Private equity path to India

World Firms seeking to invest in mostly medium-sized family businesses in this vital market are finding they have to adapt.

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The holy grail of the private equity fund is a small, relatively unknown and unlisted firm that has big growth potential. Find one, buy a strategic stake at a rock-bottom price, restructure, make it grow and then sell out at a huge profit. That is the abiding fantasy that drives the private equity fund manager. Private equity funds are private pools of capital that seek above-average returns. Not for them are the passive investment in an established company; they want managing stakes in small companies with a view to enhancing their value. In India, most such opportunities are in the typical medium-sized family enterprises. Many are local market leaders with established products and lines of business, but have little idea how to expand to the next level. But most are not for sale. "Big foreign PE (private equity) firms like Carlyle and Blackstone came to India thinking they could buy out firms like these as they do in the West, but had to settle for minority stakes and providing them growth capital," says Arun Natarajan, the chief executive of the fund researcher Venture Intelligence based in Chennai. "Up to the end of 2008, buyouts constituted just 5 per cent of all private equity investments in value and volume." With deep pockets, global business networks and the ability to attract top managerial talent, the private equity firm would appear to be the ideal partner for an ambitious small family business. That is precisely what the UK-based Actis, which has raised US$7.6 billion (Dh27.91bn) in the past five years and has investments across emerging markets, has sought to demonstrate. "We initially started by taking minority stakes to provide growth capital, whether to fund capital expenditure or meet working capital requirements, essentially to help the existing entrepreneur," says J M Trivedi, a partner at Actis who heads the firm's India operations. "But we knew that gaining a controlling stake would enable us to do so much more for the company." Many family-managed businesses are run by the second or even third generation of entrepreneurs, Mr Trivedi points out. They are beset by succession issues and often the next generation has no interest in running the family business and wants to cash out. "We provide a solution," he says. "By gaining control while letting those in the family who want to stay on do so, we bring in professional managers with experience of industry-best practice, whether in pharmaceuticals, FMCG (fast-moving consumer goods) or banking, to run the operation." Attracting such talent is no small matter, Mr Trivedi explains. Professionals working in large Indian companies or multinational firms would hardly give a small family firm a second look. "We encourage them to invest in the company, aided by loans we provide, and multiply that investment as the company grows," he says. "Along with performance-linked options, his stake often multiplies faster than ours. Thus the professional becomes an entrepreneur." Besides providing capital and professional expertise, the private equity firm brings its global network of partners comprising all the companies in its portfolio. Actis has investments spread across Latin America, Africa, South East Asia and China. These links provide the invested company with new opportunities for exports and sourcing goods. The Blackstone Group, the world's largest private equity firm, has followed a similar model with its recent investments in Gokaldas Exports in Bangalore, the country's top clothing exporter, and Intelenet, a leading third-party outsourcer. While a new management team is helping to streamline Gokaldas's 46 factories, Blackstone has sought to use its huge global network of invested firms to find new outsourcing contracts for Intelenet. Private equity firms with minority stakes can leave the company through an initial public offering, but where they hold a majority share in the company they would have to sell out to a strategic investor. But their exit does not necessarily leave the invested company in a lurch. As Nitin Deshpande, the chief executive of Kotak ­Private ­Equity Group in Mumbai, explains: "Even with a minority stake we professionalise the firm and inculcate management systems and processes that remain a legacy of our involvement. In fact, most often the professional management we induct stays on even after we exit." Kotak India Growth Fund investments include: Home Solutions, a subsidiary of Pantaloon Retail; INX Media, an entertainment company; DRS Logistics; and BFW, a leading machine maker. The firm is also involved with: SIRO Clinpharm, India's largest clinical-research services company; Metahelix, a biotech company; ICOMM Tele, India's largest telecoms tower-making company; and BVG India, the country's leading facilities management service provider. Despite the global slowdown, private equity firms invested about $888 million in 44 deals in the June quarter, according to a study by Venture Intelligence. While that was significantly lower than that in the same period last year, which saw $2.58bn invested in 92 deals, it was higher compared with the previous quarter, $612m in 43 deals.