Despite increased investments from private equity (PE) and venture capitalists (VCs) in India, the holding period is getting wider owing to a gamut of factors. The sluggish macroeconomic conditions and a weak IPO market prior to Covid-19 had been affecting the PE and VC space, observes KPMG in its latest report.
Nitish Poddar, Partner (Deal advisory), National Leader, Private Equity, KPMG, said: "However, the decline in number of exits and consequent increase in median holding period to 6.2 years could be attributed to sluggish macroeconomic conditions and a weak IPO market even prior to the onset of Covid-19. PE exits in 2020 have fallen drastically, primarily due to business disruption on account of Covid19 and resultant impact on valuations."
India witnessed $79billion of PE exits in the last six years, of which $42billion were through M&A exits and $16billion of open market transactions.
"Although the number of exits per year has declined 50 per cent between 2017 and 2019, they have generated good returns for the PEs," adds Amit Roongta, partner, M&A Consulting, KPMG.
KPMG in India analyzed the top-300 exits in the last six years and observed that nearly 50 per cent of the exits in India generated an annualised return in excess of 30 per cent, across sectors, whilst nearly half the exits outperformed market indices which grew at 10 per cent CAGR during the corresponding period.
Exit Plans Begins Before Investment Date
Generally, exit planning starts right from the date the investment is made in the portfolio company.
Vikram Hosangady, partner and head (clients & markets), KPMG, and Vikram Srinivas, partner (M&A consulting), KPMG, said: "As market dynamics impact return on investments (RoI), investors need to be cautious when reviewing targets and have a clear exit strategy in mind, even prior to signing the deal. Exit planning structures the timeline for pursuing value enhancing activities, improving performance and exiting with good returns (MOIC or IRR). A poorly planned exit can turn an otherwise good deal into an average one. Besides creating a compelling story around revenue growth, market reach and profitability, exit planning should also focus on strengthening the quality of management team and creating a transparent track record."
An investor’s ability to achieve timely and profitable exits across multiple investments is a key indicator of its quality of initiatives and efforts to enhance value. As per our internal study, exit strategies can be formulated three years in advance from the tentative quarter of the planned exit.
Streamlining corporate strategy, financial analytics are typically the first initiatives to be implemented, followed by performance improvements, refining organisation structure and other initiatives.
Exercises around planning the exit and enhancing board structures are initiated 12- 18 months prior to the targeted exit quarter. In our experience, we have observed the following activities and considerations incorporated by PEs / VCs in their exit planning.
Alignment And Cooperation Of The Portfolio Management
A clear exit strategy: Executing a good exit begins much earlier than the actual sale and attempts to establish a sound deal rationale. The strategy must include the guiding principles for exit and detail the key milestones and roadmap of activities till actual exit, observes the report.
Get the timing right: This is critical and often dependent on macroeconomic factors and overall market outlook. Unforeseen events such as Covid-19, weak consumer sentiments and choppy near term forecasts, especially in price sensitive sectors like automotive, auto components or real estate, may adversely impact valuations, resulting in postponing the exit.
If the exit is delayed or the return multiple does not fall within the predefined threshold, PEs need to develop a Plan B.
Ashish Bansal, head (M&A consulting), KPMG, remarked that "whilst the median holding period of PE investments have declined globally between CY15 - CY19, in India they have had to adopt a ‘wait and watch’ approach during this period. On the portfolio management side - the skills, capabilities and experience that directors and senior management teams bring to the table can be of immense value succession plans that they have for the portfolio company are often important buy side deal considerations."
Some themes that PEs need to keep in mind while deciding the quality of management teams required are:
Selecting the right buyer: Identifying the right buyer, i.e., a strategic buyer, financial investor or exit through Initial Public Offering (IPO), helps in tailoring the sell- side story to fit the investor’s needs and highlighting the key achievements and milestones. For example, a strategic buyer would be more interested in operational metrics and integration challenges, while a PE would be more interested in financial metrics. This also has implications on selecting the right deal-type for the exit.
Amit Roongta, partner (M&A consulting), KPMG in India, elaborates: "PE Exit Route between CY15 and CY20 shows that Open Market transactions followed by M&A have remained the most preferable exit routes for PEs in Indian, both in terms of aggregate deal value and deal volume."
Orienting the management: Identify program leader for the exit planning to ensure clear and consistent messaging throughout the exit process. Management teams also need to be sensitised on do’s and don’ts, impact of information shared on valuation, risk of value erosion due to a poorly managed process and the benefits of proactive communication to stakeholders, according to the KPMG report.
Ensure management bandwidth is not choked: Management team’s bandwidth is usually consumed in maintaining business as usual. Managing multiple projects simultaneously, such as exit planning and running operations, requires intense focus and efforts, lest one suffers at the cost of the other.
In such scenarios, setting priorities and striking a balance between the two during the exit process becomes crucial.
Build a due diligence proof business case: As part of the exit strategy, PE firms should also develop a compelling business case, showcasing historical accomplishments, robust business plan and well documented assumptions. The process also involves identifying operational blind spots that can be fixed and creating a convincing sell- side story. Performing an exit readiness assessment one year prior to the actual exit can help identify weaknesses and aid adequate planning.
Execute the entire exit process in a time-bound manner. The entire exit planning and execution process could easily last from one to three years depending on the size and complexity of the deal and the type of buyer involved. In this context, operating groups of PE firms need to have the necessary bandwidth to support the sell side management teams in the exit process, says the KPMG report.
Further, legal and regulatory requirements especially in cross-border transactions can impact the overall duration of this process. Normally, a sale to another PE investor should take less time to complete compared to a strategic buyer.
Elaborating the efforts made in bringing the report on VC and PE investment trends, Vikram Srinivas said: "In this making it count publication, we have attempted to identify the common themes followed by investors in India to protect and enhance value of their portfolio companies.
We have delved deep and analysed Indian case studies to analyze the key interventions made by the fund houses right from signing off on an investment until its exit."
The ‘Value protection’ philosophy underlines the importance of plugging leakages identified during the diligence phase, while effectively taking control of the investment, emphasising on the following core areas:
Developing a robust finance function – to ensure availability of reliable data and key decision support Enhancing the enterprise risk framework to detect, prevent and mitigate risks
Being cyber secure and having a robust business continuity plan in place. On the other hand, returns on investment are driven by clear vision and ‘Value enhancement’ measures such as:
Streamlining the operating model – Rationalising non-core functions and simplifying processes to optimise costs and free up capital.
Enabling technology as a differentiator: Digitizing the operating processes & customer experience to enhance the company’s competitiveness.
Investing in human capital: Upskilling and importing talent to setup the organization for success.
Revamping the Go-to-market strategy: Optimizing the product/ service offerings.
Integrating strategy and business planning to help improve operational efficiency and provide a seamless experience to customers.
Supercharging business with data and analytics to help identify levers to unlock and enhance value. Whilst there is no single play-book for an investor to follow, covering all bases and proactively driving transformation, without antagonizing key stakeholders if more often than not, a recipe for success.
Poddar said: "Over the years, the financial sponsor community has realized that while choosing the right asset and making the investment is important, the real value creation happens when global best practices are implemented, right professional management is hired and technology/ data is used to drive the business forward. This is what differentiates a good investment from a better investment."
Investor confidence in India continues to remain high. With the Indian economy expected to emerge as the third largest by 2030, investors have earmarked significant capital to actively participate in the India growth story, driven primarily by the sizable market, inherent cost advantage and young talent pool.
Especially in the last five years, investors have made multi-billion dollar investments across the growth lifecycle and sectors, with consumer goods, financial services and e-commerce leading the pack. Whilst competing for an asset and successfully concluding a deal is half the battle won, the real challenge is to maximize return on investments, within the stipulated investment horizon. This game has been mastered by investors who bring in deep sector experience and drive strategic initiatives across the portfolio right from the word go. Our analysis of select 300 transactions between CY16 and 20 indicate that returns on private investments have out-performed public markets, across sectors, underpinning the importance of investor led intervention in helping the company enhance its valuation, whilst navigating critical challenges or competitive pressures.
Whilst successful investments that add value to the portfolio, help PEs and VCs differentiate themselves and raise future capital, lack of alignment with founder promoters, management or forced value additions, can be counterproductive and erode investor’s brand equity.
Two-third of PE investments in India are in mature stage companies, with an increasing preference for buy-out/controlling stake transactions.
Despite macroeconomic headwinds, PE/VC investments in India have steadily grown, with funds continuing to actively scout for opportunities across the growth cycle of companies.
Early stage investments are a leap of faith, considering the absence of established track record and benchmarks Startup businesses in the early stages are characterised by steep growth curves that generate high returns for the investor.
However, these businesses often lack the resources or the professional expertise or the operational flexibility to sustainably scale up their businesses.
VCs step in to support these startups with growth capital, technical expertise, market insights and strategic guidance. This enables them to navigate through volatile and dynamic market conditions. Of the c.1900 transactions analysed by KPMG in India, 850+ deals were in early stage companies, wherein investors committed c. USD 44billion between CY15 to CY208.
Investments in mature companies are mostly strategic, with an intent to enhance overall value, leveraging the existing setup8 Mature stage investments are often strategic in nature, with the intent to ramp up revenue, rationalise cost structure, strengthen value perception and enhance enterprise valuation, prior to exit. These investments can be classified into a) financial investments in companies in need of growth capital, or, b) acquisition of controlling stake in companies for a bolt-on or platform play operations.
When PEs pick up financial stakes in mature entities, they may not have enough headroom to bring about transformative changes. However, this does not deter them from sharing best practices and experience with supporting the investee’s management.
PEs, acting through their portfolio companies, also look for bolt-on acquisitions to reap combinational and transformational synergies on integration. In mature investees, PEs typically focus on expanding geographic footprint, enhancing asset capacity utilizations, new product developments and refreshing go-to-market strategies, among others. Mature stage companies attracted $108 billion across 1,000+ deals in the last 6 years.
-The writer is a business journalist with 27 years of experience