While Indian Private Equity (PE) players continue to have significant capital to deploy in the country’s emerging businesses, the deal landscape in India is definitely changing with new regulations, challenges and opportunities in sectors and at certain times, with the potential conflicts in expectations between the PE investors and the investee companies.
In my view, robust due diligence prior to investing in India has always been important but possibly, becoming even more critical for PE investors before taking investment calls. Some of the critical/watch-list areas (these are indicative and not an exhaustive list) that need to be focused upon during the due diligence phase of PE deals are:
Integrity/background of promoters: While PE funds do integrity/background check on promoters, the importance and depth of such checks may need to be enhanced, given the increased risks of corporate governance. The integrity due diligence should not only focus on the background of the promoters in terms of litigations/questionable corporate actions but it should also focus on entrepreneurship background and past businesses.
Foreign Corrupt Practices Act (FCPA) / Ant-Bribery risks: Given the US Rules on Corrupt Practices and the UK Anti-Bribery Rules, Foreign PE Funds operating in India need to comply with these Regulations. Due Diligence should focus on the anti-corruption and bribery governance structure and analysis of suspect and questionable transactions.
Human Resources (HR)/management team diligence: It has been often seen that promoter-led companies are significantly dependent on the promoters and the management teams are often not robust. Due diligence on the current management team including the promoter, which should cover areas like management style, senior management compensation, experience, background, gives a solid insight for the PE funds on the execution capability of the management team.
Quality of earnings: Growth is good but earnings are better. Diligence should focus on the quality of historical earnings and identify potential adjustments due to accounting matters, one-off items and sustainability issues. It is critical to assess whether the business EBITDA is 15 per cent levels or is it actually 5 per cent levels. In my view, apart from valuation, earnings quality gives a significant insight into the overall business quality as well.
Cash flows and frequency of cash transactions: Focus should be on assessing the underlying cash flows of the business and the cash-generation ability. In India, in certain sectors, the quantum of cash transactions is high and due diligence should focus on assessing the quantum of cash transactions and the mechanism to track and monitor cash transactions.
Tax structuring and tax position: Focus should be on assessing tax exposures and cash flow implications. Moreover, with the recent Budget amendment on overseas share transfer linked to asset in India, PE funds may have to consider additional tax costs as part of doing deals in India.
Net debt position: Focus should be on assessing the debt position, interest costs and potential net debt items like off-balance sheet liabilities, tax exposures, etc. These should be identified and captured to arrive at the net debt position.
While doing deals in India provides significant growth opportunities, the potential landscape and dynamics in India are surely becoming challenging and some of these key challenges need to be identified during the due diligence phase.
(The views expressed here are personal and not the views of the organisation).
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