Transcript Document

Contractual Risks
in
Private Equity Investments
Dr. Kishore N.K.
M.Com., ACS., MDBA., Ph.D., LLB
BEKEM Infra Projects Private Limited
Scheme of discussion:
•
PE and related investments
•
Investment strategies of PE
•
Process of PE and Fund’s Life cycle
•
Valuation Methodologies of PE
•
Contractual Risks in PE Investments:
–
–
Liquidity Preference Rights
Equity Ratchet Rights
•
Risks in Pre and Post Money valuation
•
Risks in 20 Pressure Clauses of PE
•
Brief case study on PE investment
•
Recent statistics of PE
PE and related investments
Private Equity – Broadly Defined
• Technically refers to any type of equity
investment in an asset in which the equity is not
freely tradable on a public market.
• Therefore, PE is:
– Less liquid
– Long Term in nature
Introduction to private equity
"Angel"
Age of
Company
"Venture Capital"
"Growth"
"Buyouts"
"Distressed Investing"
"Hedge
Funds"
Seed
1st Round
2nd & 3rd
Round
Emerging
Growth
Leveraged
Buyouts
Mezzanine
Debt
Distressed
Equity
Distressed
Debt
Hedge Funds
0 years
0-1 year
1-3 years
3-10 years
10-50 years
10-50 years
10-50 years
10-50 years
5+ years
2nd or 3rd
generation
product
Established,
slow growth
Established,
slow growth
Stressed
Stressed
Public
Stage of
Company
Idea
Prototype
1st generation
product
Public or
Private?
Private
Private
Private
Private or
Public
Private or
Public
Private or
Public
Private or
Public
Private or
Public
Public
Equity
Requirement
$0.2-0.5m
$1-2m
$2-5m
$5-20m
$10 - 250m
$10 - 250m
$10 - 250m
$10 - 250m
N/A
Return
Expectations
70%+
50-70%
50-60%
40-50%
25-40%
20-30%
30-50%
30-40%
20%
Angel Investors
• Angel investor is typically a wealthy individual
• Often with a technical industry background
• Able to judge high-risk investments
• Invests in early stage companies up to Rs. 50 lacs
• Expects investment through IPO or subsequent
financing rounds
Financial VCs
• Most common type of VC
• Is an investment firm, capital raised from
institutions and individual investors
• Being formal VC funds, have limits on size,
lifetime and exits
• Are entitled to carried interest
• Fund size ranges between Rs. 100 crores to
Rs. 50,000 crores
• Exits from IPOs, mergers & acquisitions, and
selling on stock exchanges
Strategic VCs
• Typically a small division
technology company
of
a
large
• Invests in companies whose success may
increase revenue growth of the VC
• May not concern only about the return on
investment
• May provide investees with
connections and partnerships
valuable
• Usually takes a back seat role in funding
Why Angels Invest
• The Person
– Familiarity with the integrity and abilities of the management team
OR
– Friends, Family & Fools
• The “Cause”
– The company is doing something that contributes to a social cause
that is meaningful to the angel…
• Curing cancer, improving the environment
– The company is targeting a market segment in which the angel
has experience and insight
• Perceived BIG opportunity
– The Angel perceives the technology to be disruptive and does
some cursory due diligence that confirms his / her suspicions
Investment strategies of PE
Private Equity strategies
Private Equity
Corporate Finance
Leveraged Buyout
(LBO)
Growth Capital
Turnaround
Venture Capital
Early Stage
Late Stage
Private Debt
Mezzanine
Distressed Debt
Infrastructure
Private Equity – Corporate Finance Strategies
Finance type
Strategy
Leveraged
Buyout
Acquisitions of operating companies that are financed with
equity and debt
Growth Capital
Expanding companies in need of capital to finance high
growth or acquisitions
Turnaround
Acquisitions of underperforming businesses or businesses in
out-of-favor industries in need of either financial or
operational restructuring
Private Equity – Venture Capital Strategies
Finance type
Strategy
Early Stage
Companies that are in the process of
developing business plans, products /
services have been developed and are
marketed to a limited number of
customers
Late Stage
High growth companies, nearing
profitability
Private Debt – Financing Strategies
Finance type
Strategy
Mezzanine
Investments in subordinated debt issued by operating
companies; frequently issued in conjunction with a buyout
acquisition and with equity kickers attached, such as
warrants or options in order to enhance returns
Distressed Debt Investments in public and private debt securities that are
trading at discounts to par value due to financial stress of the
underlying company
Infrastructure
Investments used to finance the construction or
enhancement of distribution networks for electricity, water
and gas, and certain transportation assets such as toll roads,
bridges and tunnels
Process of PE & Fund’s Life cycle
Process of PE fund
(7) Liquidate / Sell
Portfolio Companies (1) Raise Capital
(6) Nurture
Portfolio Companies
(2) Evaluate
Market Segments
(5) Negotiate and
Structure Investments
(4) Select Investment
Candidates
(3) Generate
Deal Flow
Private Equity Fund Lifecycle
Period
Private
Equity
Activity
Fund raising
(6 – 18
months)
The first phase of a fund’s life cycle is the
fundraising period, during which a fund is
marketed to potential investors who commit
capital. Capital commitments from investors are
essentially promises to fund future investments as
a fund manager identifies them.
Investment
Period
(5 – 6 years)
Once fundraising is complete, the fund closes and
begins its investment period, which typically lasts
five years. During the investment period the fund
manager calls capital from commitments provided
by investors to make investments
Realization
Period
( 5 – 8 years)
After the investment period, the fund enters the
realization period, which lasts five to eight years
on average. During the realization period,
investments are sold or liquidated, and proceeds
are returned to the investors
Valuation Methodologies
of Private Equity
Valuation methodologies
• Price of recent investment
• Earnings multiple
• Net assets
• DCF or earnings (of business)
• DCF from investment
• Industry valuation benchmarks
Price of recent investment
• Since the previous investment was
made recently, the same price may be
adopted for the current investment as
well
• The validity of the valuation obtained in
this way is inevitably eroded over time.
• To adopt price as above, background to
the previous transaction and investment
must be evaluated (such as volume,
rights, strategic considerations etc)
Evaluation of previous investment
and business
• Performance and prospects of the business
against the assumptions / terms of previous
investment
• Extent of compliance with the terms and
conditions of investment documents
• Present business environment, including
technical, market, economic, legal and
regulatory, in comparison with previous
investment
Earnings multiple
• Is applying an earnings multiple to the
earnings of the business to derive the
value of the business.
• This methodology is appropriate for
investing in established businesses
with
identifiable
stream
of
maintainable continuous earnings
• The earnings figures for a number of
periods may be averaged using a
forecast level of earnings or applying a
sustainable profit margin to current or
forecast revenues.
Essentials to apply earnings multiple
• Multiple
should
be
appropriate,
reasonable, and commensurate with the
earnings growth prospects of the
underlying company.
• Earnings should be adjusted for the
surplus assets or excess liabilities and
other relevant factors to derive
enterprise value for the company
• This methodology may even be applied
to companies with negative earnings if
the losses are considered to be
temporary and one can identify a level of
normalized maintainable earnings
Various multiples
Multiple
Applicability
P/E
Price / Earnings of comparative company may be used. It signifies the
price market is willing to pay for the Company based on its earnings
(EPS). Theoretically the company can be purchased at the MPS on the
stock exchange
EV / EBIT
EV, Enterprise Value, is the sum of net worth and net financial debt of
the Company. EV / EBIT indicates the multiple of EV for the total
earnings of the Company
EV / EBITDA
EBITDA is the total cash earnings of the Company.
EV / EBITDA indicates the multiple of EV for the total cash earnings of
the Company
Caution required while applying multiples
Multiple
Caution
P/E
P / E is a market based approach.
Market capitalization of a quoted company may not reflect the value of
the Company but only the price at which ‘small parcels’ of shares are
exchanged.
The comparative companies should be similar in terms of business
activities, markets served, size, geography and applicable tax rates.
EV / EBIT
This multiple ignores the benefit of depreciation, particularly in case of
assets depreciated for accounting purpose over a limited period but
practically have a longer economic usable value.
EV / EBITDA
This multiple removes the impact on the value of depreciation of fixed
assets and amortization of goodwill and other tangibles. The need of
replacement of highly depreciable assets, need for expending additional
amounts to be amortized over a limited period have to be factored in.
Net assets
• This methodology involves deriving the
value of business by reference to the value
of its net assets
• This is likely to be appropriate for a business
whose value derives mainly from the
underlying value of its assets rather than its
earnings. Ex., property holding companies
and investment businesses.
• This may also be appropriate if return on
assets is inadequate and greater value can
be realized by liquidating the business and
selling its assets
Caution required while applying
Net assets method
Net
Assets
• Contingent assets and liabilities may
also be included while valuing assets
and liabilities of the Company
• An appropriate marketability discount
should be applied to arrive at a
realistic value of the assets
• The value of the redeemable
instruments, if any, should be
deducted to arrive at the available
value of the assets
DCF from the underlying business
• Discounted Cash Flow (DCF) methodology
involves deriving the value of a business by
calculating the present value of expected
future cash flows
• Is flexible as it can be applied to any stream
of cash flows or earnings
• This methodology may be applied for
businesses going through a period of great
change, such as a rescue refinancing,
turnaround, strategic repositioning, loss
making, or is in its startup phase etc.
DCF from the investment
• Unlike the DCF from the business
earnings, this methodology applies DCF
technique to the expected cash flows from
the investment itself.
• Where pricing for the return on the
investment or floating Initial Public Offer
(IPO) is / to be agreed at the time of
making investment, this is the appropriate
methodology.
• Is particularly suitable for valuing nonequity investment in instruments like debt,
mezzanine debt etc since the value of such
instruments derives mainly from the
instrument-specific cash flows and risks
than of the underlying business as a whole
Caution for applying DCF
methodology
• Cash flow forecasts, estimation of terminal
value, and selecting risk-adjusted discount
rate should be appropriate
• Ideally DCF based valuations should be
used as a cross-check of values estimated
under market based methodologies and
should be used in isolation of other
methodologies only under extreme caution
Industry valuation benchmarks
• Industry specific valuation benchmarks are used
as per the prevailing practice of the industry
• Examples: price paid per bed for hospitals, price
per seater for BPO, price per head for schools,
price per subscriber for cable-television, mobile,
internet companies etc
• These industry norms are based on assumptions
that investors are willing to pay for turnover or
market share and that the normal profitability of
business in the industry does not vary much
• This may be used as a sense-check of values
produced using other methodologies
Duration of Private Equity/ Venture Capital
Investment normally ranges from 3-7 years
EXIT
OPTIONS
AVAILABLE
TO
PRIVATE
EQUITY
FUNDS
EXIT OPTIONS:
• IPOs
• Mergers & Acquisitions
• Management Buy-out
• Sale to Another Fund
• Buyback by Promoter/ Company
• Stock Market
In case of Buyback by Promoter/Company , the value at
which PE Fund would exit is IRR or market-based and is
pre decided at the time of investment on a certain valuation
Popular Investment instruments of PE
(For issue to PE by investee companies)
Equity shares at a premium
Traditional pricing. Ratchet rights may not be
involved
Optionally Convertible Preference
Shares
ECB guidelines apply and foreign PE / VC may
not find it attractive.
Pricing can be in favour of PE. Ratchet rights
may be stipulated.
Fewer no of equity shares (with
disproportionately higher voting
rights) and substantial portion in
Preference shares
Market pricing. Deal in favour of PE. Voting
control is provided to PE with the differential
voting rights. (Present version of new
Companies bill bans DVRs)
Cumulative Compulsory
Convertible Preference Shares
with participating rights
Prospective pricing. Participating rights in
residual income. Very popular instrument
and widely used in the recent past.
Mix of Equity + convertible equity
warrants + preference shares
Multiple convertible instruments. Very complex
to structure. Pricing can be manipulated as per
the agreement between the parties.
Debentures convertible into equity
shares at the time of IPO at the
IPO price
Pricing can be fair and neutral. Comfort to PE
with the periodical interest cash flows and
comfort to Investee Company with the nonequity control by PE (till conversion into equity)
Contractual rights and
corresponding risks in PE
investments
Liquidity Preference Rights
(and Risks)
Liquidity Preference
• Liquidity preference right applies for
liquidation,
merger,
acquisition,
takeover, sale of asset of company,
IPO, or any other exit
• If company is liquidated the PE
investors
(holding
liquidity
preference rights) will be entitled to
get their money back in 1 or more
multiples as per the liquidity
preference right
(ex: Invst x 1; invst x 1.5; invst x 2)
Liquidity Preference distribution
Liquidity preference distribution if liquidity realization is Rs. 14000 lacs
PE Invst
Rs lacs
PE %
shareholding
Liquidity
prefer
X
Liquidity pref
amt
distributed#
2500
5%
1
2500
575
3075
2500
5%
2
5000
450
5450
2500
11%
1
2500
1265
3765
2500
11%
2
5000
990
5990
2500
26%
1
2500
2990
5490
2500
26%
2
5000
2340
7340
# PE invst x Liquidity Pref
* PE shareholding % x (Liquidity realization – Liquidity pref amt distributed)
Capital share
distributed
*
Total
distributed
Liquidity Preference distribution
Liquidity preference distribution if liquidity realization is Rs. 8000 lacs
PE Invst
Rs lacs
PE %
shareholding
Liquidity
prefer
X
Liquidity pref
amt
distributed#
2500
5%
1
2500
275
3075
2500
5%
2
5000
150
5450
2500
11%
1
2500
605
3765
2500
11%
2
5000
330
5990
2500
26%
1
2500
1430
5490
2500
26%
2
5000
780
7340
# PE invst x Liquidity Pref
* PE shareholding % x (Liquidity realization – Liquidity pref amt distributed)
Capital share
distributed
*
Total
distributed
Liquidity Preference distribution
Liquidity preference distribution if liquidity realization is Rs. 4500 lacs
PE Invst
Rs lacs
PE %
shareholding
Liquidity
prefer
X
Liquidity pref
amt
distributed#
2500
5%
1
2500
100
2600
2500
5%
2
5000
0
4500
2500
11%
1
2500
220
2720
2500
11%
2
5000
0
4500
2500
26%
1
2500
520
3020
2500
26%
2
4500
0
4500
# PE invst x Liquidity Pref
* PE shareholding % x (Liquidity realization – Liquidity pref amt distributed)
Capital share
distributed
*
Total
distributed
Liquidity preference equations
Liquidity
preference
amount to PE
Liquidity realization amount x
PE % shareholding x liquidity
preference number
Capital share on
liquidation
% PE shareholding x (Total
liquidity realization – liquidity
preference distribution amount)
Total distribution
to PE on
liquidation
Liquidity preference amount +
capital share distribution
Amount available Liquidity realization amount –
to other
total amount distributed to PE
shareholders
Equity Ratchet Rights (and Risks)
Anti-dilution price protection provision
(Equity ratchets)
• Ratchet is the structure of resetting (adjustment)
of equity price and shares allocations
depending on subsequent equity allotment
price, future performance of company or the
rate of growth etc.
• Anti-dilution price protection gives PE the
benefit of reduced effective price per share if
the company issues its shares at a lower price
in a later round (down round)
• Later round price is considered as lower if it is
lower than the share value projected to prevail
at the later round price
Types of equity ratchets
• Weighted ratchet anti-dilution price protection
• Narrow based weighted average anti-dilution price
protection provision
• Broad based weighted average anti-dilution price
protection provision
• Full ratchet anti-dilution price protection
Nature of ratchets
• Weighted ratchet: The resetting allotment
price is lowered to a price that is a
weighted average of the price at which
the company issued shares valuing the
company at the pre-adjusted price. It has
two sub-types viz., narrow based
weighted average ratchet and broad
based weighted average ratchet
• Full ratchet: The resetting allotment price
is lowered to the lowest price, that is
lower than PE’s purchase price,
regardless of the number of shares
issued (but not weighted average price)
Kinds of weighted average ratchets
• Narrow based weighted ratchet: Narrow
based weighted average anti-dilution price
protection provision might include only
equity share capital and convertible
preferred shares then outstanding
• Broad based weighted ratchet: Broad based
weighted
average
anti-dilution
price
protection provision includes equity shares
outstanding and issuable upon conversion,
warrants, convertible debt, options and any
other contingent right to equity shares or
equity share capital
Share price adjustments with Ratchets
Share price adjustments with weighted average ratchets
Investor
No of
shares
Promoters
10,00,000
80
8,00,00,000
64.52%
10,00,000
63.73%
Private
Equity
50,000
125
62,50,000
3.23%
69,095*
4.40%
New Invst - 1
2,00,000
90
1,80,00,000
12.90%
2,00,000
12.75%
New Invst - 2
3,00,000
85
2,55,00,000
19.35%
3,00,000
19.12%
12,97,50,000
100.00%
15,69,095
100.00%
Total
15,50,000
Allot
price
Invest amt
Before adj %
shareholding
After adj
no of shares
* Rs. 62,50,000/90.45; Rs. 90.45 = (Sum invst amt of PE + NI 1 & 2)/(Sum of no. of shares to PE, NI 1& 2)
After adj %
shareholding
Share price adjustments with Ratchets
Share price adjustments with Full ratchets
Investor
No of
shares
Promoters
10,00,000
80
8,00,00,000
64.52%
10,00,000
63.55%
Private
Equity
50,000
125
62,50,000
3.23%
73,529*
4.67%
New Invst - 1
2,00,000
90
1,80,00,000
12.90%
2,00,000
12.71%
New Invst - 2
3,00,000
85
2,55,00,000
19.35%
3,00,000
19.07%
12,97,50,000
100.00%
15,73,529
100.00%
Total
15,50,000
Allot
price
Invest amt
* Rs. 62,50,000/85; Rs. 85 = Lower of Allot price to PE, NI 1 & 2)
Before adj %
shareholding
After adj
no of shares
After adj %
shareholding
Ratchet flow chart
PE 1 invests
@ x price
Company
(Equity Issuer)
If issue price
is > x,
no ratchet
Proposal for
Follow on Issue
If issue price
is < x,
ratchet kicks-in
Weighted
Full
Reset the price:
Sum invst amt
PE 1 + new shares
Reset the price:
PE 1 invst amt
Lowest new issue price
Total eligible shares to PE 1 @:
PE 1 invst amt
Reset price as above
Ratchet exercise completes; PE investor gets additional shares
Ratchets in connection with
book value of equity shares
In addition to the ratchets connected with down-rounds, ratchets are also
structured in connection with book value of equity shares. While ratchets of
former type protect the control interests of PE investor, the latter protects the
monetary interests of the PE investors even if no down-rounds are made. The
following is one of the practices to structure these kinds of ratchets.
•
Optionally convertible cumulative participating redeemable preference shares
will be issued at premium to equal the determined value at the time of PE
investment for the equity shares of the Company.
•
The intrinsically prevailing value of the equity share will be arrived at at the end
of each year
•
If share value as in 2 is greater than in 1, no ratchet kicks-in; If share value as in
2 is lower than in 1, no ratchet kicks-in.
•
As per the ratchet, either of the following two or a mix of the following two will be
effected at the option of the PE investor:
i)
for the payable preference dividend amount, PE investors will have to be allotted equity
shares at value that will compensate the PE investor in value terms for his total
investment and this dividend receipt.
ii)
Convert the preference shares into equity shares at the relevant valuation as on the date
of opting for conversion
Risks in
Pre-money and Post-money valuation
Pre-money and post-money valuation
• The following are the two valuation
concepts
in
connection
with
computing the % of shareholding a
PE gets for its investment in the
company:
• Pre-money valuation
• Post-money valuation
Pre & post money valuation equations
Pre-money
valuation
Post money valuation – PE
investment
Post money
valuation
PE investment / PE ownership
percentage or Pre-money
valuation + PE investment
Share price
Pre money valuation / no of pre
money shares; or
Post money valuation / no of
post money shares
New shares
issued
PE investment / share price
Total outstanding Pre money shares + new
shares
shares issued
Pre money and post money valuation
- illustration - 1
Pre money
valuation
Rs. 100 crores
Investment
amount proposed
Rs. 25 crores
Post money
valuation
Rs. 125 crores
PE’s percentage
shares
Rs. 25 / 125 x 100 = 20%
Pre money and post money valuation
- illustration - 2
Post money
valuation
Rs. 100 crores
Investment
amount of PE
Rs. 25 crores
Pre money
valuation
Rs. 75 crores
PE’s
percentage
share
25 / 75 x 100 = 25%
Rights and Risks associated with
20 Key Pressure-Clauses
in PE investments
1/20 Key pressure clauses of PE investment
Dividend Rights:
• Dividend policy of the investee company during the
period of PE investment is influenced by PE.
• The dividend policy is formulated in a tax efficient
way
• Usually, on account of taxation, PEs do not
encourage periodical dividend payments
• PE investor holds an overriding right to veto the
payment of any dividend.
2/20 Key pressure clauses of PE investment
Nature (kind) of shares for PE investors:
•
PE investors usually invest in either Equity or
preference depending on the legal provisions
prevailing in the host country
•
Since ratchet rights have to be accommodated,
generally PE investors prefer convertible preference
shares over equity shares. However, since veto rights
are available only for equity shareholders, PEs prefer
to hold a mix of preference and equity.
•
PEs also prefer to hold golden shares (with additional
rights).
•
Differential Voting Right (DVR) shares are considered
in India. However, the new companies bill prohibits
issuance of DVR shares.
3/20 Key pressure clauses of PE investment
Liquidation Preference:
•
Liquidation preference accords a right to the
PE investors to receive certain amount of
the realized amount out of liquidation of the
Company
in
preference
to
other
shareholders.
•
This preference amount may be equal to the
amount of the original amount invested by
the PE investor or a multiple of it.
•
In India liquidation preference rights may not
be possible on equity shares and hence PE
investors prefer ‘cumulative participating
preference shares’
4/20 Key pressure clauses of PE investment
Redemption Rights (Equivalent to sell-back right in
India):
•
PEs demand that the Company shall buy back
its own shares from investors. PEs insist that the
other shareholders (usually promoters) should
not participate in the buy back scheme thereby
facilitating their shares to be bought back by the
Company.
•
Valuation of the buy back of the shares is subject
to the guidelines issued by the competent
authorities.
•
Alternately and / or simultaneously, as per the
terms of the investment agreement, promoters
will have the obligation to purchase the shares
from PE investor at a price to yield the required
rate of return
5/20 Key pressure clauses of PE investment
Anti dilution (Price protection ratchets /
Price protection rights):
•
PEs hold anti-dilution protection
rights to protect the value of their stake in
the Company if new shares are issued at
a valuation which is lower than that at
which they have originally invested. Such
subsequent or follow on issue round is
termed as ‘down round’.
•
These rights are termed as ratchet
rights. Ratchets could relate to price of
follow on issue price or valuation of the
equity share even in the absence of a
subsequent equity issue.
6/20 Key pressure clauses of PE investment
Right of first refusal (ROFR):
•
ROFR right provides that if any
shareholder (usually promoter) intends to
dispose of shares, such shares must be first
offered to the PEs (if ROFR right is held) at
the same terms and conditions the shares
are intended to be sold.
•
These rights ensure that the promoters
do not sell their shares to persons whom
PE would not like to be shareholders of the
Company.
• These rights also ensure that the promoters
do not sell their shares at unusual terms to
their preferred persons
7/20 Key pressure clauses of PE investment
Drag along (Bring along) rights:
• A drag along provision creates an obligation
on the other shareholders (usually promoters)
of the Company to sell their shares to a
potential purchaser if and when PE
shareholder votes to sell its shares to the
potential purchaser
• These rights will be useful in the context of a
sale where potential purchasers intend to
acquire substantial majority (usually 100%) of
the shares of the Company in order to avoid
having responsibilities towards minority
shareholders after the acquisition.
8/20 Key pressure clauses of PE investment
Tag along (Co sale) rights:
• A tag along provision creates an obligation
on the other shareholders (usually
promoters) of the Company to ensure that
the potential purchaser agrees to purchase
an equivalent percentage of PE’s shares at
the same price and under the same terms
and conditions.
• This right may have the effect of making the
shares more difficult to sell.
9/20 Key pressure clauses of PE investment
Pre-emption right :
• Preemption is the right of PE investor to
participate in a financing to the extent
necessary to ensure that, if exercised, its
percentage ownership of the Company’s
shares will remain the same after the financing
as it was before.
• In Indian term sheets, it could even mean
rights of PE to decide whether certain items
can be taken up by the Board or General
Meeting in the agenda.
10/20 Key pressure clauses of PE
investment
Representations:
PE investors insist on representations from the issuer Company
(and from the Promoters) to be included in the investment
agreement / term sheet confirming about the information
disclosed and that the deal (investment by PE) is subject to
the facts, information, statements furnished by way of
representations.
Representations are also stated as recitals. Recitals usually
form part of the agreement. PE investors prefer to include
the representations in the agreement rather than in recitals
since as per the legal interpretation, recitals are considered
as jointly agreed upon statements / situations than a cover
to the other party.
If any representation is found inaccurate subsequently, PE will
have a right to initiate corrective action including
accelerating the investment as per the terms of the
investment.
11/20 Key pressure clauses of PE
investment
Warranties:
PE investors insist on warranties from the issuer Company (and
from the Promoters) to be included in the investment
agreement / term sheet to provide the investors with a
complete and accurate understanding of the current
condition of the Company and the past history so that the
investors can evaluate the risks of investing in the Company
prior to investing in the Company.
The warranties typically cover areas such as legal existence of
the Company, financial statements, business plan, assets,
liabilities, material contracts, employees and litigation.
If any warranty is is found inaccurate subsequently, such an
event will be considered as breach of the agreement and
the PE will have a right to be reimbursed for the loss /
expenses etc with an additional right to rescind the
investment agreement itself.
12/20 Key pressure clauses of PE
investment
Consent Rights:
PE investors normally hold consent rights which provides that
that certain actions cannot be taken by the Company
without the consent of the PE investors or of a majority %
(as specified)
These consent rights need not confine to only board agenda
items
13/20 Key pressure clauses of PE
investment
Board Seats:
PE investors will require a right to nominate one or more
directors to be appointed on the Board of the investee
Company.
PE investors may also require a right to appoint a Board
Observer who can attend all Board Meetings but will not
participate in any board decisions.
14/20 Key pressure clauses of PE
investment
Information Rights:
PE investors will require right to receive information on a regular
basis concerning the financial condition and budgets along
with a general right to visit the company and examine its
books and records.
15/20 Key pressure clauses of PE
investment
Registration Rights:
These are specific only to USA since SEC requires the
registration of the securities to be eligible for offering for
public sale (Offer for Sale). The registration process
involves the Company providing significant information
about its operations and financial condition which can be
time consuming and expensive.
In India this clause is non-existent. However a corresponding
clause to this in India is that PE investors insist that the
Company do not recognize PE investors under promoter
group and also should endeavor to avoid PE investors
being recognized as promoters under law. This will help PE
investors not to be subject to the lock-in requirement of the
promoters’ shares at the time of IPO of the Company.
16/20 Key pressure clauses of PE
investment
Conditions Precedent:
Term Sheet / Investment agreement of PE investors will include
a full list of conditions to be satisfied before investment will
be disbursed.
Conditions to be fulfilled
in advance
Usually Conditions Precedent to signing of the investment
agreement and Conditions precedent to releasing of the
investment amount to the investee Company will be
separately laid down clearly in the term sheet and the
investment agreement respectively.
17/20 Key pressure clauses of PE
investment
Tranche Disbursements:
PE investors will have a right to release the investment amount
in one or more tranches (stages / phases) dependant on
achievement of targets or milestones claimed to be
achieved in the business plan of the Company.
While the investment price may be determined at the time of
signing of the investment agreement itself, the investment
amount is structured to be released in tranches (stages) to
ensure that the Company is growing as per the growth
guidance issued by the Company / Promoters.
18/20 Key pressure clauses of PE
investment
Exit Options / Rights:
PE investors will reserve right to exist in various ways including:
- Initial Public Offer (IPO)
- Offer For Sale (OFS)
- Merger
- Take Over
- Strategic Sale
19/20 Key pressure clauses of PE
investment
Non Compete Clause:
Cant
PE investors will require the promoters to sign non-compete
agreements so that the promoters will not nurse their
interests to promote and develop other companies which
may eat in to the business of the investee Company or
which may stand competition to the investee company.
Usually the Non-Compete agreements will carry a tenure of
about 5 years from the date of investment.
20/20 Key pressure clauses of PE
investment
Special Audit:
PE investors will require the Company’s financials to be audited
by a special auditor usually appointed by them in addition to
the statutory auditor of the Company.
The costs of the audit and the audit fee for the special auditorr
have to be borne by the Company.
Special Auditor submits his audit report to the PE investor with
a copy of the audit report to the Company. In addition to the
usual financial audit, he may also comment on the status of
the compliance of the conditions of the terms and conditions
of the investment agreement signed by the Company with
the PE investor.
Pros and Cons of Private Equity
Advantages for Company
Disadvantages for Company
Faster Growth
More complex accounting and
reporting
Unsecured Finance
Investor veto rights
Employee ownership (in the case
of MBO)
Accountability to investor
Strengthens financial position
Investor’s involvement in board
decisions
Facilitates obtaining other forms
of finance
Restrictive covenants for
managers / operations
Funding is committed until exit
(unlike bank loans)
Warranties to be given by
promoters / company
Management and relationship
advise
Investor’s objective / motive is
exit at good return
Challenges to PE in India
Area
Challenge
Value of
Private Equity
-Important to be an active investor to understand the
value add from PE
-Must trade-off value, growth and risk
-Analyzing the relative merits of a potential non-PE
investment
-No relevant experience to guide
Market
conditions
-Developing business plans and best practices for
privately held and family run Indian firms
-Questions of global competitiveness
-Discarding what is irrelevant and possibly damaging
for Indian companies
Exit Strategy
-Market and business tolerance for public offerings
-Family business reluctant to relinquish control
-Inevitability of an Initial Public Offer (IPO)
Others
- PE sponsors more susceptible to volatility in the global
debt market
-Increased regulations
-Lower IRR on existing PE portfolios
Case study on PE
Investment and
associated risks
CLSA Private Equity Investment in Apar
Industries Limited
Apar Industries Limited:
USD 250 million Apar is the largest player in transformer oil
division with 50% market share. It is second largest player in the
aluminium power conductor business with 25% market share. It
is largest exporter of aluminium power conductors from India.
.
The PE Investor:
Credit Lyonnais Securities Asia (CLSA) is Asia’s leading
independent brokerage and investment group. It is active in
equity broking, capital markets, mergers and acquisition, asset
management services, and private equity investments
Investment vehicle:
CLSA CLSA PE Limited, Hongkong  Aria Investments
Partners  Shinny Limited, Mauritius
The PE Transaction:
Private Equity investment:
•
•
•
•
In September 2005, CLSA Private Equity was issued 3,445,978 shares as 5.4% cumulative
compulsory convertible preference shares with participating rights for Rs. 185 per share.
Convertible on 11th October 2006 into equity shares resulting in 14.21% equity stake of Rs. 10
each at a premium of Rs. 175 per share
Number of shares: 3,445,978
Converted into equity on 11-10-2006: 3445978 equity shares of Rs. 10 each with a premium of
Rs. 175 each
Market Price of Share (MPS): On date of conversion (pre-bonus): Rs. 246; Post-bonus : Rs. 188;
Highest till Jan 2008 (post-bonus): Rs. 450;
Bonus issue on 18-Jan-2007: 1:3 ratio; Initially issued: 3,445,978 + bonus: 1,148,659 = 4,594,637
Rights & Risks:
•
Board seat (Directorship) to be reappointed during the currency of the Investment Agreement
•
Right to appoint observers; Right to call for special audit;
•
Identified material adverse events;
•
Obligation on Company and Promoters to ensure exit by way of strategic sale / FPO
•
Tag along and drag along rights
•
Information rights
•
Pre-emptive rights
•
Anti dilution rights (read implied ratchets)
Recent Key statistics related to
PE investments
PE: funds raised &
investments made (amount in US $ mio)
PE Funds raised
Location
2002
2003
2004
2005
2006
2007
India
160
260
823
2,637
4,859
5,831
Asia
2,991
3,322
11,463
28,010
41,113
50,671
PE investments made
Location
2002
2003
2004
2005
2006
2007
India
1,050
865
1,479
2,424
7,520
17,273
Asia
9,112
17,580
19,010
33,596
62,818
82,955
PE Investments in India
: FDI & GDP
(amount in US $ mio)
PE Investments versus FDI
Investment
2002
2003
2004
2005
2006
2007
PE
1,050
865
1,479
2,424
7,520
17,273
FDI
5,035
4,322
6,051
7,722
19,531
45,455
PE investments versus GDP
Value
2002
PE Investment 1,050
GDP
495,651
2003
2004
2005
2006
2007
865
1,479
2,424
7,520
17,273
575,245
666,305
778,666
873,659
Most active international players in 2007
Fund manager
Nationality
Firm Type
Deal value
(US $ mio)
Temasek Holdings
Singapore
Govt affiliate
3,152.2
CVC International
US
Bank private equity arm
2,057.8
Goldman Sachs
US
Bank private equity arm
1,883.0
Blackstone Group
US
Independent VC / PE firm
1,136.8
India Equity partners
US
Independent VC / PE firm
1,098.9
AIF Capital
Hong Kong
Independent VC / PE firm
1,008.2
Macquarie Bank
Australia
Bank private equity arm
1,000.0
Avenue Capital
US
Independent VC / PE firm
717.8
Carlyle Asia
US
Independent VC / PE firm
701.0
Dubai International
Capital
UAE
Investment Company
637.8
Most active Domestic players in 2007
Fund manager
Nationality Firm Type
Deal value
(US $ mio)
ICICI Venture Funds
India
Bank Private Equity arm
1,106.5
New Silk Route Advisors
India
Independent VC / PE firm
443.0
IL&FS Investment Managers
India
Independent VC / PE firm
324.6
Beacon India Advisors
India
Independent VC / PE firm
273.2
IDFC Private Equity
India
Bank Private Equity Arm
268.8
Indivision Investment Advisors
India
Independent VC / PE firm
217.0
UTI Venture Funds
India
Independent VC / PE firm
156.6
Zeus Inframanagement
India
Independent VC / PE firm
127.5
Jacob Ballas Capital
India
Independent VC / PE firm
119.3
ChrysCapital Management
India
Independent VC / PE firm
117.9
Stage-wise investments
(amount in US $ mio)
Stage
2003
2004
2005
2006
2007
2008*
Bridge loan
0.0
0.0
0.0
0.0
11.3
0.0
Buyout (M/LBO)
126.0
564.9
174.5
1,280.2
967.9
70.0
Expansion
204.2
468.5
1,168.3
3,074.7
7,096.1
4,166.1
Franchise funding
0.0
0.0
0.0
0.0
15.2
0.0
Mezzanine / PreIPO
4.7
7.3
112.2
1,236.0
800.4
442.7
PIPE financing
526.7
438.3
910.6
1,290.3
5,581.2
1,028.6
Seed / R&D
0.0
0.0
0.0
7.0
31.7
0.0
Start-up / early
stage
17.2
0.0
58.4
627.2
2,768.7
1,142.7
Turnaround /
restructuring
27.2
0.0
0.0
5.1
0.0
0.0
Total
906.10
1,479.2
2,423.9
7,520.5
17,272.4
6,850
* First half of 2008
Investments by Industry (no of deals)
Industry
2003
2004
2005
2006
2007
2008* (HY)
Agriculture / fisheries
0
0
0
1
1
1
Computer related
6
10
8
15
22
6
Conglomerates
0
0
0
0
0
0
Construction
1
1
1
8
11
2
Consumer prod/ servi
0
3
3
20
7
6
Ecology
0
0
0
0
0
0
Electronics
1
2
1
6
16
3
Financial services
8
4
10
39
72
23
Information Tech
6
4
19
28
47
24
Infrastructure
0
3
4
19
13
6
Leis / Entertainment
1
0
7
4
3
1
Manufac – heavy
3
6
18
23
13
17
Manufac – light
1
0
2
4
1
2
Media
2
2
0
6
5
2
Medical
6
8
20
22
28
15
Mining & metals
0
0
0
6
10
3
Retail / wholesale
0
3
2
6
9
5
11
5
3
22
21
15
Telecommunications
1
3
8
6
23
11
Textiles & Clothing
0
2
10
13
11
5
Transport / distribut
3
3
18
34
30
17
Travel / Hospitality
0
0
7
9
9
8
Utilities
1
4
6
11
9
7
51
63
147
302
361
179
Services non-fin
Total
Select PE transactions in 2007
Investee
Ind
Amt $
mn
%
Investors
Computer Age Mgmt services
Computer
related
90.0
Advent Intnl Corp / South East Asia
Venture Investment (SEAVI)
ICSA (India)
Computer
related
22.0
Goldman Sachs (Asia)
Infotech Enterprises
Computer
63.9
Divya Sree Developers
Construction
100.0
TPG-Axon Capital LLC
Jaypee Infratech
Construction
815.3
ICICI Venture Funds Mmgt Co.
Punj Lyod
Construction
198.7
Avenue Capital / Blackstone / DKR Oasis
/ Kingdom capital / Warburg Pincus
Soma Enterprise
Construction
102.9
India Reit Fund Advisors
Heritage Foods
Consumer
products
8.9
Carlyle Asia India
BGR Energy Systems
Electronics
32.6
4.0
Citi group Venture Capital Intnl
Havell’s India
Electronics
112.1
11.2
Warburg Pincus India
Sudhir Gensets
Electronics
65.0
15
GE Commercial Finance; Goldman Sachs
AK Capital Services
Fin services
9.1
13
Global Technology Investments LLC
Anand Rathi Securities
Fin services
22.7
19.9
Citi group Venture Capital Intnl
Angel Broking
Fin services
37.
12.5
IFC (world bank group)
ARCIL (Asset Reconstruction)
Fin services
13.7
9.2
Ankar Capital Management LLC
Bombay Stock Exchange
Fin services
79.8
8.0
Atticus Mgt LLC; Caldwell Asset Mgt,
Urbana Corp
13.0
General Atlantic LLC
(contd) Select PE transactions in 2007
Investee
Ind
Amt $
mn
%
Investors
CDSL Central Depository
Fin services
4.1
5.0
Croupier Private Equity Partners
Centurian Bank of Punjab
Fin services
41.6
5.3
ICICI Venture Funds Mgmt Company
City Union Bank
Fin services
18.7
12.5
Argonaut PE, Blue River Capital, FMO
(Netherlands Devpt. Fin Company)
Delhi Stock Exchange
Fin services
10.3
20.0
Kuwait Privatization Project Holding Co.,
New Vernon PE, Noor Financial Invst Co,
Passport Capital
Future Capital Holdings
Fin services
23.5
10.0
Och-Ziff Capital Mgmt Group
HDFC
Fin services
649.9
5.6
3 Logi Capital
ICICI Bank
Fin services
598.3
2.9
Dubai International Capital
IDFC
Fin services
185.9
10.0
Khazanah Nasional Bhd.
India Infoline Investment
Fin services
76.4
22.5
Orient Global Pte.
Karnataka Bank
Fin services
36.2
5.0
IFC (world Bank)
Karvy Stock Broking
Fin services
44.0
IFC (world bank)
Magma Leasing
Fin services
15.0
FMO Netherlands Devp. Fin Corp.
M&M Financial services
Fin services
6.6
1.4
Chrys Capital Mgmt. Co
Mahindra Forgings, Mauritius
Fin services
4.9
10.0
Promethean Investments LLP
Manappuram General Finance &
Leasing
Fin services
11.8
30.0
India Equity Partners; Sequoia Capital
Limited
National Stock Exchange
Fin services
345.0
15.0
General Atlantic; Goldman Sachs; SAIF
Partners
(contd) Select PE transactions in 2007
Investee
Ind
Amt $
mn
%
Investors
Religare Enterprises
Fin services
15.6
5.0
Merrill Lynch Global Principal Inv.
Shriram Transport Finance
Company
Fin services
82.1
5.7
Infinite India
SKS Micofinance
Fin services
11.3
IDFC Private Equity Co.
Spandana Spoorty Innovative
Financial Services
Fin services
12.0
Blue Ridge Capital; IFC; UTI Venture
Capital Funds Mgmt. Co.
YES Bank
Fin services
48.6
5.0
Khazanah Nasional Bhd.
Intelenet Global Services
IT
200.0
100.0
Blackstone Advisors India; Intelenet
Global Services Mgt. Team
RT Outsourcing Services
IT
7.9
Motilal Oswal Venture Capital Advisors
V Soft
IT
10.4
iLabs
Ansal Properties – SPVs
Infra
29.4
49.0
IL&FS Investment Managers
B. Seenaiah & Company
Infra
38.4
7.0
Amansa Capital Pte; IDFC; L&T Capital
Company; L&T Infrastructure Finance;
Lehman Brothers
Indu Projects
Infra
33.9
Citigroup Venture Capital Intnl.
KMC Constructions
Infra
35.0
Baring Pvt Equity; ICICI Venture
Patil Infrastructure Holdings
Infra
56.7
26.0
One Equity Partners
Ramky Infrastructure
Infra
28.3
13.5
IL&FS Invst Managers; Sabre Capital
Sea King Infrastructure SKIL
Infra
500.0
26.0
Future Capital Holdings
Subhash Projects
Infra
61.4
20.0
Citigroup Venture Capital Intnl.
(contd) Select PE transactions in 2007
Investee
Ind
Amt $
mn
%
Investors
Aparna Constructions
Real Estate
100.0
JP Morgan Asset Mgt
DLF Assets
Real Estate
400.0
DE Shaw India Advisory Services
DLF Assets
Real Estate
200.0
Lehman Brothers
Emaar MGF Land
Real Estate
100.0
QVC Realty
Real Estate
100.0
IL&FS Investment Managers
Shriram Properties
Real Estate
100.0
Infinite India
Vatika Group
Real Estate
254.8
10.8
Beacon India Advisors; Goldman
Sachs; Wachovia Capital
Firstsource Solutions
Services
22.4
42.0
6.0
4.5
Galleon Partners;
SUN Group
Apollo Hospitals Ent
Health
103.5
12.0
One Equity Partners LLC
Fortis Healthcare
Health
20.0
3.2
TCK Advisors (Trikona Capital)
GVK Biosciences
Health
25.5
Sequoia Capital
Max Healthcare Institute
Health
74.0
IFC (World bank)
Great Offshore
Shipping
40.8
5.0
Carlyle Asia India
Quipo Infrastructure Equip
Infra renting
34.0
31.0
GIC Special Invsts Pte; IDFC PE
Vandana Luthra Curls &
Curves (VLCC)
Health care
11.3
Bharti Artel
Telecom
2013.5
5.0
Temasek Holdings Advisors India
Bharti Infratel
Telecom
1000.0
10.0
AIF; Citigroup; Goldman Sachs; India
Equity Partners; Dubai Invst Corp; etc
1.5
JP Morgan Asset Mgt; & others
Indivision Investment Advisors
(contd) Select PE transactions in 2007
Investee
Ind
Amt $
mn
%
4.9
Investors
Dish TV India
Telecom
63.0
Indivision Investment Advisors
Hutchison Essar
Telecom
25.0
Reliance Telecom
Telecom
346.5
5.0
DA Capital; Fortress Capital; Galleon
Partners; GLG Partners; HSBC Principal
Invsts; New Silk Route; Soros Fund
Tata Sky
Telecom
56.5
10.0
Temasek Holdings Advisors India
Gokaldas Exports
Textiles
165.0
70.1
Blaackstone Advisors India
Mudra Lifestyle
Textiles
3.3
S. Kumars Nationwide
Textiles
82.0
10.0
Citigroup Venture Capital Intnl
BLR India
Transport
11.3
31.0
Reliance Private Equity
DRS Logistics
Transport
22.7
First Flight Couriers
Transport
26.7
Ocean Sparkle Limited
Shipping
18.0
Reliable Autotech
Shipping
4.6
17.0
BTS Investment Advisors Private
Adani Power
Utilities
229.6
8.0
Tano India Advisors
KVK Energy & Infrastructure
Utilities
26.0
Lanco Amarkantak Power
Utilities
8.0
Moser Baer Photo Voltaic
Utilities
100.0
IDFC Private Equity Co
SIDBI Venture Capital; SBI
Kotak Investment Advisors
27.7
Temasek Holdings Advisors India
India Equity Partners
Old Lane, LP
5.8
International Finance Corporation (IFC)
CDC Group; GIC Special Investments
Pte; IDFC PE, IDFC Company
Select PE transactions in 2008 (first-half)
Investee
Ind
Amt $
mn
%
Investors
Ashoka Buildcon
Construction
180.3
15.6
IDFC PE Co.
Nagarjuna Construction
Construction
50.0
3.2
Blackstone Advisors India
ICOMM Tele
Telecom
12.4
Tano India Advisors
Parag Milk Foods
Food items
14.1
Motilal Oswal Venture Capital
Mahindra & Mahindra Fin service
Fin services
105.6
Totem Infrastructure
Infra
7.4
Mahindra & Mahindra
Manufacture
172.4
Maithan Ispat
Manufacture
18.5
Shakti Pumps (India)
Manufacture
0.2
Anil Printers
Media
7.4
Apollo Hospital Enterprises
Medical
13.9
Gland Pharma
Medical
30.4
3 Logi Capital
Healthcare Global Ent
Medical
20.0
Premji Invest
Parabolic Drugs
Medical
7.0
BTS Investment Advisors Pvt.
Sai Advantium Pharma
Medical
20.0
12.0
ICICI Venture Funds Mgmt. Co.
Punj Lloyd Upstream
Metals
30.0
12.0
IFC (world bank)
DLF Assets
Real estate
450.0
11.2
Standard Chartered Private Equity
Aquarius Investment Advisors (India)
3.7
Goldman Sachs (India) LLC
IL&FS Investment Managers; Orix Corp
9.1
Mayfield
Tano India Advisors
1.9
Apax Partners India Advisors
Symphony Capital
Select PE transactions in 2008 (first-half)
Investee
Ind
Amt $
mn
%
Investors
Maytas Properties
Real Estate
153.3
Infinite India Investment Management
Vaishnavi Group
Real Estate
28.0
Actis Capital LLP
Shriram EPC
Services
3.5
1.1
Asiabridge Fund, Bessemer Venture
Partners, Chrys Capital Mgmt. Co., ICICI
Venture Funds Mgt. Company
Aditya Birla Telecom
Telecom
640.0
20.0
Providence Equity Partners
Bharti Infratel
Telecom
250.0
2.5
KKR Asia
TV 18 Home Shopping Network /
HomeShop 18
Telecom
10.0
25.0
SAIF Partners
Reid & Taylor (India)
Textiles
209.6
25.4
GIC Special Investments Pte.
TVS Logistics Services
Transport
25.1
ACME Tele Power
Utilities
100.8
3.4
Jacksons Heights Investments, Monsoon
Capital LLC
KLG Power
Utilities
50.1
20.0
TPG Growth, LLC
Shree Maheswar Hydel Power
Utilities
24.0
Sophia Power
Utilities
403.8
Goldman Sachs (Asia)
Henderson Equity Partners
37.5
DE Shaw India Advisory Services
Select PE Exit transactions in 2007
Investee
Amt $
mn
Deal
%
Seller
Investor
Nagarjuna Construction
Company Ltd
16.4
2.1
ICICI Venture Funds
Mgmt. Co. Ltd
Indian investors
Punj Lloyd Ltd
54.5
2.2
Standard Chartered PE;
Temasek Holdings
Chinese Investors
Godrej Beverages
53.9
51.0
Godrej & IL&FS
The Hershey Co. (US)
MTR Foods Ltd
100.0
Aquarius Invst;
JP Morgan Partners
Orkla ASA (Norway)
Federal Bank Ltd
10.6
2.2
IFC (world bank)
Indian investors
Sharekhan
118.2
85.0
General Atlantic; HSBC
PE; Intel India
Citigroup VC Intnl
NIIT Ltd
48.4
10.0
Intel Capital (India)
Indian investors
Gammon Infrastructure
17.9
3.5
Och-Ziff Capital Mgt Co.
Gammon Cooling
PVR Ltd
3.2
3.7
ICICI Venture Funds
Calderys (Finance)
Sintex Industries
256.4
25
Warburg Pincus
Indian investors
Apollo Hospitals
30.3
5.3
Temasek Holdings
Indian investors
Aurobindo Pharma
23.2
2.5
Standard Chartered
Indian investors
Subhiksha Trading
18.6
5.0
ICICI Venture Funds
Prudential ICICI
Trinethra Pvt. Ltd
76.8
90.0
India Value Funds
Aditya Birla
Select PE Exit transactions in 2007
Investee
Amt $
mn
New Delhi Television
Deal
%
Seller
Investor
7.7
General Atlantic
Prannoy & Radhika Roy
Welspun India Ltd
5.0
4.3
ICICI Venture Funds
Indian Investors
Deccan Aviation
104.6
20.0
Deccan Aviation, ICICI
Kingfisher Radio; UB
Ocean Sparkle Ltd
18.0
APIDC Venture Capital
India Equity Partners
Thank
you!