Recently private equity giants Bain Capital and Texas Pacific Group wrote off their investment in Lilliput Kidswear Ltd, an year after the partnership between investors and promoters went sour following a series of allegations related to corporate governance and financial mismanagement.
This is not the first time that there have been issues between PE firms and promoters. ICICI Venture and Premjinvest-backed Subhiksha Trading Services Ltd was another high profile case, where the PE backers clashed with promoters following the company’s hyper expansion resulting in a capital crunch and the eventual shutting down of the company. There were also allegations of accounting irregularities.
In another instance, New Silk Route (NSR) and Baring PE Asia-backed KS Oils saw its stock value plunge on grounds of alleged corporate governance and mismanagement of funds. Delhi-based Baring Private Equity India is in a legal battle with Kochi-based JRG Securities on several issues including control over the management of the stock broking firm, while Temasek and NSR advisors threw out the promoter-management of INX Media.
Morgan Stanley PE’s first and its only investment from Asia- dedicated fund in Biotor Industries, a Mumbai-based biofuel company, also ran into rough weather. The promoters allegedly siphoned off money, and after having issues for almost a year, it filed for corporate debt restructuring.
Such unhappy or inharmonious relationships between investors and promoters naturally raise concerns on how can there be potentially value creation in an enterprise in such situations, which is the basic premise for PE investing if at all. Remember those tall claims by investors — almost rhetoric in nature — such as “we back high quality entrepreneurs in a true partner-like fashion for long lasting value creation to all stakeholders”.
Take the case of Lilliput, which had almost become the poster boy for PE deals, but ended up being in a situation where the investors and the promoters didn’t see eye to eye and there had been no direct communication between both the parties for past many months.
The end result is that the company which was once well run and a showcase investment by its previous investor to its LPs, saw many of its stores being shut down, its market reputation taking a hit. Eventually, it had to file for corporate debt restructuring. The company alleged the investors were trying to stall it’s Rs 850-crore initial public offering and seize majority control while the investors accused the promoter of fudging the books of the company and not providing access to its financials to auditors.
While the inside story is not known, but conversations within the industry circles often turn to why the investors woke up to the “reality” so late although they invested in the company two years back; how come the previous investors did not smell anything fishy or the fact that the company reported a topline of Rs 339 crore in 2010 — at a time when their retail peers were bleeding — should have set the alarm bells ringing.
Of course, such motivations raise natural questions on the due-diligence done by the PE investors. While obviously there must have been diligence performed by the investors, there is now a pressing need to be more stringent especially when Indian private equity is essentially about minority growth investing and the investors are always at the mercy of smart and shrewd promoters.
Secondly, at a time when PE professionals are gearing towards value creation through operational enhancements, they should rather focus on the basics and getting it right — finding clean, trustworthy management teams and make sure that the management is on board from the start. Leveraging proprietary relationships and referral networks to scout for management teams to work with could be a good step in that direction.
However, such homework becomes difficult in a market when PE investors are in a race to put money to work. To top it there are auction deals that now happen to constitute the majority of deal making. Perhaps it’s now time to calibrate investment banks on the basis of deals that they do and block the ones who do bad deals. Well, that is beyond the scope of this article.
Lastly, it’s not about one Lilliput alone. The financial aspects of which would be outdone by both the parties. It’s a bigger question on how the larger institutional investors are looking at us as it’s not hidden from them anymore that the Indian deals market is not as deep as it is made out to be. There is just too much capital chasing a few high quality companies. And such fraud deals on portfolios of large PE funds not only put a question mark on the judgement of the investor, but also the worth of the market as a whole to put money to work. It’s time private equity firms identified growth opportunities others don’t see, vigorously tested the investment thesis, made sure management is on board from the start, thereby building a repeatable model for success themselves.