishaan Gera of VCCircle)
