In the recent past, there are many instances of ugly public spats between the investors and owners of the businesses. These incidents, widely covered and reported in media, bring the focus back on the quality, strength and longevity of relationship between funds and its investments.
Since the evolution of private equity investing in India, there have been many reported (and unreported) examples of friction and litigation between the investors and investees. Without getting specific in to any of such disputes, it is good to discuss and debate the possible ways and practices to avoid such situations and grow relationship from strength to strength during the investment period.
First of all, let me say that it is never an easy relationship. I often say PEVC investments are like marriages with agreement to divorce in a stipulated time. Moreover, the terms of divorce (exit clauses) are laid down at the engagement stage (term sheet) itself much before the marriage (shareholder agreement) has happened.
So how do you manage the relationships when you both parties are sure to split in typical timeframe of five-seven years? I don’t think there is a set formula as each investor, entrepreneur and investment is unique. There is no way to mitigate the risk of friction in the investment period but there are ways to probably minimise it. Here are some of my learnings from managing an active portfolio:
In general, most entrepreneurs and Investment bankers are in a hurry to raise the money when they approach investors. This leaves less quality time for investors to evaluate the entrepreneurs and merits of transactions. In some cases, even funds have pressure to deploy money in a relatively shorter time frame because of defined investment period timelines. In such situations, funds end up outsourcing significant part of diligence efforts, which ideally should be done by the fund team.
A hurried deal always throws challenges in the longer term. My experience is that minimum 6 – 12 months prenup relationship is probably needed for investors and promoters to understand each other. Both need to first understand whether they can work together for next five-seven years and if yes, they need to find alignment in terms of growing the business together and developing a mutually acceptable exit plan.
Longer courtship offers opportunity to investors to monitor the company for three-four quarters and evaluate execution capabilities. Investors can also use this period to interact with key employees, customers, bankers and vendors of the company. Likewise, entrepreneurs can judge their investors capabilities and connect with their network.
The longer pre-investment period is possible only when investors have the habit of tracking potential investments and when promoters are in no hurry to close the deal. I often advise young entrepreneurs to raise money when they don’t need to so that they choose investors rather than reluctantly going with someone.
I think the best way for investors to win trust from promoters is to constantly demonstrate value-add right from the beginning of investment period and in some cases from the day you have known the promoters. Most entrepreneurs are constantly seeking help in developing markets, forming JVs, raising more money, hiring team, accessing technology, etc. These are the areas where investors have a definite role to play. The “value add beyond just capital” is key to engage with promoters and make them accountable to your money and time.
Entrepreneurs are always smarter than investors but the outside-in view that investors bring to the table is often respected by the promoters. Also investors need to keep working on demonstrating the need and role of governance, financial control and process in building value and get promoter buy-ins rather pushing it down their throat from the day one.
I admit that this is easier said than done. Investors are always under dilemma of when to motivate and when to discipline entrepreneurs. In the matter of conflicting opinions, It is often good to have debates but without interference of personal egos.
The elasticity of investor-investee relationship is tested to the core in difficult times. There is a good chance that every investment will go through at least one difficult phase in five-seven years. In difficult times, the key is speed, transparency in communication and ability to jointly work out a plan to get over it. Investors’ broad-based relationship with promoter group/family as well as key employees also helps in anticipating and solving issues.
Without sounding pedantic; investor’s ability to stand together with the company and jointly addressing the situation is a mark of maturity of the relationship.
These are some of the ways to establish positive, resonating and long-lasting relationships in the investment period. I am sure there are many other approaches and it is good to have more tailing questions rather than conclusive answers around this topic.
(Hemendra Mathur is Managing Director at SEAF India Investment Advisors.)