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Finding The Exit

Over the long term, no doubt, the underlying fundamentals of a changing India will support the case for burgeoning PE/ VC investments

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The upside potential for Private Equity (PE) and Venture Capital (VC) investment in India is enormous.  The PE and VC industry has consequently developed rapidly in size and sophistication.  The year 2017 saw a record level of new private investment in the country, at $27 billion according to VCCEdge, the data system of  NewsCorp VCCircle.  

Yet skepticism about India as a destination for PE/VC investment remains widespread among international investors.  They not only cite the complexity and risk of doing business in India, they also point to the poor average returns achieved by PE/ VC investors in India to date.  There have indeed been prominent ten-bagger exits, and no doubt there are some India funds which have achieved excellent returns for their Limited Partners (LPs).  The general perception internationally, however, has been that India funds have not been exiting enough investments profitably to underpin the story of tomorrow’s promise.

An excellent analysis of historic exits by Indian PE/VC funds by VCCEdge supports this cautious view.  Since 2003, funds have invested $183 billion in India but only achieved exits of $66 billion.  Only in one year (2005) did exits marginally exceed investments. The year 2017 did see an increase of exits to 276 deals, realising $11.5 billion.  However, that still represented an In to Out ratio of 2.3.

As the PE/VC industry grows, one would initially expect to see more capital invested than realised.  At the fund level, not all investments will succeed and many will take time to turn profitable.  Nevertheless,   enough must be winners in order to yield an attractive return overall.  For the industry, over the long term, the excess of investment over exits cannot continue if new money is to be attracted by opportunity India.  PE/ VC funds need to demonstrate IRRs in excess of say 15-20 per cent otherwise the risk and cost of this type of investing is unjustifiable.  Other markets (including China) have so far demonstrated better returns, so without a better record in India, capital will tend to be allocated elsewhere.  

I have previously argued that the PE/ VC industry in India remains immature in a number of respects.  Too many investment decisions appear to be skewed to the latest hot sector leading to high valuations at the point of investment after banker-led bidding.  Too few funds have demonstrated the ability to support their investee companies in improving and growing their businesses.  No doubt these weaknesses will be addressed as the industry develops.  

In addition, I hear views in the market that some India funds seem unrealistic in exit valuation expectations, preferring to hang on longer in a rising market.  Cynics would add that holding investments longer maintains management fees, traditionally two per cent per annum of funds invested.  

The reality is that fund lives will eventually force exits.  A restructuring of the VC/PE industry seems likely as those funds and teams with demonstrated track records are able to raise fresh capital in greater quantum, while others with poorer records cannot.  

Over the long term, no doubt, the underlying fundamentals of a changing India will support the case for burgeoning PE/ VC investments.  Economic growth, better governance and the easing of business complexity will reinforce a positive view of India as an increasingly attractive investment destination, which will in turn be confirmed by growing numbers of profitable PE/VC exits.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.


Alan Rosling

The author is an entrepreneur and strategic adviser. He co-founded Kiran Energy and was earlier an Executive Director of Tata Sons. He was a Special Advisor to the British Prime Minister during 1991-93. He now lives in Hong Kong but is frequently in India. He is the author of Boom Country? the New Wave of Indian Enterprise.

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