Trends in Private Equity and Venture Capital Investments with Special Focus on the Booming India Growth Story
| Author | Ritankar Sahu/Ananya Nath/Priyadarshi Banerjee |
| Position | National Law University Jodhpur (India) Corresponding Author: email: rs32cnlu@gmail.com |
| Pages | 128-141 |
Page 128
Private Equity is the provision of equity capital by financial investors - over the medium or long term - to non- quoted companies with high growth potential.1 Venture capital is, strictly speaking, a subset of private equity and refers to equity investments made for the launch, early development, or expansion of a business. Private equity covers not only the financing required to create a business, but also includes financing in the subsequent development stages of its life-cycle. When financing is required by a management team to buy an existing company from its current stakeholders, such a transaction is called a buy-out. 2
Private Equity and Venture Capital may refer to various stages of the investment but the essential investment remains the same: it is the provision of capital, after a process of negotiation between the investment fund manager and the entrepreneur, with the aim of developing the business and creating value. For the sake of simplicity, from this point onwards, the term private equity will be used to cover both venture capital and buyout. (Refer Annex 1)
Private equity firms have a main goal: seek out companies with the potential for growth and with the aim to put in place the capital, talent and strategy needed to permanently strengthen the company and raise its value. Private equity is often categorized under the umbrella of "alternative investments", complementary to the stock and bond portfolios traditionally held by investors.
Private Equity and venture capital is an increasingly important source of finance for high-growth potential companies. The goal of private equity and venture capital is to help more businesses achieve their ambitions for growth by providing them with finance, strategic advice and information at critical stages of their development.3Most entrepreneurs who approach private equity and venture capital investors welcome the improvement in their business activities and in their budgetary and financial monitoring. In a similar vein, the investor's experience and network of contacts were also engaged as very positive elements. 4Furthermore, private equity and venture capital investors provide the companies with more credibility with their clients, suppliers, banks and competitors. This is particularly true for start-ups, which have intangible assets and which have to provide numerous guarantees.
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Private Equity and venture capital plays a critical role in driving growth and jobs. e.g. since 2000 private equity and venture capital professionals have invested more than euros270 billion in over 56000 companies in Europe. The year 2006 was one of record private equity investment of euros71 billion in over 7500 European companies. 5
The objective of this paper is to analyze the growing volume of private equity investments and also to establish that private equity investments are entering those sectors significantly which were the domain of strategic buyers until a few years ago. In light of the spurt witnessed in private equity market, the paper also aims to discuss the potential harnessed by the Indian market.
Private equity and venture capital enables companies to grow and develop, and supports companies which would have a lower growth or would not have been able to survive without it. 6It improves the performance of thousands of companies and allows the development of new technologies and their applications. The industry's focus on improving fundamental business performance means that private equity and venture capital investment may be one of the most potent forces driving economic-wide improvement in corporate productivity. Between 2000 and 2004, private equity and venture capital finances companies created 1 million new jobs 7 which translate to a compound annual growth rate of 5.4% per year (eight times the EU25 total employment growth rate of 0.7%).
European companies such as Skype, Mobistar and TomTom have benefited from private equity and venture capital to become global players. The big winners benefiting from the returns made by private equity and venture capital firms are their institutional investors, mainly pension funds, which in 2006 continued to be the industry's single largest source of capital. The latter accounted for 27.1% of the total funds raised, thus bringing the financial gains back to millions of pensioners and saving account holders. 8
There are several alternatives to private equity: self-financing, debt or raising capital via stock market floatation.
Self financing either by self-owned funds or by friends, family or business angels 9 can be relatively easy and quick but it is seldom a viable long term solution for a growth business. Personal relationships can become entangled with the business and the joint shareholders rarely play an effective role in supporting the entrepreneur. On the other hand, professional investors can mobilize a great deal of capital, support growth and help the entrepreneur but the process can be long and may mean giving up more of the equity of the company.
As creditors of the company, lenders demand guarantees - either personal or from the company. Companies with few or no assets, or entrepreneurs already deeply involved in their project, will find it hard or even impossible to produce theses guarantees. However, the loan has no impact on the share structure of the company and the lender will not intervene with the running of the company.
A private equity investor brings capital, does not require interest payments, is subject to the risks of the company like any other shareholder and will only profit if the company grows. Such an investor has specific controlling rights over how the company is managed.
A private equity investment is a medium to long-term investment, which does not provide the same liquidity as a stock market floatation and which ties the investor closely to the company. The investment is more secure because it is less vulnerable to external economic fluctuations. The closed structure of a private equity fund prevents fund managers from exiting prematurely and strengthens the long term engagement of the fund in the companies inPage 130 which it invests. In comparison, a stock market flotation requires that the company has already reached a certain level of activity, as well as regular public reporting and control by stock market regulations.
After obtaining the agreement of the controlling authorities, private equity firms (known as private equity management companies or General Partners (GPs)), establish investment funds that collect capital from investors (known as Limited Partners or LPs). The private equity firms use this capital to buy high-potential companies (known as the portfolio or investee companies).10
Therefore, private equity managers invite institutional investors and individuals with particular expertise or significant assets, to subscribe to an investment fund for a set period (on average ten years), which will take equity stakes in high potential companies following a clearly defined investment strategy. This can be according to the size of the target companies, their sector, stage of development and/or geographical location. These investors are often known as "sophisticated or professional investors", because they understand the risks inherent in this type of operation.11 The fundraising period lasts six months to one year.
Investment funds are mostly closed; hence institutional investors cannot leave those funds before their term. This element of financial stability is one of the clear advantages for the entrepreneur who seeks a private equity investment. 12 In exchange for money they provide, investors receive a pre-negotiated stake in the equity of the investment fund and they become fully-fledged shareholders, sharing in the risks associated with the private equity firm. 13 The aim of the investors, through the fund, is not to take control of the portfolio company (with particular exception of majority shareholdings) but to help create value in order to realize a capital gain - shared with the owners - on exit. This type of financing is often called 'patient capital', as it seeks to profit from long term capital gains rather than short term regular investments.14
Post realization of the target amount of capital, the subscription is closed. The private equity investment managers then seek high growth companies to invest in, following the investment strategy they proposed to the...
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