The perception of India as an investment destination has significantly improved with the roll-out of big-ticket reforms like the Goods and Services Tax and the Insolvency and Bankruptcy Code. Major reforms related to foreign direct investment in sectors such as defence, construction, insurance, pension, broadcasting, single-brand retail and civil aviation have helped, too.
These reforms reiterate the government’s commitment to streamlining the regulatory environment and making it easier to do business in the country.
In recent times, various domestic private equity funds and their investors, or Limited Partners (LPs), are entering into collaboration in the form of “co-investment”, which presents a favourable scenario for both sides.
Examples of co-investments in India include a joint venture between Brookfield Asset Management Inc. and State Bank of India for distressed assets; the acquisition of a stake in Mankind Pharma by ChrysCapital, GIC and Canada Pension Plan Investment Board; and Resurgent Power Ventures Pvt. Ltd, a platform created by Tata Power Co. and ICICI Venture, raising capital from Kuwait Investment Authority and State General Reserve Fund of Oman.
There are various advantages of co-investing. It helps LPs improve returns by reducing the fee cost as they do not have to pay any incremental management fee to the General Partners (GP). It provides PE funds with the flexibility to execute large transactions. It also allows the target to partner with its choice of fund in the event a PE fund has limited capital but can invest only with support from the LPs. Besides, it aids LPs who don't have sufficient knowhow for investments in certain jurisdictions to collaborate with domestic PE funds.
Highlighting the growing trend of co-investing, the India Private Equity Report 2018 by Bain & Co. indicated that most investors expected to offer more such opportunities to LPs in 2018. The Global Limited Partners Survey, 2018, conducted by the Emerging Markets Private Equity Association, indicates that LPs are forming fewer new GP relationships but appear committed to expanding their co-investment and direct investment programmes in emerging markets.
There are a number of steps involved in the process of co-investment transactions. These include sourcing, due diligence/evaluating, closing and consequential monitoring and exit. For sourcing, the PE fund can seek to access a co-investment deal through its existing relationships and/or proactively source opportunities outside of its core relationships. LPs may not want to conduct due diligence on the target and may rely on the PE fund. After due diligence, the co-investors typically set out the terms of investment governance framework in the legal documents so as to avoid any conflict in future.
While co-investment offers myriad benefits, there are certain issues which have the potential to create hassles.
For instance, investment by LPs directly into a target that the PE fund is considering investing may affect the returns to the PE fund in the event such investment yields good returns and the PE fund’s investment allocation was reduced to allow direct investment by the LPs.
Concerns can also arise whether the PE fund has a bias in allocating its own capital to attractive deals and is only offering less attractive deals to the LPs. There might be potential conflict of interest in cases where the LPs invest directly in the companies engaged in competing businesses carried on by the portfolio companies of the PE fund.
Many LPs do not have the staffing or infrastructure to commit and manage the co-investment in a timely manner. When LPs invest through a fund, it gives them exposure to a web of underlying companies. However, co-investing involves investing directly into a single target. This may lead to a portfolio concentration risk for LPs.
There is little doubt that co-investments offer attractive opportunities for both the PE fund and the LP. But care should be taken to align the interests of the co-investors as closely as possible to avoid potential conflicts and to ensure that the co-investors get the benefit of the bargain they have sought.