an overview of private equity investments

8/6/2019 An Overview of Private Equity Investments

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equity. The buyout can be Management Buy In (MBI) or Management Buy Out (MBO).

Angle Investing: It refers to investment in small closely held companies by wealthy individuals,

which they generally have some operational experience. They may have substantial ownership sand may be active in advising the company, but they generally are not as active as professional

managers in monitoring the company and rarely exercise control.

Venture Capital: It refers to long term equity investment in novel technology based projects whi

display potential for significant growt and financial returns. It provides seed, start up and first stfinancing to these industrial enterprises.

Growth Capital: Growth capital is a very flexible type of financing. The money borrowed under acapital line of credit can be used for any corporate purposes. There are no requirements to prov

invoices or other backup material when borrowing under this type of facility, so administration issimplified as well. Growth capital can be a beneficial way to extend a company's runway betwee

rounds of financing. The extra time can be used to complete additional milestones that will raisecompany's valuation, or as insurance to ensure that all intended milestones are successfully

accomplished.

Mezzanine Capital: It refers to investment in those companies that have already proven their via

but still have to raise money from the public market. It is associated with the middle layer of finin leveraged buy-outs.

Private equity funds are the pools of capital invested by private equity firms. They are generally

organized as limited partnerships which are controlled by the private equity firm that acts as the

general partner. The limited partnership is often called 'Management Company'. The fund obtaincapital commitments from certain qualified investors such as pension funds, financial institutions

wealthy individuals to invest a specified amount. These investors become passive limited partnethe fund partnership and when the general partner identifies an appropriate investment opportu

is entitled to call for drawdown i.e. the required equity capital each limited partner contribute to on pro rata portion of its commitment. All investment decisions are made by the General Partne

also manages the portfolio.The normal lifetime of a fund is about 10 years. Over its lifetime it mvarious investments and usually the amount invested in each investment is not more than 10%.

General partners, who are responsible for fund management, are typically compensated with amanagement fee i.e. a percentage of the fund's total equity capital. In addition, the general part

usually is entitled to carried interest i.e. performance based fee, based on the profits generated fund. Typically, the general partner will receive an annual management fee of 2% to 4% of com

capital and carried interest of 20% of profits above some target rate of return called hurdle rate

A variety of groups invest in Private Equity Market. Public Pension Funds and Corporate Pension accounts for 50% of the total market. Other investors include Endowment Funds, Insurance

Companies, Banks, Non-Financial Corporations and others.


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The Organized Private Equity market consists of four players:1. Issuers - It refers to the companies that cannot raise or have opted to raise capital thrthe private equity market for various reasons like to develop new product and technologie

make acquisition or to strengthen the balance sheet.

2. Intermediaries- It refers to the fund under management. Typically 80% of the global p

equity investment is managed by the funds on the limited partnership model. Otherintermediaries like Small Business Investment Companies (SBIC's) accounts for a margin

share of private equity market.

3. Investors- A wide variety of people invest in private equity funds. Public and corporate

Pension Funds accounts for 40% of global capital outstandings. Endowment Funds and windividuals, each accounts for aprox. 10% of outstandings. The other investors include

insurance companies, investment banks and non-banking financial corporations.

4. Agents and Advisors - With the coming up of various private equity funds, the role of a

and advisors are all more important. They act as information disseminators. They performfunctions:

o They identify the potential private equity funds, evaluate them and provide inform

to investors.

o They help funds raise capital. They often negotiate the terms on behalf of their cli

obtain better terms.

HISTORY OF PRIVATE EQUITY

The organized private equity investments started way back in 1946 with the establishment of Am

Research and Development Corporation (ARD). Its founders are Ralph Flanders, President of FedReserve Bank of Boston and General George Doriot, a Harvard Business professor. The basic pur

of ARD was

To devise a private sector solution to the lack of financing for new enterprises and newbusiness.

To create an institution that provides managerial expertise as well as capital to business.

To manage venture capital of wealthy families such as Paysons, Rockefelers and Whitney

Initially ARD failed to attract much interest among institutional investors. The company wto raise only $3.5 mn of the $5 mn it hoped to raise in 1946. In 1959, Small Business

Investment Companies (SBIC's) are organized. SBIC's are private corporations licensed bSmall Business Administrations (SBA) to provide professionally managed capital to risky


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companies. But they have several limitations:

o All SBIC's did not provide equity finance to new ventures. SBIC's who took loans t

advantage of leverage are required to meet out their interest obligations. So, theypreferred to invest in companies with positive cash flows.

o SBIC's attracted only individuals rather than Institutional Investors.o They failed to attract individual managers of highest caliber.

But inspite of all these limitations, they managed to raise $464 mn of which $350 mn was throu

public offerings. In mid 1970, the market for IPO's virtually disappeared especially for small firm

venture capital cooled down due to poor exit conditions. Moreover, they were forced to invest incompanies already in their portfolio leaving limited scope for new investment.

In 1980, the surge in private equity commitments was mainly towards venture capital. The totalcommitments increased from $600 mn in 1980 to $3 bn in 1984. This big boost was mainly due

successful investment in companies like Apple Computers, Intel, Genentech, Federal Express, TaComputers and lot many.

Untill 1980, funds for non-venture private equity came from venture capital partnership and infoinvestor group organized by investment bank and other agents. Non-venture partnership receive

commitment of $1.8 bn in 1983, $6.8 bn in 1986, $14.6 bn in 1987. In the same year, KKR's re$5.6 bn fund was almost twice the all venture capital raised during the same period. Commitme

both LBO and Mezzanine funds peaked in late 1980's.

FUND RAISING

Since, the partnerships have finite lives, the private equity managers who serve as general partmust regularly raise new funds in order to stay in business. In fact, to invest in portfolio compan

a continuing basis, managers must raise a new partnership once the funds from the existing

partnership are fully invested. The fund raising-investment cycle last from three to five years.

The fund raising is very time consuming and costly exercise, involving presentations to institutioinvestors and their advisors that can take from two months to well over a year depending on the

general partners' reputation and experience.

To minimize their fund-raising expenses, partnership managers generally turn first to those that

invested in their previous partnerships. In addition, funds are often raised in several stages, refeas 'closings', to get a favorable evaluation of the fund by those that have already committed.

General Partners prefer investors that have a long-term commitment to private equity investingBecause past investors are most familiar with a general partner's ability, general partners face g

difficulties when experienced investors withdraw from the market. For instance, insurance compdrastically reduced their commitments to private equity in 1990 owing to concerns among the p

about insurance companies financial condition. More recently, IBM, a major corporate pension fuinvestor, withdrew from the private equity market as part of a broad reduction in pension staff.

SELECTING INVESTMENT

The success of private equity funds depends on the selection of right kind of investment.Generapartners rely on relationships with investment bankers, brokers, consultants, lawyers, and accou


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equity investors typically are also majority owners, so the investors have even greater incentivewell as authority, to become involved in the company's decision making.

Even when the degree of involvement is lowestfor example, when a partnership is a minority iin large private or public companiesgeneral partners may spend as much as a third of their tim

portfolio companies. A partnership rarely is a completely passive investor; an exception is the casyndication, when other partnerships may allow the lead investor to take the active role.

Exiting Investments

General Partners have an obligation to return the capital to limited partners within a specified pe

time based on contractual agreement.The three possible exit routes are a public offering, a privsale, and a share repurchase by the company.

Public Offering- IPO is a win-win situation for both private equity fund and issuer company. A puoffering generally results in the highest valuation of a company and, thus, is often the preferred

route. The company management favors an IPO because it preserves the firm's independence an

provides it with continued access to capital by creating a liquid market for the firm's securities.However, a public offering, unlike a private sale, usually does not end the partnership's involvemwith the firm. The partnership may be restricted from selling any or a portion of its shares in the

offering.

Private Sale- It is preferred by general and limited partners as it provides payment in cash ormarketable securities and ends the partnership's involvement with the firm. But the company's

management dislikes the private sale to the extent that the company is merged with or acquired

larger company and cannot remain independent.

Buyback of Shares by Company- The third exit route is a put of stock back to the firm, in the ca

common stock, or a mandatory redemption, in the case of preferred shares. With puts of commo

stock, a valuation algorithm is agreed to in advance. For minority investments, a guaranteed buprovision is essential, as it is the only means by which the partnership firm can be assured of liqHowever, buybacks by the firm are considered a backup exit route and are used primarily when

investment has been unsuccessful.

Sale to another PE Fund- The general partners may liquidate their investments by selling their s

another private equity fund. General and limited partners generally prefer this route as it providimmediate liquidation of their investments.

GLOBAL SCENARIO

2006 turned to be a remarkable year for the private equity funds. Global mergers and acquisitio

received a big boost-topped to $3.8 trillion, a bump of 38% of which 20% was financed by privaequity buyers. The large portion of the deals was handled by Goldman Sachs and Citigroup. Gold

Sachs took the crown for advising on the largest volume of global announced deals. It advised o$1.09 trillion in deals, for a 28.6% market share.

Perhaps more surprising was last year's showing by Citigroup, which leaped from fifth place in 2second last year. Citigroup advised on $1.03 trillion in transactions, claiming a 27.2 percent mar

share (Thomson Financial). Morgan Stanley, which was number 2 in 2005, fell to 3rd slot in 2006


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advising on $975 bn in global deals for 25.7% market share.

In 2005, no single investment banker cracked the $1 trillion mark. Goldman Sachs worked on th

worth $951 bn, Morgan Stanley $720 bn and Citigroup $695 bn.

According to Private Equity Intelligence 2007, a record $401 bn was raised worldwide in newcommitments. A total of 612 new funds held a final close during 2006.US-focused funds continu

dominate the market, taking 63% of the global share in terms of new commitments. Europe, ma

to hold the second spot with 27% of all capital raised in last being committed to funds in this regAsian and rest of world funds also grew marginally, raising 5% more than 2005.

In total 311 US-focused funds raised an aggregate $252 bn, while 168 Europe-focused funds raisaggregate $108 bn. The 133 Asian and rest of the world funds raised an aggregate of $41 bn.

Real estate funds continued to be increasingly popular with investors, while natural resources aninfrastructure funds have also been successful to great extent.

There were 175 buyout and co-investment funds raised, attracting an aggregate $204 bn duringwith $96 bn of this coming from just 10 mega-funds greater than $5 bn in size. Real estate priva

equity funds raised an aggregate $53 bn from 79 new funds in 2006.In total 174 venture funds

achieved a final close in 2006 collecting $42 bn in new commitments, while 65 Fund of funds raiaggregate $23 bn.

2006 was a remarkable year for mergers and acquisitions in general. Some of the major deals in

last year are:

Equity Office Properties Trust, the US's largest publicly held office-building owner for $36Blackstone Group.

US hospital chain HCA Inc. for $33 bn by syndication of KKR, Bain Capital, and Merrill Lyn

Global Private Equity. Radio chain owner Clear Channel Communications for $27 bn by Bain Capital and Thoma

Lee.

Electronics firm Freescale Semiconductor for $17.6 bn by Blackstone and others.

Natural gas pipeline company Kinder Morgan for $22 bn by Goldman Sachs equity group,

equity group, a private investor.

The acquisition of Harrah's, the world's number 1 casino company in $17 bn by Texas PacGroup and Apollo Management outbidding a strategic buyer , the casino firm Penn Nation

Gaming.

Private Equity deal volumes since 1996

The Private Equity Deal volumes show a continuous increase since 1996. It has increased from $


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in 1996 to $137 bn in 2000. But it declined sharply in 2001 due to DOTCOM BUBBLE BURST. TPrivate Equity investments in the upcoming Information Technology Sector declined to $72 bn in

The PE investments improved in the coming years with the strengthing of global economy. The tdeal volumes stood at $738.10 bn in 2006.SECTORAL ANALYSIS OF PRIVATE EQUITY DEALS

INDUSTRY VALUE ($ Billions) NO. OF DEALS

Media & Entertainment 154.6 325

Industrials 99.9 513

Real Estate 85.2 100

Health Care 76.8 194

Retail 62.4 210

High Technology 60.7 372

Consumer Product & Services 56.2 448

Energy & Power 53.4 146

Financials 31.9 203

Materials 32.2 272

Total 738.1 3052

Top Ten Private Equity Dealmakers In 2006

Acquiring firms VALUE ($ Billions) NO. OF DEALS

Texas Pacific Group Inc. 100 16

Blackstone Group LP 93.1 19

Bain Capital Partners LLC 84.8 12

Kohlberg Kravis Roberts & Co. 77.7 13

Carlyle Group LLC 71.9 32

Thomas H. Lee Partners LP 64.6 7

GS Capital Partners LP 55.8 6

Apollo Management LP 48.7 9

Cereberus Capital Management LP 34.2 9

Merrill Lynch Global Private Equity 32.5 2

PRIVATE EQUITY IN INDIAA decade ago, India did not figure in most investors definitions of "Asia"- or at least not in a maj

way. During those times, the investors were attracted to destinations like Indonesia and ThailanInitially, private equity came into India in the form of early stage/venture capital, particularly in

and IT-enabled services, and telecom sectors.

It was telecommunications that ignited interest in India in March, 2005, when the international pequity firm Warburg Pincus sold a $560 million stake in Bharti Tele-ventures, India's largest pub

traded mobile telephone company. Warburg Pincus has made $1.1 billion by selling off two-third

18% share in Bharti, which was acquired at $300 million, made in stages between 1999 and 200shares, offered in the Bombay Stock Exchange(BSE), was consummated in a breathtaking 28 mwhich revealed to the world the depth and maturity of the Indian equity market.

This deal ignited the interests of Private Equity firms not only within India, but also around the wPrivate equity investors from around the world are increasing their bets on Indian corporates or

new ones. That includes big-name U.S. firms like Blackstone Group, Texas Pacific Group, KohlbeKravis and Robert's (KKR), Carlyle Group and General Atlantic Partners, and Britain's Actis Partn

Local firms such as ICICI Venture Funds Management Ltd. and Kotak are also stepping up invest


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There has been a tremendous increase in the pace in which deals are being made. In the first nimonths of 2006, India saw 329 venture capital and private-equity investments worth a total of $

billion -- more than double the tally for 2005 -- with some 60% coming from foreign players, acto researcher Venture Intelligence India. Private equity investment in India shot up by over 230

cent in 2006, owing to the growing interest of equity funds in domestic companies and high retu

from the stock markets here. Private equity fund investment in 2006 was $7.46 billion, up from billion a year earlier, according to industry tracking firm Venture Intelligence. The size of deals isgrowing, too: from around $8 million four years ago to an average of $25 million today.

The record for 2006 was set by Idea Cellular, which in November received $950 million from a c

investors including Providence Equity Partners, ChrysCapital, Citigroup, and Spinnaker Capital. T

second largest deal was the $900-million buyout by Kohlberg Kravis Roberts and Co, one of the PE funds in the US, for 85 per cent in Flextronics Software. Singapore's Temasek bought 10 per

stake in Tata Teleservices for $360 million, Farallon invested $143 million in Indiabulls Financial Warburg Pincus acquired 27 per cent stake in Lemon Tree Hotels.

A new benchmark may be on the horizon: Reliance Communications is in talks with private-equi

players such as Blackstone, Texas Pacific, and KKR to fund its $10 billion bid for cellular carrierHutchison Essar.

Private equity emerged as the single largest investor class driving equity deals in India in 2006,

overtaking both foreign and domestic strategic investors. PE investment in India also broke throglobal average (20%) of investment as a proportion of total merger & acquisition (M&A) deals b

accounting for 28% of the total deals in India by value, which touched $28.16 billion in 2006. Sothe sectors that are of interest to the private equity firms recently are micro-finance and real es

They have also indulged in the purchase of stressed assets, from asset reconstruction companiehave acquired them from the banking system. The purchase of OCM Textiles by Wilbur Ross from

ARCIL is a case in this point.

While the traditional route for private equity firms is to buy a controlling stake in struggling, mat

corporations and then try to turn them around, in an emerging economy such as India, these firmore like venture capitalists. They look for promising companies in industries ranging from tech

textiles and seek to give them a boost, doing everything from injecting more capital for expansioholding the hand of management and providing strategic guidance.

Private equity investment in India shot up by over 230 per cent in 2006, owing to the growing inof equity funds in domestic companies and high returns from the stock markets here. Private eq

fund investment in 2006 was $7.46 billion, up from $2.26 billion a year earlier, according to indutracking firm Venture Intelligence. Private equity deals were led by the technology sector with 8

for $1.47 billion, up from 46 deals for $434 million in 2005. Private investment in listed companito 22 per cent of total deals, from 34 per cent a year earlier.

There have been a few significant management buyouts in the recent past in the Indian PE induSome examples are Actis' acquisition of significant stakes in Nilgiris, Phoenix Lamps, Paras Pharm

Navis Capital Partners' acquisition of Nirulas, ICICI Venture acquisition of controlling stake in Tat

Infomedia, CDC's Capital Partners acquisition of ICI India's industrial Chemical etc.

Some of the reasons for the heightened interest in the Indian economy are:

o The Indian stock market is comparatively liquid and transparent. The Bombay Sto


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Exchange's benchmark Sensex index is up 42% since January, spurred in part by for 15 private-equity-backed companies that raised a total of $887 million. The Bo

Stock Exchange has the largest number of listed stocks- 7000stocks.

o Another selling point is an abundance of family-owned companies. Although India

have traditionally been reluctant to give up management control, the younger gen

is often prepared to trade away a chunk of the company in exchange for cash and advice on beefing up sales.

o India offers investors better trained managers and more corporate transparency in

private sector.o The Indian courts are a fairly reliable arbiter of investors' rights.

REGULATORY FRAMEWORK

The SEBI Regulations, among others, specify the investment criteria for venture capital and priv

equity investors seeking to invest in Indian companies. A foreign venture capital investor proposcarry on venture capital activity in India may register with the Securities and Exchange Board of

(SEBI), subject to fulfilling the eligibility criteria and other requirements contained in the SEBI FV

Regulations.

Eligibility Criteria - For granting the certificate to an applicant as a Foreign Venture Capital Investhe Board shall consider the following conditions for eligibility:

The applicants track record, professional competence, financial soundness, experience, g

reputation of fairness and integrity.

Whether the applicant has been granted necessary approval by the Reserve Bank of Indiamaking investments in India.

Whether the applicant is an investment company, investment trust, investment partnershpension fund, mutual fund, endowment fund, university fund, charitable institution or any

entity incorporated outside India.

Whether the applicant is an asset management company, investment manager or investmmanagement company or any other investment vehicle incorporated outside India.

Whether the applicant is authorised to invest in venture capital fund or carry on activity aa foreign venture capital investors.

Whether the applicant is regulated by an appropriate foreign regulatory authority or is an

income tax payer; or submits a certificate from its banker of its or its promoter's track rewhere the applicant is neither a regulated entity nor an income tax payer.

The applicant has not been refused a certificate by the Board.

Whether the applicant is a fit and proper person.

The SEBI FVCI Regulations prescribe the following investment guidelines, which can impact overfinancing plans of foreign venture capital funds.

a) The foreign venture capital investor must disclose its investment strategy and life cycle to SEit must achieve the investment conditions by the end of its life cycle.

b) At least 66.67% of the investible funds must be invested in unlisted equity shares or equity liinstruments.

c) Not more than 33.33% of the investible funds may be invested by way of:


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(i) subscription to initial public offer of a venture capital undertaking, whose shares are proposedlisted.

(ii) debt or debt instrument of a venture capital undertaking in which the foreign venture capitalinvestor has already made an investment, by way of equity.

(iii) preferential allotment of equity shares of a listed company, subject to a lock-in period of one

(iv) the equity shares or equity linked instruments of a financially weak or a sick industrial comp

whose shares are listed.

Apart from tax exemptions, one key advantage of registering under the SEBI FVCIRegulations is that at the time of an IPO of the investee company, a SEBI-registered foventure capital investor will not be subject to the one-year lock-in period in respect ofissue share capital held by it.

FEMA REGULATIONS prescribe the manner in which a foreign venture capital investor can make

investments. A foreign venture capital investor, can through SEBI, apply to the Reserve Bank of(RBI) for permission to invest in an Indian venture capital undertaking, a venture capital fund or

scheme floated by a venture capital fund. The consideration amount for investment can be paid

inward remittances from abroad through normal banking channels. Subject to RBI approval, a foventure capital investor can maintain a foreign currency or rupee account with an authorized Ind

bank. The funds held in such accounts can be used for investment purposes.

The FEMA Regulations prescribe the sectoral limits on foreign investments into India. A companyis inter alia engaged in the print media sector, atomic energy and related projects, broadcasting

services, defence and agricultural activities, must obtain the approval of the Foreign InvestmentPromotion Board or Secretariat of Industrial Assistance, depending on the quantum of investmen

before issuing shares to a foreign venture capital investor situated abroad.

INCOME TAX ACT, 1961- The income of venture capital companies or funds set up to raise funds

investment in venture capital undertakings is tax exempt, if they are registered with SEBI and incompliance with Indian government and SEBI Regulations. The income of such companies and/o

will continue to be exempt, if the undertaking in which its funds are invested, subsequent to theinvestment, gets listed on a stock exchange.

Venture capital companies or funds are exempt from withholding tax in respect of income distrib

their investors. The provisions of the IT Act regarding taxation on distributed profits (dividend),distributed income and deduction of tax at source do not apply to venture capital companies or f

PROCEDURE FOR ACTION IN CASE OF DEFAULT- The FIPB has the right to suspend or canc

certificate of registration. Without prejudice to the appropriate directions or measures under reg19, it may after consideration of the investigation report, initiate action for suspension or cancel

of the registration of such Foreign Venture Capital Investor:

The board may suspend the certificate-

contravenes any of the provisions of the Act or these regulations;

fails to furnish any information relating to its activity as a Foreign Venture Capital Investo

required by the Board;


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an overview of private equity investments

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