• LIFe Thoughts

How Private Equity is challenging other forms of Investments in India

Over the last decade, the total annual capital raised by companies as a result of private equity investments has seen a growing percentage.

With over $100 billion of capital originating from private equity investments in India in the past 13 years, the role of private equity has come in to question. Different types of investments cause various kinds of structural changes to investee companies.

The question - “Is the role of private equity investments beneficially pivotal to company structures or does it thrust companies to overuse assets and take excessive leverage?”

First consider the financial approach. Private-equity capital has a financial standard deviation of 76% as compared to 100% for foreign institutional investment and 103% for IPOs. This shows its stability and reliability as compared to financing options. Revenue and earnings have grown faster at companies that are backed by private equity. In a report by McKinsey and Company, the revenue and earnings difference was shown to be 28% and 39% higher respectively for PE-backed companies.

Building from the financial side, the size of the investee companies is important to understand the level of influence that financing can have. Out of the 3100 companies that received private equity capital, approximately 50% were companies with annual revenues of less than $2 million. Private equity investors are known to have global experience, foreign-market access, and deal-making expertise. Bringing these qualities to the smaller firms resulted in faster growth of exports (up to 60% more) and increase in cross-border M&As (up to 80%).

Lastly, private-equity investors have paramount influence in the investee companies’ compliance and governance measures. Private equity investors prompt the companies to appoint independent directors, improve audit and compensation committee functions, and increase board oversight. For small- size companies, these practices shape the organisation and its future management techniques.

Private equity investments do have fallbacks. Before the financial downturn (2008-09), private equity investors took minority positions which then led to lack of governance rights. This led to strategy, operations, and capital management disputes.

However, the level of influence of private equity investments should not go unnoticed. The importance of Venture Capital (accounting for approximately 50% of India’s private equity investments) is growing with India’s start-up culture. It goes without saying that these practices will hit roadblocks but as far as management techniques and accountability are concerned, this leaves us with optimism for India’s future industries.