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Brush strokes of private equity for growth hunger artists : ET

Shopping for funds? But ask yourself this first; Is my company attractive enough or does it need a more focused growth plan in a niche space? Today, most entrepreneurs reckon that over 90 funds are sniffing at any business opportunity that is more often than most deals get done. But is your business one of them?

Obviously, each business is a separate case study for a private equity firm but there are some deal breakers. The usual, integrity, ethics and transparency are a given. But, an investor is looking for three key ingredients in a prospective investee company. The most important is management and execution ability, second is a competitive and largely unique product or service and third, let’s get real, good return on investment.

“The most important thing for us is a clear growth path and the fact that the company has to exploit a niche opportunity. The sector is also extremely important, as we invest only in five sectors,” says Nitin Deshmukh, head private equity, Kotak Mahindra Bank.

The hunger for growth and a good management to back the company is what PE players are desperately seeking. Most PE firms in India do not have the bandwidth to personally manage companies that they invest in, so back to square one – funds look for entrepreneurs or a team that has made ideas succeed in the past. While most PE firms have a board seat, they would rather invest in the management of the company than get into the nitty-gritty.

Pie-in-the-sky ideas don’t work. It is crucial that a business plan is exploiting a niche opportunity that addresses a very real market demand. The proof of the concept and its scalibility is imperative, it is not about the cash flows. On the other hand, funds are interested in businesses that may not be profitable today but a clear turnaround path is visible.

The fund in a partnership will be able to complement a business in areas of finance, legal and business development. “The entrepreneur should be interested in a partnership. We must be completely open about borrowing future capital, change in business plans, board rights and dominance. Obviously we always keep an eye open for that exit option,” says Luis Miranda, president and CEO, IDFC Private Equity.

High profile clients, strategic alliances with key players in the industry, distributors, vendors et al to show that partners want to do business with you. All these aspects are checked out when a PE fund is conducting its due diligence. Most funds are sector specific and also look for indications of market acceptance.

When it comes to enterprises, funds generally steer clear of anything that has become commodities leading to low margins. While this one is not strictly followed, must funds prefer sectors that are not capital intensive and more service oriented.
Funds always, but always have an eye on the exit options. They are in the business of making good returns for their investors and have to plough back the funds that they have raised obviously with the added interest. An exit option could be the potential of a sell-out or scalibility to the extent of an IPO.

Of late, a lot of PE players are also making their portfolio companies more attractive but assisting them with inorganic growth through acquisitions. These companies eventually go public presenting a perfect exit opportunity to the fund. “Essentially an IPO happens when an industry has arrived and PE firms invest in industries that will happen tomorrow. So PE investing in a company is a re-affirmation of sorts,” says Ravi Sardana, senior VP, ICICI Securities.

PE players undertake considerable risks while investing in a company and could choose to activate the ratchet clause which ensures that a PE player can protect his interests while a clawback ensures that an entrepreneur is rewarded for good performance. And no, these are not the torture instruments that they sound like. These are just meant to be an equitable distribution of risks and rewards.

But the bottom line is that a business has to appeal to the risk appetite of a fund. All funds are not the same — while some are conservative, there are others who will bet on a high-risk, high-return enterprise. A wise entrepreneur with a good business plan therefore needs to do their homework and target the right investors.

Source : Economic Times

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