Fund Raising for Real Estate Opportunities for Chartered Accountants CA Vinit Vyankatesh Deo Chairman & Managing Director Posiview Consulting Partners Group April 2014
Disclaimer The document contains selected information to assist the recipient in making an initial decision to proceed with further investigation. The information contained in document will not constitute or form part of any offer for sale or purchase shares in the Company / Project nor will any such information form the basis of any contract in respect thereof. An investor must rely on the terms and conditions contained in such a contract subject to such limitations and restrictions as may be therein. No representation or warranty, expressed or implied, is given by the Shareholders, Posiview, the Company or any of their respective directors, partners, officers, affiliates, employees, advisers or agents. No responsibility or liability is accepted for any loss or damage howsoever arising that you may suffer as a result of the document and any, and all responsibility and liability is expressly declaimed by the Shareholders, Posiview and the Company or any of their respective directors, partners, officers, affiliates, employees, advisors or agents. Information provided in this document contains forward-looking statements that involve risks and uncertainties. Certain information included in this presentation may contain statements that are forwardlooking, such as statements relating to uncertainties that could affect performance and results of the Company in the future and, accordingly, such performance and results may materially differ from those expressed or implied in any forward looking statements made by or on behalf of the Company. The Company believes that the expectations reflected in such forward looking statements are reasonable at this time, but it can give no assurance that such expectations will prove to have been correct.
Assessing Fund Requirements: Why & When would a Developer need money?
Why do you need money? Land Stage Commencement of Project Growth & Liquidity Token JV Deposit Buying Land To get plan sanctioned For initiation of work For advances to creditors For Construction Many a times the company lets go of several opportunities because of lack of liquidity or Growth Capital. It is important not just to get the money, but to get it at the right time!
Understanding Private Equity: How Private equity has grown in importance
What is a Private Equity Fund Private equity is an asset class consisting of equity securities in companies that are not publicly traded on a stock exchange. A private equity fund is a pool of funds from institutional investors used for making equity investments in various companies according to a fixed investment strategy. At inception, institutional investors make an unfunded commitment which is then drawn over the term of the fund. A private equity investment is generally made by a private equity firm, a venture capital firm or an angel investor. Each of these categories of investor has its own set of goals, preferences and investment strategies.
Assessing Funding Options: Pros and cons of various sources of funds available to developers
Fund Raising Options for a Developer Debt Construction Finance Working Capital requirement Term Loan Post Construction Finance Loan against property Lease Rental Discounting Equity Funding at Land Acquisition Stage (50% stake) Cash Out (after acquisition of land) Equity Funding at Project Level from Venture Capital Fund Equity Funding at Company Level from Venture Capital Fund Initial Public Offering (IPO) Practically, maximum proportion of developers need funds for acquisition of land and as per RBI guidelines, Banks do not provide loan for Land. Posiview Consulting Partners Private Limited 8
Debt Funding Construction Finance Working Capital Requirement Term Loan Post Construction Finance Loan Against Property Lease Rental Discounting Posiview Consulting Partners Private Limited 9
Bank Loan Positives & Negatives Positives Can be secured easily by providing security and sufficient collateral Relatively lower cost than equity funding No need to share profits with the Lender Negatives Limitation on the amount which can be raised In case of slowdown, repayment of principal and interest becomes a burden Bank does not share Project risk Posiview Consulting Partners Private Limited
Equity Funding Land Acquisition Stage Cash Out Project Level and /Or Company Level from Venture Capital Fund Initial Public Offer (IPO) Posiview Consulting Partners Private Limited 11
Understanding Equity Funding : - Various stages at which Private equity funds can bring in money - Understanding the Pros and Cons - The role of SPVs
Land Acquisition stage The Funding at Land Acquisition stage includes the involvement of Investor & Developer jointly for acquisition of land. Separate Private Company need to be formed for stamp purpose in which both the parties will have share depending upon the agreement signed by them. Typically the Investor looks for: Whether the fund is FDI Complaint or Domestic. (The Foreign Investment Promotion Board has set up guidelines for FDI projects). Non-Agriculture Land Whether the land is outright purchase or the Developer will get Development Authority and Power of Attorney. Normally the Investor invest for 50% of the share, however in some exceptional cases it can be more or less than 50%. Posiview Consulting Partners Private Limited 13
FDI Guidelines for Reference FDI in townships, housing and construction-development projects: Conditions: Minimum area be developed under In case of development of serviced housing plots, a minimum land area of 10 hectares (25 acres). In case of construction-development projects, a minimum built-up area of 50,000 sq.mts. In case of a combination project, anyone (above) two conditions would suffice. The investment would further be subject to the following conditions: Minimum capitalization of US$ 5 million (Rs 24 crs) for JV with Indian partners. Investment cannot be repatriated before 3 years. At least 50% of the project must be developed within a period of 5 years from the date of obtaining all statutory clearances. Posiview Consulting Partners Private Limited 14
Cash Out (After Acquisition) The investor reimburses the fully/partially amount invested by developer in land. This is a means by which a developers get back the money already invested in land. A Separate SPV is formed and the land is transferred to that SPV and then later the developer takes out money from the SPV. The decision for cash out depends upon the credibility of the builder and market Value of the land and the potential to generate the return, i.e., future cash flows. Posiview Consulting Partners Private Limited 15
Entity Level Vs SPV Level Particulars Entity SPV Amount Returned after 3 Years Whether Company has to Return Amount Exit of the investor is through a listing on the stock exchanges Not Necessary. Investor can exit form listing on Stock Exchange or selling his stake to a Third party. Exit to Investor Yes. Compulsory for the Company to return this amount. What is the Advantage Since the initial capital does not go out of the Company, the Company s financials and cash flow become strong There is a pressure on the Company to return the amount with IRR of around 25%. Posiview Consulting Partners Private Limited 16
What is a Special Purpose Vehicle (SPV) A Special Purpose Vehicle (SPV) is a new Private Limited Company formed for the purpose of a specific Project. The SPV can also be a Partnership or a Limited Liability Partnership (LLP). However Foreign Direct Investment (FDI) is not allowed in such case. In this case usages of funds given by an investor is for the specific project. Based on the valuation of the project, the equity in the SPV will be given to the investor so as to generate a minimum of the required IRR Post completion of the project, the profits will be distributed between the equity investors as agreed and the Company will be closed. Posiview Consulting Partners Private Limited 17
Venture Capital/Private Equity Positives & Negatives Positives Investor shares the risk of the Project Enables Company to raise additional Debt Funding Market perception of companies having equity financing is generally better Negatives Relatively high cost of capital over a long period of time. Private equity needs exit avenues over a period of time. Additional compliance requirements and public scrutiny of companies accessing public markets. Would want to get involved in some key management decisions. Posiview Consulting Partners Private Limited 18
PE Funding Benefits & Responsibilities Benefits Responsibilities Long Term Funds; Increased Shareholder Value; Diversified Equity Base; Liquidity Premium to Shares; Higher Market Visibility; Attract and Retain Talent. Disclosure Requirements; Promoters Holding diluted; Corporate Governance; Transparent Reporting; Shareholder Expectations; Increased Regulations; Restrictions on transfer of shares.
Evaluating your funding options: Comparing the impact of various avenues of funding in the light of distinct parameters
Impact of Fund Raising Options Parameters Debt (Construction Finance) Private Equity (Project level) Private Equity (Entity level) IPO Cost of finance 14 18% per annum 22% + per annum 22%+ per annum Return on market performance Return of Principal and Interest Yes Yes No No Term Short Term 2-3 years Short Term 2-3 years Medium Term 3-5 Years Long Term Permanent Industry / Market perception High Debt companies are not perceived well Project Risk is shared with the Investor Creates a Market Value for the Company Increases visibility and brand value Posiview Consulting Partners Private Limited 21
Getting familiar with the concept of IRR: Understanding the impact of Cash Flows using illustrations
What is Internal Rate of Return (IRR) The concept of IRR is based on the fact that the cash that you receive today is more valuable than the cash you receive two years down the line or anytime in the future. Suppose an investor invests Rs. 150 Cr in your project. The Table below indicates the amount that has to be paid back to the Investor in addition to the principal of Rs. 150 Cr. If we agree on 22% IRR and return the money after 4 Years, then we have to give a Pay Out of Rs 239 Crs (including Dividend Tax) in addition to the Principal. Period of Investment (Years) Internal Rate of Return (IRR) Amount (in Rs. Cr.) 10% 15% 18% 22% 25% 3 84 117 138 169 193 4 107 157 190 239 278 5 133 203 252 324 386 Posiview Consulting Partners Private Limited 23
Why Cash Flows matter & Why is IRR so important? More than Profits, it is the IRR that attracts funds! The reason is that IRRs are based on the cash flows of the project and hence take into consideration the time value of money. Let s take an illustration to see the importance of IRR. You are presented with the following two options to invest your money in which project will you choose? Time Period Project A Project B 0 (1,000,000) (1,000,000) 1 450,000 250,000 2 400,000 300,000 Investment made 3 350,000 450,000 4 300,000 450,000 5 250,000 450,000 Net Cash Flow 7,50,000 9,00,000 IRR 25% 23% Although the cash flows from Project B exceed that of Project A, IRR of Project A is 25% while the other has an IRR of 23%.
Understanding IRR difference using Affordable Vs Premium Project Premium Project (Amount in Rs. Cr.) Inflow Year 0 Year I Year II Year III Total Promoter Contribution 7.50 - - - 7.50 Amount from Customers - 4.50 6.75 11.25 22.50 Total Inflows 7.50 4.50 6.75 11.25 30.00 Outflow Year 0 Year I Year II Year III Total Land 7.50 - - - - Construction - 1.35 2.70 2.70 6.75 Overheads - 0.34 0.08 0.34 0.75 Total Outflows 7.50 1.69 2.78 3.04 7.50 Investment made in acquiring land. Cash Balances Year 0 Year I Year II Year III Total Opening Cash Balance - - 0.50 0.50 - Net Inflow / Outflow - 2.81 3.98 8.21 15.00 Drawings - 2.31 3.98 8.71 15.00 Closing Cash Balance - 0.50 0.50 - - IRR 34%
Affordable Project (Amount in Rs. Cr.) Inflow Year 0 Year I Year II Year III Total Promoter Contribution 7.50 0 - - 7.50 Amount from Customers 0 22.50 13.50 9.00 45.00 Total Inflows 7.50 22.50 13.50 9.00 45.00 Outflow Year 0 Year I Year II Year III Total Land 7.50 0 - - 7.50 Construction 0 11.25 9.00 2.25 22.50 Overheads 0 2.03 2.03 0.45 4.50 Total Outflows 7.50 13.28 11.03 2.70 27.00 Investment made in acquiring land. Cash Balances Year 0 Year I Year II Year III Total Opening Cash Balance 0-0.49 0.49 - Net Inflow / Outflow - 9.23 2.48 6.30 18.00 Drawings 0 8.73 2.48 6.79 18.00 Closing Cash Balance - 0.49 0.49 0.00 0.00 IRR 68% With the same amount of investment, an affordable project given higher returns over the same time period!
What do Fund Managers look at before investing? Understanding various assessment parameters that Private Equity investors use. This needs a few answers from you
1. Company background / History How long have you been into existence? Do you have a established a track record? What projects do you have to showcase? How quality conscious are you? 2. Financials Do you have timely debt repayments? Your creditors matter a lot! How strong is your balance sheet? 3. Management & Execution How strong is your management team and your organizational structure? How disciplined a company you are in managing your day to day records? Can you prove your project execution capability? How time bound and cost effective are you in your construction?
4. Promoters How efficient and visionary are the promoters? How flexible and open to ideas are they? How comfortable are the promoters towards partnering with someone and sharing data on a regular basis? Would the promoters be willing to be disciplined in simple things like board meetings and regularly tracking the projects? Would the promoter be fine with justifying delays in timelines or cost to a partner? A Private equity investment is not just flow of funds but a meeting of minds.
5. Project For a Real Estate Company, ultimately it boils down to the project! Location Cash Flow visibility Returns / IRR
PE Funds - Priorities Criteria Bank Funding PE Funding/IPO Track Record High Low / Medium Management Medium High Past Financials High Medium Product / Service Low High Corporate Governance Low High Market Size & Growth Low High
Getting ready for funding: Partnering with a Private Equity Fund is about taking your organization through a change
Need For Readiness Several Entities like Regulators, Advisors, Auditors etc. are involved; Time-bound steps are to be taken; Company s Operations and Records become transparent; Financial and Intangible Penalties. Stage 1 Stage 2 Stage 3 Stage 4 Strengthen the Company Financial & Legal Readiness Manage the Funding Process Post Funding Precautions Company has to be fully ready and prepared to face the outside World.
Strengthen the Company Stage 1 Stage 2 Stage 3 Stage 4 Strengthen the Company Financial & Legal Readiness Manage the Funding Process Post Funding Precautions Strengthening management team, board of directors and advisory board; Protect Intellectual Property; Steps to increase the Valuation of the Company to increase the bargaining power; Forming Joint Ventures, Collaborations; Marketing Agents,Offices etc; Corporate Brand building.
Financial & Legal Readiness Stage 1 Stage 2 Stage 3 Stage 4 Strengthen the Company Financial & Legal Readiness Manage the Funding Process Post Funding Precautions Corporatisation of business; Consolidation of all businesses; Divesting non-core, low value business; Accounting and Financial Systems; Past Financial and Operational Information; Regularising defaults, if any. Create a Core Group consisting of Financial Advisor, Auditor, Finance Head & CEO to handle the process.
Managing the Funding Process Stage 1 Stage 2 Stage 3 Stage 4 Strengthen the Company Financial & Legal Readiness Manage the Funding Process Post Funding Precautions Identification of Investors; Data Compilation; Assistance in Selection of various agencies; Support services during Due Diligence; Restatement of Balance Sheet, Profit & Loss Account to confirm to legal requirements; Assistance in drafting of Information Memorandum (PE) / Prospectus (IPO); Co-ordination with Merchant Bankers, Auditors, Legal Advisors. Track the Process Regularly.
Post Funding Precautions Stage 1 Stage 2 Stage 3 Stage 4 Strengthen the Company Financial & Legal Readiness Manage the Funding Process Post Funding Precautions Market & Key Investor Relations; Assistance to Finance Department in Regulatory & Reporting requirements; Financial Forecasts for Analysts and Investors; Management of Issue Funds; Improving Operational Efficiency; Project Monitoring. Remember: All your Actions will be in the Public Domain
Understanding the investment Process: Deal making, structuring and exit
The Investment Process Pre Funding Fund Raising Post Funding Industry Analysis Business Plan Draft Financial Projections Legal Structuring Investor Identification Deal Structuring Valuation & Negotiation Documentation Closure Disbursement System & Process Setup Internal Audit MIS Internal Control
What is a term sheet? Term Sheets are brief preliminary documents designed to facilitate and provide a framework for negotiations between investors and developers. A term sheet generally focuses on a given enterprise s valuation and the conditions under which investors agree to provide financing. The term sheet eventually forms the basis of several formal agreements including the Stock Purchase Agreement, which is a legal document that details who is buying what from whom, at what price, and when.
Managing valuation expectations Discounted Cash Flow based Valuation Based on the present value of the future cash flows of the project.. Relative Valuation Based on the current market price/agreed price of the land to be acquired. Factors on which Valuations depend: Ultimately, Cash Flows of the project are being valued. If the Project has very clear visibility of upcoming cash flows, it would fetch good valuation. Risker the project, lesser the valuation. There is lot of dependency on the philosophy of the investor as well. Valuations are done based on assumptions and logical calculations. At the end it is negotiation that brings the actual valuation on the table. More importantly there are trade offs. The money required today and the money required tomorrow are valued differently. It is important to understand that Real estate is not a very standardized industry till date. Valuations are based on several explicit and implicit factors. Different developers may get different valuations on the same piece of land based on their credibility and past track record!
Various Structures prevalent Waterfall Structure Distribution waterfall is a hierarchy delineating the order in which profit of the project will be distributed. The order in which the profits are distributed between the private equity fund and developer are fixed beforehand. Usually the fund gets a higher proportion in the beginning until a certain IRR is achieved and gradually the proportion of the developer increases. Fixed IRR The fund gets a pre-decided IRR on the basis of which it gets returns irrespective of the upside that that the developer gets on the project. Minimun Fixed IRR + Upside There can also be structure wherein the Private Equity partner is promised a minimum IRR and is also a partner in the upside. This would usually happen in a project where the fund is taking higher risks. No IRR Commitment Here the fund comes in without any IRR commitment and this is a pure partnership wherein the profits are distributed as per the share of each party in the project. The distribution however can be structured as per pre-decided manner.
Exit Issues Management Buyout Management buys out the stake of the Equity partner and give it an exit with the expected returns. Issue: Cash availability with the management Strategic Sale Entrance of a strategic acquirer through a merger or acquisition (M&A) Issue: Finding the right buyer wherein the fund and promoter both agree. Secondary Sale Sale of the stake to another Private Equity firm. Issue: Agreement of both the parties. IPOs Listing of the company of the stock exchange. Issue: Reluctance of the promoters to go public Liquidation In case of SPVs, liquidation is common. Issues: Marketing & Sales Strategy Funds wants steady cash flows and expect the strategy in accordance whereas the promoters might be willing to wait. Black money/cash transactions prohibited
Pune Shyamala, 2nd Floor Behind Vidya Bank, Off Senapati Bapat Road, Pune 411016 Contact Person : Vinit Deo Email: vinit@posiview.in Phone : +918975761062