CAIIB ABFM Module D Unit 3 : Private Equity and Venture Capital

Table of Contents

CAIIB Paper 3 ABFM Module D Unit 3 : Private Equity and Venture Capital (New Syllabus) 

IIBF has released the New Syllabus Exam Pattern for CAIIB Exam 2023. Following the format of the current exam, CAIIB 2023 will have now four papers. The CAIIB Paper 3 (ADVANCED CONCEPTS OF FINANCIAL MANAGEMENT) includes an important topic called “Private Equity and Venture Capital”. Every candidate who are appearing for the CAIIB Certification Examination 2023 must understand each unit included in the syllabus.

In this article, we are going to cover all the necessary details of CAIIB Paper 3 (ABFM) Module D (EMERGING BUSINESS SOLUTIONS) Unit 3 : Private Equity and Venture Capital, Aspirants must go through this article to better understand the topic, Private Equity and Venture Capital and practice using our Online Mock Test Series to strengthen their knowledge of Private Equity and Venture Capital. Unit 3 : Private Equity and Venture Capital

Introduction

  • Investors contribute venture capital, which is a form of private equity as well as a type of finance, to new enterprises and start-up organizations that they believe have the ability to expand their operations over the long term.
  • The majority of funding for new businesses comes from wealthy individuals, investment banks, and various other types of financial institutions.
  • Nevertheless, it does not always take the form of monetary compensation; rather, it may also be supplied in the form of specialized knowledge or managerial experience.
  • Small businesses with outstanding growth potential, or businesses that have expanded rapidly in the recent past and appear to be in a position to continue their expansion, are the traditional recipients of venture capital.

 

  • It is possible for a young private, firm that is not yet ready or willing to access the public financial market, to look into obtaining venture capital.
  • Venture capital fund anticipate a high rate of return on their investments.
  • The industry of venture capital has only recently reached a certain level of maturity and sophistication, particularly in the United States,during the course of the past half century or more.
  • Private equity is a word that is frequently encountered in business contexts.

Why does VC Exist 

  • It is a result of the existing deficiencies in bank lending.
  • Visiting a bank is the typical first step for someone who is interested in beginning a new enterprise.
  • However, banks will only provide financing to newly established companies if those companies already possess tangible assets to use as collateral for the loan (e.g., a factory).
  • However, in today’s information economy, many new businesses have little tangible assets, making it difficult for them to obtain a bank loan.
  • Additionally, the risk involved in starting a new business is rather significant.
  • The risk level is so high that even if financial institutions were willing to lend, they would have to apply interest rates that were so prohibitively expensive that no one would take out the loan.
  • Venture capitalists flourish in the high-risk environment that traditional financial institutions avoid.
  • They are willing to provide financial backing to very new businesses that have no assets and likely to do business with people with little or no prior expertise as well.
  • Instead of providing financial assistance in the form of a loan, the investors demand a share of the company as compensation for the risk they are taking, so that they can take a greater percentage of the upside, which means they can get a portion of the profits that will be made in the future.
  • Another distinction is that the word “bank” simply refers to money. However, venture capital consists of financial backing in addition to strategic guidance on how to create enterprises, making it more beneficial to business owners.

Characteristics Of Venture Capital Investments

The following is a list of the most important aspects of a venture capital arrangement, although there are no standard terms and conditions that apply to venture capital companies.

High Risk, High Return:

  • Investors in venture capital are typically willing to take on a high level of risk in the hope of achieving a high rate of return on their investment.

Control:

  • The venture capitalist not only provides the aided company with funding, but also takes an active interest in leading the company.

Shareholders:

  • The venture capitalist will often make a subscription to stock or quasi-equity financing instruments, which gives it the opportunity to partake in both the risk and the profit of the company in which it invests.

The financial burden that is placed on the aided company is often minimal in the early years of the partnership. 

Exit Strategy:

  • The venture capitalist typically has an exit strategy in place for his or her investment in the business being aided after 3 to 7 years.
  • In most cases, the promoter of the company, that is receiving assistance, has the first option to purchase the equity investment that is being held by the VC.

Characteristics Shared By Private Equity And Venture Capital, As Well As Their Key Distinctions

The following is a list of characteristics that are shared by private equity and venture capital:

  • They are established as autonomous pools of capital, to which contributions may be made by institutions or high-net-worth individuals, and they are managed by managers who have significant financial incentives directly connected to the funds’ levels of success.
  • They make investments in businesses that are either unable or not yet prepared to raise funds from members of the general public.
  • There are not many restrictions placed on the activities they engage in.
  • Equipped with carefully drafted investment agreements, they engage in active oversight of the enterprises in which they have invested.

Some distinctions that can be made between private equity and venture capital are as follows:

  • A private equity investment might be used by the investee company to restructure either its finances or its operations.
  • In contrast to venture capitalists, private equity investors typically put their money into established businesses in their later stages of development that have a proven track record.
  • Private equity investors place a greater premium on good corporate governance, whereas various venture capital investors devote more of their attention on management capability.
  • A private equity investment deal may incorporate debt, which is unusual for a venture capital investment deal.

Financing Options Available Through Venture Capital

The various forms of venture capital can be categorized according to the stages of a company’s development in which they are most useful.

The following are the three primary forms of venture capital financing:

The following is a list of the many forms of financing based on the stages of business development: 

The Procedures Involved In Obtaining Venture Capital Funding

In most cases, the financing of venture capital is accomplished through the following six primary steps:

Advantages and Disadvantages Of Venture Capital Funding

The following are some of the benefits that come along with financing through venture capital: 

  • The investor will receive a significant amount of wealth and expertise from the investment, despite the fact that the investment is time consuming and fraught with risk.
  • The amount of funding that can be delivered through equity is enormous.
  • The business owner is in a less precarious situation because there is no responsibility for the company to repay the investor’s money. This is because the investor is well aware of the risks associated with the project.

The following is a list of the drawbacks of financing through venture capital: 

  • The procedure is drawn out and difficult because there is a significant amount of risk involved.
  • The founder loses his or her independence and control of the business after an investor becomes a part owner.
  • Since the investments are made with a long-term objective, the return of the earnings is often delayed.
  • Both the potential for the investment’s purpose and the return on investment are undetermined and uncertain

Examples Of Venture Capital Financing

  • One of the top-tier alternative investment asset managers in the world, Kohlberg Kravis & Roberts (KKR), has entered into a definitive agreement to invest USD150 million (roughly equivalent to Rs. 962 crore) in Mumbai-based listed polyester maker JBF Industries Ltd.
  • The company intends to purchase a 20% ownership in JBF Industries and will also make an investment in zero-coupon compulsorily convertible preference shares with 14.5% of voting rights in its wholly owned subsidiary JBF Global Pte Ltd, which is situated in Singapore.
  • The financing that is being provided by KKR will assist JBF in finishing the projects that are currently underway.

Pepperfry.com 

  • The most recent funding round for India’s largest furniture e-marketplace was led by Goldman Sachs and Zodius Technology Fund, and it brought in a total of 100 million dollars.
  • Pepperfry plans to utilise the cash to increase the size of its fleet of delivery vehicles, which will allow the company to increase its presence in Tier III and Tier IV cities.
  • In addition to that, it plans to extend its network of carpentry and assembly service providers as well as build new distribution centres.
  • This represents the highest amount of capital ever raised by a company in India that is solely focused on the e-commerce sector.

The Importance Of Private Equity And Venture Capital For New Businesses

  • Due to the fact that their options are limited, entrepreneurs and small businesses that are just getting started often choose to work with venture capitalists.
  • They are not in a position to raise funds through the stock market due to the numerous conditions that must be satisfied before a company can launch an initial public offer or become a listed company.
  • On the other side, entrepreneurs would also prefer venture capital investments over loan financing because the latter places on them a significant amount of responsibility to pay interest, which is especially problematic for young businesses that are not yet profitable.
  • But why is it considered a short-term investment to engage in venture capital?
  • Typically, venture capitalists invest for a period of five years; after that, when the company has reached a substantial size or stature, the venture capitalists sell their ownership and make returns that are multiples of their initial investment.
  • In most cases, this takes place during a time in the development of the business when the company is in need of additional funds and is eager to raise more capital.
  • This may occur if the startup decides to sell its shares to additional investors or if it goes public in the market by way of an initial public offering (IPO).
  • At this point, investment bankers are brought in, which paves the way for the owners to execute their exit plan.

Indian Venture Capital Firms

The companies listed below are among the successful venture capital firms in the country: 

Blume Ventures: 

  • Established: 2010
  • By Karthik Reddy and Sanjay Nath.
  • They presently have $280 million invested in over 150 startup businesses as part of their portfolio and have 24 exits.
  • These include popular platforms such as Dunzo, Unacademy, Instamojo, and Milkbasket, among others.

Kalaari Capital: 

  • Kalaari Capital is an early-stage, technology-focused venture capital firm.
  • It invests across Seed and Series A startups
  • Empower visionary entrepreneurs to build unique solutions that reshape the way people live, work, consume and transact.
  • Created: 2006 in Bengaluru by Vani Kola.
  • This venture capitalist is responsible for managing a portfolio that is currently worth $650 million.
  • Among these are companies such as Cure.fit, Milkbasket, CashKaro, and Zivame, among others.
  • They have already left some well-known organisations, like Myntra and Snapdeal, among others.

Nexus Venture Partners: 

  • Founded: 2006,
  • Nexus was one of the first India-US venture funds started by successful entrepreneurs in enterprise technology and consumer
  • Nexus has been a pioneer of investing in global technology products and technology-led businesses for India.
  • Nexus Venture Partner has offices in both the United States and India.
  • The present portfolio managed by the organization is worth more than US$1.5 billion.
  • Zomato, Snapdeal, Delhivery, WhiteHat Jr., Delhivery, Rapido, Unacademy, and Olx are some of the significant companies in which they have invested.

Roles At a VC

  • Analysts: Those with the least experience.
  • These individuals are either folks who have recently graduated from school or MBA students who are participating in an internship.
  • Primary responsibility: To attend conferences and to look for business opportunities that might fit inside the framework of the investment thesis of the fund being managed by the venture capital firm.
  • They also undertake research on the market and analyse potential business opportunities and also look at the competitive environment to help the decision makers at the Venture Capital Fund take proper and informed decisions.
  • Associate: Comes immediately following the analyst post.
  • An associate may either be junior or senior depending on their experience.
  • People who arrive with a financial background and significant skills in creating relationships are typically the types of people who are considered associates.
  • Associates at a company do not participate in the decision-making process, but they may surely make a good first impression on those who are responsible for making decisions.
  • Even if they are senior members of the company and have the ability to make choices when it comes to investments, they do not have complete control over how the company puts its overall plan into action.
  • A principal can get you in the door and act as your guide to help you receive funding by bringing you through the full process.
  • Principals: are persons who are on the cusp of becoming partners in the company.
  • They hold a position of authority inside the company, yet they cannot
  • be ranked among the most senior employees of the company.
  • Partners: are considered to be the most senior members of a venture capital firm, placing them a tier above principals.

There are two types of partners:

  • The difference between these two titles is determined by whether the individual only has a say in the decisions pertaining to investments or whether they also have the ability to weigh in on operational matters.
  • In addition to making investments, partners are responsible for bringing in new financial backing for the money with which the company will be working in the future.

General Partners 

The actual management of the fund is often handled by experienced investment experts who have a history of successful performance. And they have to juggle a number of different jobs:

  • Arrange capital: They raise capital by contacting potential limited partners (LPs) and selling them on the fund’s concept (they also actually make a deck like startup founders do). And, if everything goes well, possibly get some cheques from them.
  • Invest: They need to find new companies to back (a process that venture capitalists refer to as “Deal Flow”), investigate those companies (known as “Due Diligence”), and finally put money into those companies (obviously by writing a cheque).
  • Grow: Now that they have invested in these new businesses, they are providing whatever assistance they can in order to assist the companies in growing. It might be anything from strategy to the recruitment of staff to referrals to possible business partners or even investors for the subsequent round of funding.
  • Exit: The GPs will either try to take the company public by means of an initial public offering (IPO), sell it to another company by means of a merger and acquisition (M&A), or sell it to another investor (Secondary sale). At this stage, they begin to generate revenue, which is then distributed to limited partners (LPs).

Terms Of V C Funding and Its Structure

Illustration:

  • Rajan is a seasoned financial professional staying in USA for the last 30 years. He believes that there is the opportunity to establish enormous businesses in India. As a result, he intends to establish a fund that will invest in and contribute to the growth of enterprises.
  • Because Rajan doesn’t actually have any money, his role as general partner (GP) now requires him to seek funding from limited partners (LPs). Therefore, what are the specifics that need to be laid forth for an LP by him?

Fund Size 

  • What is the total amount that Rajan hopes to garner support for? $50M or $500M.

Fund Theme 

The topics that Rajan will be concentrating on are as follows: 

  • Which industries will he be investing in (such as healthcare or direct-to-consumer brands, software, for example)?
  • At what point in the company’s development? The Seed, the First Series…
  • Which regions would those be? (South Asia, India, Southeast Asia…)

Hurdle Rate 

  • This is the minimum annual return, measured as an internal rate of return (IRR), that Rajan is required to guarantee for LPs.
  • If the fund is unable to achieve this rate of return, it is considered to be unsuccessful (and a lot of VC funds fail).
  • Rajan constructs a financial model in Excel in order to compute the anticipated returns and determine the required rate of return.
  • The barrier rate will be affected both by the sectors that are the primary focus and the stage of investment.
  • For example, the Direct-to-Consumer (D2C) industry generates a smaller return than the Software-as-a-Service (SaaS) industry does because of the disparity in their cost structures; yet, the D2C industry will have a lower hurdle rate.
  • It is possible that a fund that focuses on seed-stage deals will have a higher barrier to entry than a fund that invests in series B companies.

Fund Life

At the conclusion of each fund’s 7–10 years’ life span, the capital must be distributed back to the limited partners who invested it.

Within the allotted amount of time, Rajan must achieve a rate that is higher than the threshold rate

  • During the first two to three years of his work, Rajan focuses on locating and investing in new businesses.
  • Building those businesses will take the next three to four years
  • During the last two to three years, Rajan shall attempt to exercise the “exit” option and earn a profit.

Deal Structure 

  • Even while the LPs are aware that venture capital is a high-risk investment, Rajan still needs to demonstrate what precautions he will take to mitigate the negative effects of the risk.
  • Investing in the startup company in the form of preferred equity rather than common equity is one strategy to accomplish this goal.
  • Preferred equity provides venture capitalists with a higher preference than common stock does for the sale of a company’s assets and technology in the event that the startup is forced to shut down, which shall be taken as a setback.

Rajan is also able to demonstrate that he will include

  • Voting rights clauses: These clauses are needed for significant business decisions such as when to go public or when to sell the company.
  • Anti-dilution clauses: In the event that the business secures the subsequent round of funding at a lower value, the number of shares owned by the fund will be changed in such a way that the fund continues to own the same percentage of the startup as it did prior to the round.

Fees 

  • Rajan will charge the limited partners (LPs) a “management fee” equal to around 2% -3% of the fund’s total value on an annual basis.
  • This fee covers his time and the costs associated with running the fund.
  • Rajan will pay himself, the rent for the office, and the salaries of the analysts and administrative personnel that he will hire out of this sum.

Carry forward: 

  • Rajan will receive a bonus, referred to as Carry, based on the performance of the fund in addition to his base compensation, which is referred to as Fee.
  • Generally speaking, limited partners receive between 70% – 80% of the fund’s profits, while general partners receive between 20%-30% of the fund’s profits.
  • This is done to ensure that Rajan is motivated to achieve the highest possible return on his fund.
  • Carry is what will eventually make up a significant amount of Rajan’s profits.

Returns For Venture Capital

  • There is a correlation between high risk and high rewards.
  • When compared to the return that public equity markets generate (12–15%) and far greater than the return that debt markets give (8–10%), venture capital is predicted to generate a return in the range of 25–35% annually.
  • Following in the footsteps of Rajan In the end, Rajan was successful in raising $50 million, which he then invested in 25 different businesses.  Rajan’s fund needs to be at least 10x its original size in order to earn an annualized return of 25%, which means the sum total of all of the assets needs to be at least $500 million (10x over a period of 10 years = 25% year-on-year growth).
  • Now, if each of the 25 firms had grown by 10 times in the 4-5 years following Rajan’s investment, then this situation would have been straightforward.
  • However, the reality is that this is very rarely the case.
  • In fact, 75% of businesses that are backed by venture capital fail.
  • And it’s not because VCs have poor judgement or inability to make decisions.
  • No matter how intelligent you are, it is extremely challenging to create a successful firm and even more difficult to recognise such a company at a very early stage in its lifespan.
  • Even if each of the components, necessary to create a successful firm, has a high probability of occurring (in this case, 80%), the overall chance that the company would be successful is still only 17%, as shown in the following graphic.
  • If even one of these factors is less likely to occur (let’s suppose it has a probability of 50%), then the entire chance of the company being successful is reduced to 10%.

Investment In Private Equity

  • A non-publicly traded form of capital is known as private equity, and it belongs to the alternative investment class known as “alternative investments.”
  • Private equity is comprised of funds and investors that either directly invest in private enterprises or that engage in buyouts of public corporations, which ultimately results in the delisting of public stock.
  • Private equity receives its funding from both institutional and individual investors, and this funding can be put to use to finance the development of new technologies, complete acquisitions, increase working capital, and reinforce and strengthen a balance sheet.
  • The Limited Partners (LP) of a private equity fund normally own 99% of the fund’s shares and have limited liability, while the General Partners (GP) own 1% of the fund’s shares and have full liability.

  • These later parties are furthermore accountable for carrying out and managing the investment.
  • Private equity is a different type of private financing that exists apart from public markets and involves funds and investors directly investing in firms or engaging in buyouts of such companies. This type of financing takes place away from public markets.
  • Private equity firms make their money by charging investors in a fund fees for management and performance.
  • One of the benefits of private equity is that it make sit easier for entrepreneurs and company founders to gain access to alternative forms of capital, and it also reduces the pressure of having to perform well on a quarterly basis. These benefits are nullified, however, by the fact that valuations of private equity are not determined by the forces of the market.

Sources of Private Equity

  • Investment in private equity comes mostly from institutional investors and accredited individuals who are in a position to commit significant sums of money over extended periods of time.
  • Private equity investments typically need to be held for a considerable amount of time before they can result in liquidity events such as an initial public offering (IPO) or a sale to a public company.
  • This is because a turnaround of financially troubled companies or the ability to sell to a public company can take a long time.

Benefits Obtained Through Private Equity

  • Companies and startups can benefit in a number of ways from private equity investments. Companies favour it because it gives them access to cash as an alternative to conventional financial processes like bank loans with high interest rates or listing on public markets.
  • Venture capital is one type of private equity that is used to finance businesses in their early stages, in addition to financing ideas.
  • In the event of businesses that have been delisted from public markets, private equity financing may be able to assist these businesses in pursuing unconventional methods of business expansion out of the public eye.
  • If not, the pressure of quarterly profitability will significantly restrict the time frame that senior management has available to try to turn a firm around or experiment with new ways to cut losses or make money.

Drawbacks To The Practice Of Private Equity

  • To begin with, it may be challenging to liquidate holdings in private equity since, in contrast to public markets, there is no ready-made order book that brings together buyers and sellers.
  • This might make it difficult to find a buyer or a seller.
  • In order to complete the sale of an investment or a company owned by the business, the company must first conduct a search for a buyer.
  • Second, the price of a company’s shares in private equity transactions is not established by the forces of the market but rather through talks between potential buyers and sellers, in contrast to the situation that typically exists for publicly traded companies.
  • Third, the rights of shareholders in private equity are typically decided on a case-by-case basis through negotiation rather than being determined by a broad governance framework, as is the case with their counterparts in public markets.
  • This is in contrast to how rights are typically determined in public markets.

What Is The Process Behind Private Equity?

Private equity firms seek funding for their funds from a variety of investors, including institutional investors and accredited investors. The funds then invest in a variety of assets.

The following is a list of the most common forms of funding through private equity: 

Funding in difficult times:

  • Also known as distress funding or vulture financing, and it involves the investment of money in struggling businesses that have business units or assets that are not performing as expected.
  • Goal: to either produce a profit from the sale of their assets or to turn around the management of the company by implementing any necessary changes to their operations or management.
  • In the latter scenario, assets can include anything from tangible property like machinery and real estate to intangible forms of property like patents.
  • In the United States, businesses that have already declared bankruptcy under Chapter 11 of the US Bankruptcy Code are frequently considered viable candidates for this kind of funding.
  • After the 2008 global financial crisis, there was a rise in the amount of distressed finance provided by private equity firms.

Leveraged Buyouts:

  • This is the most common type of private equity investing, and it entails buying out a company completely with the goal of improving its business and financial health, and then reselling it for a profit to an interested party or executing an initial public offering (IPO).
  • Before the year 2004, the most common type of leveraged buyouts undertaken by private equity firms consisted of the sale of non-core business units of publicly listed companies.
  • The following is an explanation of how the leveraged buyout process works.
  • A private equity firm will first locate a possible acquisition target before forming a special purpose entity, often known as an SPV, to provide the necessary cash for the acquisition.
  • In most cases, businesses will finance a transaction by utilising a combination of debt and equity in their capital structure.
  • It is possible that as much as 90% of the total funds will come from debt financing, which will then be transferred to the balance sheet of the acquired company in order to take advantage of the tax benefits.
  • To turn around a company, private equity companies will use a range of techniques, ranging from laying off a significant portion of the workforce to completely revamping the management team.

Real Estate Private Equity:

  • After the 2008 financial crisis caused a drop in real estate prices, there was a boom in the number of people looking for this sort of funding.
  • Commercial real estate and real estate investment trusts (REITs) are two examples of typical places where monies are invested.
  • When compared to investments in other types of private equity funding, the minimum amount of capital required to purchase shares in real estate funds is significantly larger.
  • In addition, the money from the investors is held in escrow for a period of time equalling several years at a time.
  • REITS have also been active in India for quite some time now.
  • During the Financial Year 2021-22, an amount of Rs. 949.99 crore was raised as against Rs. 14,300 crore in the Financial Year 2020-21.

Fund of funds:

  • Primary objective: To invest in other funds, most commonly mutual funds and hedge funds.
  • They provide an alternative access point for investors who are unable to meet the minimum investment criteria of some funds.
  • However, opponents of these types of funds object to the higher management fees associated with them (due to the fact that they are rolled up from numerous funds) and the possibility that unrestricted diversification does not always result in the most effective method to multiply profits.
  • During the Financial Year 2021-22, the average domestic net assets under management amounted to Rs. 47,088.98 crore as against Rs. 26,485.80 crore in the Financial Year 2020-21.

Venture Capital:

  • A sort of private equity, venture funds funding is a type of investment in which investors (also known as angels) donate capital to entrepreneurs.
  • Angels are another name for investors.
  • There are a few different formats that venture capital can take, and each one corresponds to a specific stage at which it is supplied.
  • Seed financing is when an investor provides the initial funding needed to take a concept from a prototype all the way to a finished product or service.
  • Series A financing, on the other hand, enables an entrepreneur to actively compete in an existing industry or to build a new one.
  • Early stage finance, on the other hand, can assist an entrepreneur grow a company even further.

 

How Do Companies That Invest In Private Equity Make Money?

  • Management fees: Most significant contributor to total revenue for private equity firms.
  • A management fee and a performance fee are frequently included in the fee structure of private equity companies, despite the fact that this structure can often vary from firm to firm.
  • Some companies deduct 20% of the total earnings made from the sale of a business in addition to charging an annual management fee equal to 2% of the assets under management.
  • There is a lot of competition for jobs in private equity firms, and there is a good reason for this.
  • Take, for instance, a company that has one billion dollars’ worth of assets under control (AUM).
  • This company, much like the vast majority of private equity firms, probably has no more than 25 investment experts working for it at any given time.
  • The 20% of total revenues earned by the private equity firm is used to create millions of dollars in fees for the firm.
  • As a result, some of the most influential personalities in the investing industry are drawn to positions in companies that use this business model.

Problems Associated With Private Equity

  • The amount of income, earnings, and exorbitant salaries earned by employees at nearly all private equity firms prompted a call for more transparency in the private equity industry beginning in 2015.
  • This was largely due to the fact that the amount of income earned by employees at private equity firms is on the rise.
  • In India, SEBI has come out with Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 to regulate Venture Capital Funds and Private Equity Funds.
  • The number of Alternative Investment Funds registered with SEBI went up to 732 as on 31st March, 2021 from 641 as on 31st March, 2020.
  • The investments as on 31st March, 2021 = Rs. 2,00,484 crore as against Rs. 1,53,403 crore on 31st March, 2020.

Companies In India That Deal In Private Equity

Important International Players Who Have A Presence In India 

  • The Carlyle Group
  • Warbug Pincus
  • Bain Capital
  • TPG Growth Capital
  • CVC Capital Partners
  • The Blackstone Group
  • KKR & Company
  • Everstone Capital
  • Baring Private Equity Asia
  • CLSA Capital Partners

Indigenous Companies Having Business Operations In India 

  • Kotak Private Equity
  • Chrys Capital Management
  • True North’s India Value Fund
  • Motilal Oswal Private Equity
  • IDFC Private Equity Fund.
  • The ICICI Venture Capital Fund
  • CX Partners
  • Premji Invest
  • Kedaara Capital
  • JM Financial Private Equity

The Legal and Administrative Structure Of India

Private equity funds in India are typically organised as trusts and registered with the Securities and Exchange board of India as alternative investment funds in accordance with the Securities and Exchange board of India (Alternative Investment Funds) Regulations, 2012. Private equity funds can also be established in the form of companies or limited liability partnerships, in addition to trusts (LLP).

The SEBI (Alternative Investment Funds) Regulations, 2012

The Securities and Exchange Board of India introduced the SEBI (Alternative Investment Funds) Regulations, 2012, with the goal of increasing both the accountability of market participants and the stability of the market. The Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 were superseded and nullified by the regulations that were notified on May 21, 2012.

Applicants can seek registration as an AIF in one of the following categories, and in sub-categories thereof, as may be applicable: [Ref. Regulation 3(4)]

Category I AIF:

  • Venture capital funds (Including Angel Funds)
  • SME Funds
  • Social Venture Funds
  • Infrastructure funds

Category II AIF

Category III AIF

  • Category I AIFs: AIFs which invest in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME Funds, social venture funds, infrastructure funds and such other Alternative Investment Funds as may be specified. [Ref. Regulation 3(4)(a)]
  • Category II AIFs: AIFs which do not fall in Category I and III and which do not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted in the SEBI (Alternative Investment Funds) Regulations, 2012. [Ref. Regulation 3(4)(b)] Various types of funds such as real estate funds, private equity funds (PE funds), funds for distressed assets, etc. are registered as Category II AIFs.
  • Category III AIFs: AIFs which employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. [Ref. Regulation 3(4)(c)] Various types of funds such as hedge funds, PIPE Funds, etc. are registered as Category III AIFs .

Angel Fund: 

“Angel fund” is a sub-category of Venture Capital Fund under Category I Alternative Investment Fund that raises funds from angel investors and invests in accordance with the provisions of Chapter III-A of AIF Regulations.  In case of an angel fund, it shall only raise funds by way of issue of units to angel investors.  “Angel investor” means any person who proposes to invest in an angel fund and satisfies one of the  following conditions, namely,

(a)An individual investor who has net tangible assets of at least two crore rupees excluding value of his principal residence, and who:

  • has early stage investment experience, or
  • has experience as a serial entrepreneur, or
  • Is a senior management professional with at least ten years of experience; (‘Early stage investment experience’ shall mean prior experience in investing in start-up or emerging  or early-stage ventures and ‘serial entrepreneur’shall mean a person who has promoted or co-promoted  more than one start-up venture.)

(b) a body corporate with a net worth of at least ten crore rupees; or

(c)An AIF registered under these regulations or a VCF registered under the SEBI (Venture Capital Funds) Regulations, 1996. Angel funds shall accept, up to a maximum period of 3 years, an investment of not less than Rs. 25 lakh from an angel investor.

Crucial Stages In The Process Of Investing In Private Equity

In India, private equity investments are frequently made in privately held businesses that are not listed on any stock exchange. Investing in publicly traded companies is not recommended for a number of reasons, including a dearth of high-quality assets and stringent requirements for delisting. Private equity transactions include seed capital, Angel investments, venture capital, growth capital, and late stage investments such as private investment in public equity, buyouts, and turn around capital. Early stage investments include venture capital, growth capital, and growth stage investments include seed

  • Teaser sent by investment bankers
  • Non-disclosure agreement (NDA)
  • Memorandum Regarding Confidential Information
  • Valuations
  • Expression of interest
  • Permitting Access to Data
  • Management meetings
  • Formal notice of intent
  • Contract for the purchase of shares

Due Diligence

  • Any transaction must be carried out and planned for with the utmost care.
  • As a consequence of this, prior to the closing of a deal, the buyer or the investor is required to conduct extensive research concerning the target company.
  • The procedure encompasses a wide range of topics, including commercial and legal considerations in addition to accounting and tax difficulties.
  • During the process of performing due diligence, there is no single, definitive formula that must be adhered to.
  • The performance of due diligence is unquestionably vital from the point of view of the
  • This is because conducting due diligence gives the buyer the opportunity to refute many allegations and lowers the risk associated with acquiring a company.
  • Also helps the seller.
  • The thorough study and analysis of the seller’s financial situation may, on occasion, show the company’s true value on the open market.
  • As a result, it is not unusual for sellers to perform due diligence on their own businesses before selling them. Carrying out an exercise known as “due diligence” is a vital step to take in order to discover any potential dangers or flaws in the deal.
  • Therefore, protecting a buyer from potential future dangers.

The essential steps :

  • An Overview of the Company Being Targeted
  • This covers the following areas:
  • Financial Matters
  • Corporate Matters
  • Customer Relationship and Sales
  • Contractual Matters
  • Employee Management Issues
  • Litigation
  • Tax Issues
  • Intellectual Property Matters
  • Transactions Involving Related Parties

Exit Strategies

  • The realisation of returns on the investments that the private equity firm has made in the company is the primary goal of an investment in private equity.
  • A private equity fund’s lifespan is typically predetermined to be somewhere between 5 and 10 years.
  • To put it another way, private equity investors buy things with the intention of selling them.
  • In point of fact, it is a common practice for an investor to begin formulating a plan for the exit motion immediately following the completion of a purchase.
  • A private equity fund will purchase a firm, then work to raise its value by taking operational and managerial control of the business before ultimately selling the company.

Exit strategies are always evolving to keep up with shifting market conditions, however some of the more prevalent tactics include the following: 

  • Initial offering to the public
  • Trade Sale
  • Secondary Buyout
  • Procedure with Two Separate Tracks
  • Recapitalization Through the Use of Leverage

Download PDF

CAIIB Paper 3 Module D Unit 3- Private Equity and Venture Capital

Buy CAIIB MAHACOMBO

 

3

RELATED ARTICLESMORE FROM AUTHOR

Leave a Reply