Private equity investments in India — Beneath the gloss

In the 25 years or so since the first venture capital institution started operations in India, venture capital and private equity seem to have caught the imagination of the stakeholders. Mention of VC, the reaction is one of either admiration or disapproval. You have to love it, or hate it. Ignore it you simply cannot any more, it would appear.

A recent meeting with a team of investment managers in Mumbai that manages a medium-size fund investing in emerging enterprises, code for companies that have a reasonably long operating history and scale of operations, was an eye opener.

What I heard in that picturesque office, overlooking the Bay where the infamous Ajmal Kasab is said to have landed for his barbaric mission, made me realise that hype aside, the industry is still struggling to deal with many fundamental problems. I list some that appear to be critical. My list does not include regulatory regime, the most common suspect and a highly overstated reason for the industry’s miseries.

This has been a pet peeve for investors for a while. For every Lilliput and Subhiksha that make it to the newspapers, there are dozens of others that are not talked about in public. Bad or poor governance is not just about outright theft of corporate cash flows. Good governance requires at the minimum that management levels with its stakeholders on important developments and prognoses. By that yardstick most Indian portfolio companies are governed poorly. Timely information helps sensible investors prepare for an unsavoury future and work with the management on dealing with the emerging situation in the portfolio company.

With the IPO markets continuing to feed more lemons than pearls to investors, this exit avenue has turned out to be unreliable, if not unavailable. Strategic sales are slow to happen as strategic investors seem to be reluctant either because of problems in their own backyards or because of the alleged uncertainty in the Indian tax regime, or worse, run away when they discover accounting shenanigans as they are about to write a cheque.

This is a tricky one. Promoters and investors seem to have gorged on debt, in an effort to grow their enterprises on thin layers of equity, on the hope that there would never be a day of reckoning in terms of sales and cash flows slowing down. But comeuppance did happen as the GDP crashed to 4.5 per cent in 2013-14, from 8.5 per cent just two years ago, leaving behind a flotsam of debt laden enterprises and remorseful investors. The luckier ones got admitted into the intensive care of corporate debt restructuring cells of their banks. Many were not that lucky.

Even a cursory examination of the accounts of failed investments that have managed to pierce the shroud of secrecy which the PE industry throws around its deals indicates that investment failures may be as much a result of the fund managers being on a “learning curve”, to put it euphemistically, as it is due to incompetent or delinquent founders. That is not surprising. The industry seems to have a larger than healthy share of managers who had worked mostly in the West. They are still discovering Indian ingenuity in accounting and learning to navigate the rapids of our judicial system. The other prominent category consists of Indian business managers who got lured into private equity in a manner that is reminiscent of the gold rush to the Wild West, not knowing a hoe from an axe.

In an industry where the discipline of managing investments is an art that requires apprenticeship in the specific market context the results of inexperience are quick to manifest.

Beneath all the gloss of the Indian private equity industry that its cheerleaders in the media would like to showcase, I think the industry is going through a turbulence that is much worse than the summer thunderstorm that buffeted the aircraft in which I was returning to Bangalore. It is a far cry from the placid waters on which dozens of fishing boats bobbed languorously under the summer skies of Mumbai.

So this is where the shroud of secrecy might possibly help, albeit temporarily. It is an ironic instance of where no news may well be good news, even if for just a short while.

And as a middle-aged man who has seen the yin and yang of the investment market play out many times before, I say to myself optimistically: This too shall pass.

(The author is Chairperson NS Raghavan Centre for Entrepreneurial Learning at IIM Bangalore. Views are his own.)