The IVCA-PRIME PE/VC Directory was launched by Mr. U.K.Sinha, Chairman, SEBI in Mumbai on 7th July 2011. Click here for photos.
Venture Capital and Private Equity Funds in India-Prospects & Challenges
Mahendra Swarup
Indian Private Equity & Venture Capital Association (IVCA)

The Private Equity in emerging markets is still in its infancy compared to the more-developed regions. However, the interesting growth prospects increasingly attract international investors, in combination with a growing number of local PE firms. PE investors are especially welcome in the emerging markets where capital shortages keep the valuations low as compared to long term value creation.
Over the years, the role of PE funds, have been well documented, in fostering innovative and competitive firms, and there now exists a broad consensus that a strong PE market is a cornerstone for commercialization and innovation in modern economies. What is valid for industrial countries should be even more important for emerging markets. The growth potential is enormous and deserves capital to be exploited. Hence, policymakers should focus on the creation of an adequate setting for a prospering PE market to support investments, growth, competitiveness and entrepreneurial activities.
In a list of emerging markets; India leads the ranking of emerging market investment activity, closely followed by China.
The global financial crisis affected the Indian economy less than anticipated, although it slightly dampened our long-term economic growth of 8 - 8.5%, which is high compared to many other countries. Economic development has remained stable, mainly due to India’s low dependence on export revenues, an extensive domestic market of 1.2 billion inhabitants, and consumption that has remained relatively resilient. Despite the difficult international financial situation, domestic assets and companies’ steady revenues have kept investment levels high.
Growth has mainly been nurtured by the government’s extensive investments in infrastructure development, particularly energy production. The rapid increase in public-private partnership projects is also a new development. Favourable economic prospects and expectations of attractive returns have stimulated private investors’ interest in India.
Private Equity in India offers huge opportunities. The increasing impact of private equity on Indian business is a dual effect of indigenous factors such as an expanding domestic market and globalization which would further scale up the PE Segment.
The Small and Medium Enterprises (SMEs) in India is an emerging segment and is looking at various avenues for raising funds. For SMEs, PE investment could be an alternative and viable source of financing. Apart from financial support, SMEs would also get exposure to global management practices in operations, human resources management, financial planning, reporting and investor relations. Such involvement would bring more accountability, transparency and corporate governance. Sectors like back-end retail, logistics, infrastructure, power, renewable energy, hospitality, transportation and telecommunication have gained favour among the private equity firms. Even the Research and Development sector has caught momentum. Initially, lack of capital to invest in R&D held back corporate India. Private Equity capital is helping address this issue. Growth in R&D investments at PE-backed companies is over twice that at their non PE backed counterparts.
Other new investment avenues with huge potential for PE investments are education and agriculture sector in India. With an estimated US$40bn market for private institutions and a CAGR of 8.6%, it is no surprise that PE & VC investors are looking to ramp up the investments they have already made in Education-related companies. Even Microfinance and Clean Technology are some emerging sectors for PE players.
Whilst the Private Equity opportunities in India are huge, so are some of the challenges that Private Equity faces in the Indian landscape, including, lack of well established domestic network of entrepreneurs, financiers, firms and research institutions; challenging operating environment including family owned management practices at the smaller firms and a complex legal system; tax environment and an innovative process to create a tax-efficient structure for international investors.
Ideally, VCs are expected to be more involved with companies compared to PEs since they invest in the entrepreneurial stage of the companies whereas, PEs invest during the growth phase. However, very often in India, PE firms have to do a lot of handholding for companies. This is because most of the companies in India are still building professional management. Hence, in order to ensure management processes and governance, PEs step in to handhold them.
Deal sizes are smaller in India because companies are smaller. Average deal size is around $25 million. Though core sectors like infrastructure may need larger investments, PE firms are keen on investing in this space because of long term value creation in India. Indian firms are mostly promoter controlled. Promoters are hesitant to let go off their control, hence, PE firms normally take minority stakes. As they say, it is more of “buy-in” than “buyout”. Besides, buyout market hasn’t really picked up in India, as yet.
The main barriers to entry for PE's in India are complex regulatory issues relating to sector investment and ambiguities in the Indian interpretation of the tax codes as well as the regulatory costs. Moreover, what aggravates the problem is that there are multiple regulations and little harmonization of guidelines across government agencies (SEBI, RBI, CBDT, Ministry of Company affairs). As on date, there are no clear cut guidelines for Private Equity investment.
PE firms were viewed generally in the past as financial investors but are now expected to provide much of strategic insight on various aspects of the business. PE firms are expected to come up with best practices and help tighten operational aspects. Most PE firms believe that the future lies in providing appropriate guidance to management teams so that the targets could be achieved and the returns could be enhanced. To get strategic insights into the business, PE firms access industry veterans and take them on as operating partners.
The PE industry is a relatively new concept in India having just less than a decade long history in India. Even though returning Indians with prior experience in PE firms abroad are coming back to India, most PE firm’s feel that they have to re-skill themselves to take up challenges in Indian business scenario. They hope to overcome the challenge as the industry takes off in future.
Some PE firms feel that privatization is yet to take off in India owing to the fact that PIPE financing still contributes almost 30% of PE investment in India. Ideally, partners do not expect PE firms to invest in public equity.
The exit period in India has also increased because of slowdown in last couple of years. The exit period, which typically was 2-3 years, has now increased to 4-5 years. Extended periods have also led to PE firms providing a second round of financing in companies in which they have already invested. Furthermore, the legal and equity protection rights are still evolving in India, enhancing the concerns of PE firms about the inherent risks involved in investment projects.
Competition owing to ‘qualified institutional placements (QIPs)’ is another challenge for Private Equity in India. Merchant bankers who advise companies on fund-raising options say companies prefer QIPs over PE investment for various reasons. These include the need for giving board representation to a representative of the PE firm if it is picking up a significant stake, which is not mandatory in case of QIPs. Besides scrutiny of management decisions, PE investors also
tend to take a much longer time to invest through stringent due diligence compared with QIPs which usually take place within a few weeks. 
Besides giving listed companies the option to raise funds, QIPs also enable them to raise money
from foreign investors in the domestic market rather than going abroad and issuing shares in international markets through depository receipts.
To sum it up, private equity has entered the economic mainstream and has gained a lot of momentum over the past few years. Venture Capital/ Private Equity funding is a significant percentage of our FDI inflow, and such funding should be nurtured and encouraged further as it creates new ventures and new employment with the investment being made with a long time horizon. VC/PE investments can significantly contribute to Forex reserves, reduce rupee volatility and be one of the important factors contributing to financial stability. A simple, welldefined and unambiguous regulatory regime can help the private equity industry to grow further. IVCA continuously works with the policy makers and the Regulators to create a positive environment for encouraging higher inflow of funds and for promoting Domestic fund raising.
The contractual nature of private equity funds in combination with the trend towards selfregulation by industry groups suggests that the sophisticated players in the private equity are themselves capable of disciplining opportunistic behaviour by fund managers and advisors. This strategy ensures that possible rules and regulations are in line with both best practices and standards applied in the world of private equity.
Everything said and done, to make the above happen; PE firms, in coordination with IVCA, have come together along with the regulators to create specific regulatory provisions for the PE industry. A right form of regulation will not only benefit the existing PE firms but also lead to the growth of the PE industry by routing more PE firms to India.
Mahendra Swarup
The Indian Private Equity & Venture Capital Association

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