The latest survey by Preqin shows India is one of the leading nations in terms of private equity professional by
number. It has more than 1,000 PE professionals and this number is higher than China, Hong Kong, Italy and
During the last bull phase (2005-2008), India has seen a tremendous growth in private equity investments.
Accompanied with robust GDP growth and upward stock market trends, lots of PE funds parked their
investments in India. It led to a huge amount of employment generation in this industry. Better remuneration
and prospects attracted many professionals to private equity sector especially from the fields like banking,
investment banking and consulting. During this period, lots of transaction happened and the main focus was to
source deals, take investment decisions and close the deals. But the recent financial meltdown has badly
affected the PE industry even in India. Lack of leverage and investors’ cautiousness towards alternative assets
like PE have put substantial amount of pressure on the fund raising. But one vital thing everyone is forgetting
that investment is just the starting point of an investment cycle. Value creation in a PE fund actually starts after
deal closing. According to Prof Steven N Kaplan of University of Chicago in private equity investment value
can be created by three ways
a) Financial Engineering
b) Governance Engineering
c) Operational Engineering
An ideal mix of the three ways yields maximum return. The formation of the mix hangs on a lot of parameters
like type of market, team capablities, industry, stage of the company, size and shareholding of the deal etc.
The take home from the last financial crisis says that there is a little room for financial engineering (I’m not
completely denying that financial engineering can’t create value) in long term value creation. More specifically,
the pre-conceived notion in PE buy-out funds that leverage will jack up returns on a going concern basis is no
longer valid in a downturn when cash flows are not able to service the debt . Value creation in excel sheet has
lost its importance. (To quote a funny sentence one of my professor told- “Life starting and ending with excel
will never excel for management graduates”). Now I’m able to realise the strength of the sentence which is
more appropriate for PE professionals in the current situation when the chance of success of financial
engineering is very bleak. So the next step is to tighten your belt and face the music on the shop floor.
Let us look at Indian scenario. I’ve seen lots of PE funds who have no legal presence in India. The Indian
presence is in the form of an advisory firm which does deal sourcing, analysis and asset management. Critical decisions like investment or exit decisions etc is taken by the founder/partner level people. This structure
incentivizes to hire more financial engineers in the team of advisory. But if the people sitting at the top are not
aware of the ground reality of Indian market and the specific industry they invest, then they are creating a big
mess for their future.
Let me narrate a real life story. I met a PE fund which has more than five years of history in India. I introduced
a promoter having an excellent track record in terms of operation, execution and value creation for the
companies he worked and also for his own company. We met two people from that fund who were at Vice
President Level. They are very smart guys graduated from top business schools in India. Just after few
seconds of discussion one guy asked the promoter about the current turn over and the industry he is into. And
surprisingly that is all he wanted. The promoter tried his best to explain him about the business, strategy and
future plan. He then within ten minutes came out with a valuation number saying that his company should try
for a distress sale. I don’t know, I’m quite junior in terms of age to that fellow, but I’m very much shocked. With
current year sales number and knowing about the industry, how a person did the valuation so confidently and
put a proposal of distress sale on the table within no time. The mind set has been developed to become a
number crunching (NC) machine forgetting the ground reality, industry expertise and ultimately without
understanding how an enterprise is being created and expanded to achieve a sustainable business.
It reminds me about one book I read few years back Barbarians at the Gate written by Bryan Burrough and
John Helyar. PE professional are considered to be the new King of Capitalism. A PE fund is like an
intermediary who has the responsibility to safeguard the investments and create return for their LPs. The
money does not belong to the PE fund. In old days, Kings were the owners of the wealth, not the agents. But
the brighter side shows if the fund people assume it is their money, they can do a responsible investment.
Hence the attitude “I’m the investor” is not wrong. The attitude of not going in depth i.e. without understanding
the business model, the revenue and cost model and the future plan for which investment is needed is
absolutely funny. I do agree benchmarking is important, but taking decision using only benchmarks is definitely
a dangerous methodology in private equity. Additionally giving a solution without understanding a problem is
The question is what type of talent the Indian PE industry needs today. It solely depends on what type of fund
it is and what is its objective. For funds which have a short-term horizon (1-3 years say) and wants to be a
passive financial investors need a lot of financial engineers and NC machines. But if a fund has a long term
horizon like infrastructure, distress assets or manufacturing focused funds, then one need to think very
carefully before hiring professionals. If a fund has invested a sizable amount in a railway logistics company
with an investment time horizon of 7-10 years, my own views is that the fund should prefer an Indian Railway Service (IRS) having more than 10 years of experience for the board seat rather than an MBA from a topnotched business school who has never experienced the Indian business environment. That is why private
equity in emerging market has always been a great challenge. Emerging markets are more susceptible to
political risks, regulatory risk and the asymmetry of information. Additionally business network and the most
vital thing i.e local knowledge play a vital role in value creation and growth. Hence there should be two
separate teams for deal making and asset management. Alternatively funds should hire people who possess
the both subjected to the availability.
Doing business in private equity successfully in India is a great challenge. I hope the initial phase of Gold Rush
of capital is over now. The country has seen unprecedented investments in this phase over last five years.
Now it is time we should see some exits and the exit multiples to evaluate the sources of return. But way
ahead, PE industry is going to see a structural change in terms of the quality of professionals. Industry is going
to attract more value-creators on ground/on shop floors rather than on paper/excel sheets. The funds which
will create a long term value are going to survive and will be able to raise future funds from their investors.
Others will be marginalised definitely as their dry powder consumed. It is the appropriate time for the LPs to do
the litmus test of the funds they have invested. They should support funds with team which can create a long
term value in the investee companies, hence a better time-weighted return on their investments.
[The author is the founder of Epsilon Advisor, a boutique investment banking and advisory firm. The
author has worked in PE funds like Eredene Capital, CLSA Capital Partners in India and Singapore.
The views stated in this article are personal.]