Different Forms Of Private Equity Funding

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1 Different Forms Of Private Equity Funding Raj Shroff Founder, Director - Aarayaa Advisory Services Presentation to WIRC 7 th January, 2012

2 Contents Why do companies need funds? When is equity financing preferred? Forms of Private Equity Funding Recent Trends General Process Valuations Structures and Instruments Exit Options Advantages and Disadvantages Important factors for consideration PE at crossroads 2

3 Why does a company need funds? Capital Expenditure Plant & Machinery Land & Building Working Capital Fund Based Non Fund Based Retiring Debt Term Loan Repayment Expansion Vertical New Product Lines / New Segment Geographical Operations in International Markets Acquisition Finance Leverage Buy-out Management Buy-out 3

4 When is equity financing preferred? Over leveraged Ideal for start ups Equity Financing Inconsistent cash flows Difficult to meet interest commitments 4

Forms of Private Equity Funding Stages of Business Mature Business SME s Mid - Large Business Ideas Micro Business Incubation Funds by Promoters Family & Friends, Angel

5 Forms of Private Equity Funding Stages of Business Mature Business SME s Mid - Large Business Ideas Micro Business Incubation Funds by Promoters Family & Friends, Angel Investors & Venture Capitalist Venture Capital, Private Equity & Mezzanine Capital Markets / Private Equity & Mezzanine Buy Out Funds/ Capital Markets Types of Private Equity Funds 5

6 Recent Trends in PE Volume Value (US$ Bn) HY1 09 HY2 09 HY1 10 HY2 10 H1 11 HY1 09 HY2 09 HY1 10 HY2 10 H1 11 PE QIP Total Source: Grand Thornton Deal Tracker 6

7 Recent Trends in PE - Sectorial Breakup For H Source: Grand Thornton Deal Tracker 7

8 Recent Trends in PE - Performance of various funds Expansion / growth capital accounts for 46% of total deals of 2011 Big trends for 2011 was surge in start-up/early stage deals from 18% of total in 2010 to 33% of total in 2011 Source: Economic Times on 6 th January,

9 Angel Investor Provides seed funding Usually affluent individual providing capital for business start-ups Different from venture capitalists Limitation on amount of money that can be raised Bear high risk Require very high return Investment holding period of <5 years 9

10 Transactions (Illustrative) 10

11 Venture Capital Typically occurs after seed funding stage Subset of private equity Venture capital consists of investing in equity, quasi equity and/or conditional loan in order to promote unlisted, high risk or high tech firms driven by technically or professionally qualified entrepreneurs. Finance companies that have demonstrated extraordinary business potential The risk anticipated is very high Follow the concept of high risk, high return Year 2011 is record year for early-stage Venture Capital investing Deal values & volumes at all time high Euphoria around e-commerce, across mobile, internet and related verticals Evident from recent deals of InMobi, Fashionandyou, Snapdeal Exit in MakeMyTrip touted as poster deal for domestic venture industry JustDial, One97 Communications and others lining up for exit over coming months 11

12 Venture Capital Sector Majorly in emerging sectors Early Stage Funds start up & early expansion Key Driver - Innovation Highly skilled professionals, scientist & innovators with innovative business idea, new product & new technology Investment & Exit Upto $10 mn, exit through strategic sale or IPO Success High mortality rate & few great success 12

13 Transactions (Illustrative) 13

14 Private Equity Equity investments in relatively mature, primarily unlisted companies requiring growth capital An asset class that involves value enhancement and high returns generation by sharing business expertise of the Investor complementing the Entrepreneur Typical value additions from the PE Fund House could include Strategy Formulation Financial Formulation, Expertise and Global/Domestic Networks (including other investee companies) Offer greater opportunity to exercise control over investments as compared with other passive asset classes like equities, mutual fund, real estate, commodities, fixed income Active involvement and influence on the company, including board seat Each investment is backed by an investment thesis which plays out over a period of 3 to 5 years Private Investment in Public Entities (PIPES) 14

15 Growth Stage Private Equity Success Investment & Exit Few failures & great success Key Driver - Innovation From $5 mn to $500 mn, exit through IPO Growth Stage Capacity expansion, new products, new geography etc. Sector Investor funds at growth stage of the company All growth sectors 15

16 Transactions (Illustrative) 16

17 Buyout Funds Globally most important strategy of PE; though not a very prevalent strategy in India Generally buyout s done at matured stage of business Mature companies with leading market position, active management team, strong cash flow Taking a controlling stake in the company through leveraged buyout (LBO) or through management team alongside the PE fund (MBO) PE funds provide capital for expansion, promoters / corporate divestures, succession issues Development of a business plan over 4 to 6 years in order to add value Revenue growth + Margins improvement + deleveraging = added value 17

18 Transactions (Illustrative) Company Financial Investor Value (US$ Mn) Type Flextronics Software Systems Kohlberg Kravis Roberts & Co. 900 LBO GE Capital International Services (GECIS) General Atlantic Partners, Oak Hills 600 LBO Phoenix Lamps Actis Capital 29 MBO Nilgiris Dairy Farm Actis Capital 65 MBO WNS Global Services Warburg Pincus 40 MBO Infomedia India ICICI Venture 25 LBO Nirula s Navis Capital Partners 20 MBO Gokaldas Export Blackstone 165 MBO Paras Pharmaceuticals Actis Capital Sequoia Capital N.A. MBO 18

19 Mezzanine Debt / Structured Product Mezzanine financing is provided by mezzanine funds and sometimes hedge funds Finance as Debt instrument / structured product like partly or optionally convertible instruments etc., immediately subordinated to equity Mezzanine financing might include, besides coupon bearing debt, an equity sweetener as well Considered as debt instrument with very high yield which at times in substitution of equity Returns generated by the fund are Interest fixed rate or fluctuate along an index (e.g. LIBOR) OR a pre agreed IRR Upside potential through Equity Illustrations: 19

20 Sector focused funds Real estate funds Focus on investments in real estate and real estate intensive businesses Infrastructure funds Roadways Port projects Railway projects Power projects Telecom Logistics 20

21 Key Differentiators Particulars Stage Level of risk Assessment Focus Investment Size Angel Investors Very Early Very High Mostly Technology < $ 1 Mn Venture Capital Early High Mostly technology < $ 10 Mn Private Equity Growth Moderate Diversified > $ 10 Mn Buyout s Mature Moderate Diversified > $ 50 Mn Mezzanine All stages Moderate Diversified > $ 5 Mn 21

22 General Process Stage Preparation Investor Identification Term Sheet Final negotiations and Closing Timing 3-4 weeks 3-5 weeks 4-6 weeks 4-6 weeks Total Time weeks Process» Understanding and evaluating historical performance» Recast of Historical numbers; if needed» Preparation of IM and Projections» Identify target Investors» Share Information» Follow-ups» Promoter Meetings» Plant visits» Negotiate valuations and other terms of the transaction» Due Diligence» Definitive Agreements» Pre & Post Closure formalities» Industry Overview Sign NDAs Sign Term Sheet Sign Definitive Agreements 22

23 Valuations Peer/ transaction Multiples Revenue EBIDTA PAT NAV DCF Willing Buyer Willing Seller 23

24 Structures and Instruments Primary Investment Involves fresh infusion of capital in the company against issue of fresh shares to augment future growth Ideal for growth companies Secondary Investment Involves payment to existing shareholders of the company Could be either on account of buying out or providing some liquidity to existing shareholders Ideal when promoters wants to cash out (fully or partially) or buyouts 24

25 Structures and Instruments Private Equity Investment Primary Investment Secondary Investment Direct Equity Convertible Preference Shares / Debentures Warrants / Options Equity Purchase / Earnouts 25

26 Exit Options Three important pillars Valuations Timings Restrictions, if any to exit Modes of exit Initial Public Offering (IPO) Exit via M&A Sale to another investor Secondary sale on stock markets Buy Back / Call / Put Option Nature of Exit Volume Value (US$ Mn) Volume Value (US$ Mn) Initial Public Offering M&A , Open Market 69 1, , Secondary Sales Buyback , Total 103 2, ,045 Source: VCEdge 26

27 Advantages Fills funding gaps for long term capital No interest cost. Seeks return through capital appreciation rather than immediate and regular interest payments Adds value because, apart from funding, PE contribution includes: Financing expertise and strategic management support Networking and Global Integration Confidential as compared to IPO or even debt funding Independence of the capital markets volatility Positive signaling effects to the market: Debt, IPO M&A Employees, Suppliers and Customers Increases Industry Visibility Corporate Governance Relatively less expensive fund raising exercise in comparison to IPO 27

28 Disadvantages Raising Private Equity finance is demanding, time consuming; at times the business may suffer if promoter devotes more time for the transaction Depending on the investor, promoters may lose a certain amount of power to make management decisions Will have to invest management time to provide regular information for the investor to monitor Might create conflict or differing opinion in long term strategy due to pressures of EXIT from the investor The cost of complying with regulations could be relatively higher Non alignment of Interest of fund manager on the board and entrepreneur could hamper the growth of company 28

29 Important factors for consideration Growth Potential Exit Market Positioning Returns Management Bandwidth Stage / Sector / Structure Historical Performance Project Period Competitive Scenario Industry Trends 29

30 PE at Crossroads PE operating in a challenging environment today Difficult fund raising environment A large number of India focused funds were raised during Many of these are due to raise their next fund Funds with dry powder putting monies to work in environment beset with intense competition Tremendous competition amongst funds to win deals resulting in bid war Expensive entry valuation continues to frustrate Investments by real estate funds have reduced - slowdown in sales & high borrowing cost continue to plague the sector Value of funds raised and announced ($ Mn) Number of funds raised and announced ,853 Announced ,828 Announced Particulars Funds Announced Funds Raised ,111 Raised 2,024 Raised Source: Economic Times on 6 th January,

31 PE at Crossroads (contd.) Deep inventory of future exits in the PE pipeline PE exits will take a lot of PE manager s time, energy and bandwidth Approximately 68% of PE deals made through boom years of remain in PE funds portfolios Now reaching the upper end of their investment holding periods, many of these holdings should soon be coming up for sale PE exits account for only 20% of PE activity in 2011, indicating strong potential for M&A transactions in the coming years. Also reflected in increased preference towards exit through M&A route. More than 100% rise in instances of exit through this option in 2010 over 2009 Source: Economic Times on 6 th January, 2011 Funds will look to learn from past and spend greater time on deal evaluation and make investment decisions based on merits rather than sentiments PE firms also expected to spend considerable time on their portfolio management as holding periods have been stretched 31

32 PE at Crossroads (contd.) Motivation for PE players to provide high yield debt finance continues to grow. Such endeavors undertaken to cater to all investment needs of promoter, debt & equity Increased activity in PIPES deals Volatile capital markets in 2011 Conventional fund raising options for listed companies not available New Takeover code provides a boost for PE funds Greater number of listed companies expected to source growth capital needs from PE Early stage investing is in the limelight & will continue to gain momentum Deals in cloud computing, clean technology, online commerce and technology enabled services such as mobile & online advertising, analytics and data management business will continue to attract Venture Capital funding Strong growth potential for Venture Capital, Buyout funds and Pre-IPO / late stage placements 32

33 Thank You Raj Shroff Founder, Director Aarayaa Advisory Services Pvt. Ltd. Cama Building, 1 st Floor, 24/26 Dalal Street, Fort, Mumbai , India D: M: T: F: E: raj@aarayaa.com Barcelona Cardiff Cascais Chicago Dősseldorf Milan Paris Porto Southfield Stockholm Toronto Zurich

36 th National Convention of Company Secretaries. Global Meltdown Challenges & Opportunities Private Equity Industry Perspective

36 th National Convention of Company Secretaries Global Meltdown Challenges & Opportunities Private Equity Industry Perspective November 7, 2008 State of Private Equity Industry Issues arising from Global