Why investment strategy of PEs is in the spotlight

Investment

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The news of Café Coffee Day founder V.G. Siddhartha’s disappearance has brought into focus the role of private equity (PE) investors in shaping the startup culture in India. Mint delves into the PE deals and the many riders that come with them.

What does the letter purportedly written by Siddhartha say about PEs in his company?

The letter blames one of his PE partners, which he says was forcing him to buy back his firm’s shares, a transaction he says he had partially completed six months ago by borrowing from a friend. Siddhartha was paying a hefty interest, as the money had come from informal sources. Coffee Day Enterprises, the holding firm of Café Coffee Day, is backed by PE firms KKR, Rivendell PE (earlier called New Silk Route) and Affirma Capital. Siddhartha’s letter doesn’t name the PE he blames for driving him to take a drastic action.

What shape do these PE deals take?

PEs typically enter a company for three-five years against a promised return by its promoter. The promoter promises an exit to the PE investor after the number of years is agreed upon through a buyback of its shares at a predetermined price or through an initial public offering. Sometimes, another PE investor acquires the equity of the original PE. Some PEs also bring in their domain expertise and help the company grow in its initial years before they exit. Often, this is a quasi or hybrid deal, in which there is both a debt and an equity component in the instrument used to make the investment.

Why are some PE deals less holy than the others?

It is alleged that some PE capital is actually political money routed via tax havens such as Mauritius to convert it into white money. Threats follow when the promoter isn’t able to repay.

What is hidden behind some PE deals?

Some so-called equity PE deals are actually debt transactions involving the issue of fully convertible debentures or compulsorily convertible preference shares. The agreement may even carry a “put” option in favour of the PE investor or a “buyback” clause that makes it incumbent upon the promoter to buy the security at a specified price and time. Promoters who do not have the money are forced to borrow or sell other assets to arrange money for the buyback, as it happened in Siddhartha’s case.

Why do some PE deals go sour?

A lot depends on the promoters’ integrity. PEs are usually not involved in the day-to-day operations of firms and set stringent terms for the promoters, so that they get their returns as PEs are answerable to investors, who have given them the money to invest on their behalf. Promoters are expected to meet preset targets on top line, bottom line, profitability and margins. The targets are written in the contracts, but an overenthusiastic promoter can bite off more than he can chew.

[“source=livemint”]

Written by Loknath Das