VCCircle

Cyrus Driver, Managing Director of a Mumbai private equity firm, starts his regular column Straight Talk.

An overused cliché purportedly coined in the French Foreign Legion, it is quite apt for the coming bear season in private equity. The great bull run of the past five years, which provided multi-bagger exits and open season for PE fund raising, is sadly but surely over and a shakeout is imminent over the next two years.

After the previous stock market crash in 2000-2001 and the quiet years of 2001-2003, consistently rising stock market valuations and an all-pervading optimism among entrepreneurs led to record deal flows and previously unheard of IRRs in PE exits on the stock market. Existing private equity teams raised funds and increased their team size, while many new teams raised their first fund and entered the fray.

Hedge funds became active in classical PE deals and PE teams started investing in public market transactions. Valuations offered by PE players became gradually less conservative and entrepreneurs shed their inhibitions to raise record sums.

Global biggies entered the Indian market and competed for talent and deals. PE professionals saw their salaries and their designations move up in fast-forward mode. Consultants, investment bankers, researchers, industry professionals – all wanted to become PE professionals and many of them did.

And we all had a blast!

Then suddenly, over the past two quarters, someone turned off the music, switched on the lights and shut the bar. Damn! It sure was fun while it lasted.

Those of us that were around in India's PE industry in 2000 will remember how quickly all-pervasive optimism turned to widespread pessimism. As stock market valuations dip and risk perceptions increase, it becomes extremely difficult for an investment professional to convince his investment committee to bet on future upside. What makes the PE investor's task more difficult is the fact that his or her existing portfolio of investments has to be marked down in tune with public market comparables, thus denting his credibility with his investment committee.

Further, deal flow dries up as entrepreneurs think twice about raising funds in an environment of reduced valuations and low business confidence. As deal activity reduces, PE teams
stop hiring and some start firing. Global firms with a short history in India find it particularly easy to shut shop or shrink their teams.
Some of these changes are already visible today. Deal flow has reduced significantly in all segments except infrastructure and pre-IPO deals. Investment bankers, who were earlier too busy to visit the smaller PE funds are now becoming increasingly social. The long list of PE invested companies that were priming for their IPO have reconciled to the fact that the IPO market is virtually shut for the rest of this year and that valuation multiples that were available last year are unlikely to be available in the medium term. Pre-IPO transactions are keeping PE firms busy right now but SEBI's recent moves to remove downside protection clauses in pre-IPO deals
may become a show stopper. Many PE firms have decided to put on hold their hiring plans; I have heard of at least one firm that's downsizing. Teams at the PE arms of bulge bracket investment banks are particularly nervous, and perhaps they should be.

The post 2000 slow down also taught us that persistence pays. The firms that stuck it out and kept investing in the years 2001-2004 reaped the biggest gains from the bull run that followed. Names like CVC, Chryscap, Warburg Pincus stand out in this respect. They used that period of sobriety in capital markets to invest in good companies at reasonable valuations, focusing on business fundamentals and management teams rather than short-term fluctuations of the Sensex. Some of the deals struck in that period – Suzlon, Glenmark, Progeon, India Bulls, WNS, Daksh, Yes Bank, are case studies for PE in India.

It is common sense that investors should invest when valuations are low and sell when valuations are high, yet it takes uncommon conviction to actually do so. India's PE industry undoubtedly has more depth and maturity now than it did in 2000. I have great confidence that this time round we shall see more investors with uncommonly common sense stay active and grease the wheels of growth. As surviving legionnaires in the God-forsaken Sahara desert would testify "if it doesn't kill you, it makes you stronger."