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When investors clash with promoters

12 December, 2012

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.

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BHARAT KANANI . 5 years ago

Write offs are part of PE/VC game, PE/VC Investors should be bold enouph in accepting the fact that they and their support agencies i.e. DD agencies were not able to understand the Promoters and business model whre they are investin. Foreign VCs considers such incidents as part of their Lessons learnt.

Dr. Kishore . 5 years ago

It was rightly said if a Bank doesn’t have any non-performing loans, it is not assuming any risk and is not fit to be in the lending business. Similarly, PEs should be capable of assuming risk and if that includes writing-off of few of their investments, so be it. But the measure should be the degree than the aspect itself. The degree could be a percent of their overall investments, a percent of investment in an industry or sector, a percent of their returns during the fund tenure etc.,

Nevertheless, such write-offs are not a concern for Indian investors at this stage since not many retail or institutional investors in India have considerable investments in PE baring very few. Least said, for investee companies, it is not at all a concern.

Nishant Kr Singh . 5 years ago

Shrija – Great Post, as usual. PE funds have raised money from the LPs to invest in clean companies and they better do their job well. You are very right that instead of focusing on operational enhancements, they should first try and get the basics right..

anoop . 5 years ago

This a nice article.PE fund sit in the board of these companies. They get their salary, bonus etc for monitoring the company.But unfortunately in Indian PE industry how many professional are competent enough to do so.They are just in a mode of deal closing and loose interest thereafter and look for another deal. They don’t expect carried interest. Do a survey on PE professional and see how many have managed an end to end life cycle investment. This short sight will instigate them to do sub-optimal deals by increasing valuation initially, favourable terms and conditions for promoters by forgetting the interest of their LP.Then sitting on the board and passing/consenting every decision acting on behalf of the promoters. In return what they get, luxury flats, Bentley cars, cash !!! This is now a very well known fact to LPs about Indian GPs.There should be an investigation carried out by the Government to save this private equity in India.

Karthik . 5 years ago

@Anoop: That’s right, Government is the solution to the problem of corruption

When investors clash with promoters

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