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What do Limited Partners want from Indian private equity fund managers: Results of an exclusive VCCircle survey of global LPs

20 May, 2013

The Indian private equity market is currently going through one of its biggest crises ever since it started in the 1990s. In the late 90s, a lot of Indian VC firms had to write off money owing to the dotcom bust. Now many PE firms are not able to raise fresh funds nor some of the entrepreneurial managers were able to raise capital because of a lack of confidence by limited partners in the Indian PE asset class.

For one, Indian PE funds have not been able to show as many exits as its other emerging market counterparts like China or Brazil. Many of the investments made in 2007-08 are under water.

So there is:

1. An ever-increasing overhang of assets waiting to be sold

2. The continued pressures to return capital to LPs

3. Diminishing chances to profitably exit from big holdings from the boom-year vintages.

The inability of GPs to exit profitably was further compounded by the depreciation of Indian rupee against dollar. To make matters worse, Indian GPs had spun out a little too often, which made LPs see it as a “betrayal of trust” or a “failure of alignment” than an “evolution of the industry” in most cases.

Consequently, limited partners are showing increasing caution when allocating funds here. The total fund value allocated to India was only $3.5 billion in 2012, down from $6.8 billion in 2011, according to London-based LP tracker Preqin.

So, is it only negative for Indian private equity?

No. A VCCircle survey of over a dozen foreign institutional limited partners with significant exposure to the region suggests that India remains an important market to them and the good news is that nobody is saying “No to India”. That said, LPs realize that India is not a beta play and they need to cherrypick fund –managers based on their track record.

A majority also believed that the public reputation of Indian PE is bad with almost 100% of respondents agreeing that the contraction in the Indian PE industry is almost probable and necessary. As balance of power shifts to LPs, there were also some interesting responses seen on what should be the ideal management fee structure for Indian PE funds. LPs also shared their views on aspects like: do they prefer allocating capital into Indian PE spin-outs; their return experience from Indian PE; do they mean to increase or decrease their allocation to the region or the key barriers for Asian LPs as they start or consider expanding their commitment to Indian PE among others.

So, what do LPs really want?

– GPs who could repeat or institutionalise success

– GPs who could build consistency, legacy and an institutional framework for repeatability

– GPs who could incentivise the team well for a long-term alignment

– GPs who have “desire to be successful” than only being “transaction oriented”

– GPs who have good infrastructure for effective LP communication

The scenario would look much better with Indian PE fixing these missing blocks as there is a scent of optimism to be seen both on the fundraising side and on the opportunity side—valuations are getting reasonable (at least PE investors are taking cognizance of the same); multinationals are looking to divest their Indian businesses, first-generation entrepreneurs are willing to let go of their businesses and so on. Plus the fact that many established GPs have proven themselves to be winners that deserve to attract additional capital and that private equity is the best-performing asset class for most LPs over any long-term horizon will bring about a new wave of Indian PE going forward.

VCCircle brings to you a survey of over a dozen LPs who have an exposure to the region to better assess their expectations going forward. Download the report here (You need to be a premium account subscriber to get the report; if you would like to sign up for a premium account, click here).


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5 Comments
varadha . 5 years ago

Exits are not happening because a lot of businesses that PE funds invested into were not worthy of investments in the first place – the surest indicators of that are Return on Equity and Free Cash Flows. Now, that expected and historical growth rates have moderated, I would be hard pressed to name more than 20 businesses that are PE funded which even have an RoE of more than 20% and are free cash flow positive. That is why, there exists a significant difference between the “market valuation/inherent worth” and “self-perceived valuation” of these assets.

Institutionalizing success at a GP level comes about only through the three pillars – strong capital allocation, sensible (not over the board understanding) of operational levers to enhance return on capital and corporate integrity (reporting material events). Too much emphasis has been paid on operational hand-holding with scant regard to the other two – if you pick an inherently unprofitable business like retail, aviation, radio cabs, e-commerce, no amount of operational intensity is going to help salvage the investment – sort of like a good coach working very hard on a dud ward. No amount of hard work is going to help him come up the curve. Shareholder value gets created only by profitability and growth in bottomline – not just growth in the topline and market share.

LPs ought to maintain an arm’s distance from GPs and take clear, objective decisions – things like being on the boards of portfolio companies, acting as an operational advisor to them are inherent conflicts of interests. Is the LP assessing the GP or assisting the GP ? How well equipped are LP’s to asssess GP’s in the first place – do they have a sense of capital allocation – viz., what creates profitability and hence shareholder returns ?

LPs have to start forming their own, independent, data driven opinions about what is working and what is not. Relying on just reports by GPs and valuation/statutory audit by friends of promoters/GPs and sitting in denial is only going to exacerbate the problem. It is a pity that this playing around with Other People’s Money is going to have a long term effect on the India story itself.

Improved governance and reporting are going to be the need of the hour even to ascertain how deep the impact is.

Anoop . 5 years ago

The biggest problem in Indian PE fund GPs is Ethics. They want Day-One-Carry rather than long term carry. There should be a proper investigation of assets and wealth of these GPs to substantiate unscrupulous nexus between the promoters and the fund managers.Unless and until this is exposed and this root cause is eradicated, LPs will not look at India so positively. The GPs in India about 90% are paper tigers who don’t understand the ground reality in India and don’t have time to understand the business. They are just greedy about their personal gain and Day-One-Carry !!!

Phoenix . 5 years ago

Well said Varadha. This comment of your is unclear, ” LPs ought to maintain an arm’s distance from GPs and take clear, objective decisions – things like being on the boards of portfolio companies, acting as an operational advisor to them are inherent conflicts of interests”. Also this statement is debatable, ” if you pick an inherently unprofitable business like retail, aviation, radio cabs, e-commerce, no amount of operational intensity is going to help salvage the investment…..”. I believe there will be a new slew of real talented GPs who understand how to respect “other people’s money” in coming years. I come across GPs who show off about how much salary they can blow. A SERIOUS LP needs to study GP cost structure and cut off hubris. They WON’T. I see GPs socialize with management and get “paly”. Directors don’t always care enough. So its all a club. Some GPs are power point experts with little experience. Others are sales/ marketing experts (” just growth in the topline and market share”)not risk experts. Even then your conclusions on ROE / cash flow and market valuation is rightly debatable. This is a tough business. LPs need to break the club of GPs who run a 2% business. They won’t.

Varadha . 5 years ago

Phoenix

LP’s are managing your money and my money – so they ought to maintain an arm’s length and review GP’s objectively. Things like being on the board of the invested companies, helping them out should be a strict “no’. Does the RBI governor Mr. Subbarao sit on the boards of say a HDFC or an ICICI ? There are instances of that happening – if there is trouble in the portfolio company, should the LP ask for an explanation or give an explanation. As long as it is other people’s money, no one cares – any rocking leads to the entire pack of cards to fall. So, everyone – LP, GP, management live in denial about valuations and the worth of the business and what you get is the ultimate, aam aadmi shareholder not getting anything.

I do not believe that India still has the environment for turn-arounds. Think about Warren Buffet’s quote ” When a management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact”.

Empirically, I have not see too many build-out deals that have succeeded – there have been cases of spin-off, buy-out. I always prefer to focus on data oriented decision making.

On GP’s emerging who will respect other people’s money, we will have to see – the only thing that matters in delivering value in the long term is focus on FCF and RoE. That requires a mindset to think like an investor – not like a “deal maker”.

Murali Apparaju . 5 years ago

Interesting surmises!

What makes the takeaways less validated however is the lack of disclosure or at least a categorization of the LPs surveyed**. This gap I felt more acutely for a few like the question # 9 the response pictorial of which indicates that 50% of LPs surveyed will put money in PE/ VCs that’re focused on investing in growth-stage enterprises – this averaged-out response doesn’t allow one to assess if this is the response of each LP sub-set falls within this range or if some LP sub-sets deviate from the mean significantly.

I also felt a lot of the questions were overtly leading & that could skew the responses in favor of the inherent bias/ prejudice in the question (for e.g. 10 & 11..)

And yeah, the sliver-lining… It warmed my cockles that LPs have acknowledged of the promise of Healthcare Industry in India & the candid confession that ‘no body’s saying no to India’ – phew, that’s a relief.

**I realize it’s possible this can be done still from the data available OR it has already been done… only I couldn’t see it in the downloaded report.

What do Limited Partners want from Indian private equity fund managers: Results of an exclusive VCCircle survey of global LPs

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