Private equity (PE) funds are no longer relying on legally documented ?preferred returns? agreed between them and the companies they invest in, as exits through public offers in stock markets or a strategic sale turn tough in a slowing economy and companies are unable to scale up to deliver returns.
?You cannot hang your hat on the legal document now,? Dhanpal Jhaveri, partner and chief executive, PE Everstone Capital, which manages $1.5 billion with 110 executives, said at a conference organised by LegalEra, a legal magazine. ?We do not want to bet on legal documents.?
A legal document assures PEs of a guaranteed return by the company either by a public offer in the stock market, a strategic sale or sale to other PEs. But, in a falling stock market, companies unable to grow at the promised rate in a slowing economy and a mismatch in valuation are blocking exits. ?A guaranteed exit is not possible now,? says Bharat Bhakhshi, partner, Jacob Balllas Capital India. ?Downside protection is a continuous challenge for outside investors,” says Pranay Bhatia, associate partner at law firm Economic Laws Practice Advocates and Solicitors.
PEs will now have to stay invested in the company to tide over slowdown and deliver more capital to grow the business. “Now we need to help companies scale up to create value,” says Jhaveri. PEs are worried about exit even if they own majority control. “Even if we manage to get 51%, how do we sell this equity?” asks Sundaram Sivaramkrishnan, partner and chief financial officer, Baring Private Equity fund, which manages $1b in India.
PEs are now looking to protect their investment with tough clauses in legal documents to insulate from being marginalised with minority ownership.
“These days, you will see clauses like liquidation preference, price protection clause or anti-dilution clause in deals,? says Sundaram of Barings.
A price protection or Rachet clause is where even though the market value of a company decreases because of external economic slowdown, the investors are promised the fair value of the stake they own. ?PE firms also ask for positions like controlling the audit committee process, chairman of compensation committee or the remuneration committee in the companies they invest in,? added Sundaram.
Lack of exit are worrying Limited Partners (LPs) who invest in PE funds as returns are declining. They are now worried about justifying allocation of funds to Indian PEs. “PE industry have not delivered returns investors were seeking,” says Muneesh Chawla, MD at PE fund Blue River Capital. “It has become difficult to convince the international investor community.”
“We (PE funds) invest in illiquid asset class because of this, it becomes difficult to exit in case of a default,” says Jhaveri of Everstone Capital Advisors
Between January and March 2012, PE funds invested $2.01 billion across 118 deals, data from Grant Thornton, an investment banker and consultant shows. They invested $8.75 billion across 373 deals in 2011 and $6.23 billion across 253 deals in 2010.
LPs feel India has failed to deliver in the last 4-5 years,” says Bharat Bakhshi, partner at Jacob Ballas Capital India. “LPs feel there is risk associated with the minority style of investing, expensive valuations and regularity structure especially around infrastructure.”
He adds: “Till 2011 foreign investors had continued to invest because of past experience.We are yet to conclude whether past funds will make good returns because the signs are not encouraging.” China is giving more than 30% return whereas India is giving 0% returns,” says Baring’s Sundaram. “We need to convince foreign investors as to show good are we as money managers.
