PRIVATE EQUITY [SUBJECT: PROJECT FINANCE] Learning Objectives: Get a brief overview on the Private Equity Market, its history, performance and trends Get a list of top 10 private equity companies in India Understanding Venture Capital Shed light on the stages of Venture Capital Financing Learn about Venture Capital Process Learn about steps in Venture Capital Process Chapter 11 Private Equity 1 11.1 Introduction . Many young companies are unable to raise capital in public equity markets because they are not large enough to attract investor’s interests. A company having a very promising product or service but not sufficient track record. This also holds true for companies that are in financial distress. Such companies can get funding from Private Equity investments. Venture represents financial investment in a risky proposition made in the hope of earning a high rate of return. Chapter 11 Private Equity 2 11.2 Private Equity Market . The Private Equity Market is dominated by private equity companies that represent large institutional investors. The private equity market is crucial for both start-up companies and established publicly traded companies. For example, a public company in financial difficulty will generally not be able to raise public equity or public debt. Private equity companies invest private money in businesses they consider attractive. Private equity companies are usually structured as partnerships, with general partners (GP) presiding over limited partners. The partners tend to be high net-worth individuals, public and private pension funds, endowments, foundations and sovereign wealth funds. According to PEI Media's 2008 ranking of the top 50 private equity companies worldwide, the top four were United States-based. These were The Carlyle Group, Goldman Sachs Principal Investment Area,TPG Capital, and Kohlberg Kravis Roberts. Chapter 11 Private Equity 3 History . From obscure beginnings as boutique investment houses, through the junkbond leveraged buyout debacle of the 1980s, to the thousands in existence today, private equity companies have become an important source of capital. According to the trade industry association, Private Equity Growth Capital Council (PEGCC), in 2009, private equity companies raised close to $250 billion and made more than 900 transactions with a total value over $76 billion. Facts . Private equity companies typically manage funds on behalf of their investors. They look for businesses with higher-than-average growth potential over the long term. They often provide senior management direction to the companies in which they invest. This is especially true in cases of majority control, because bigger returns mean bigger carried interest payouts for the GPs. Carried interest is the portion of the funds that remains with the company after paying the limited partners and other investors their paid-in capital plus a minimum rate of return, known as the hurdle rate, and transaction expenses. Chapter 11 Private Equity 4 Strategies . In 2009, private equity companies invested mainly in five sectors: business services, consumer products, healthcare, industrial products and services, and information technology. The most common types of investment structures are: 1) Leveraged buyouts, or LBOs; LBOs use both equity and borrowed capital to invest in companies, hence the term "leveraged”. 2) Venture capital funds focus on new companies, mainly in the technology, biotechnology and green energy sectors. 3) Growth capital invests in mature companies deemed to be undervalued. 4) Turnaround capital, also known as distressed capital or vulture funds, looks for financially-troubled companies to buy inexpensively; potentially restructured, often through layoffs and asset sales; and then sold for a healthy profit. Chapter 11 Private Equity 5 Performance 5) Bank Guarantee: . It is difficult, from the outside, to judge the performance of a private equity firm. Unlike public companies that trade on the stock exchanges, subject to regulatory disclosure requirements, private equity companies do not typically disclose their financial statements. Private equity companies that trade publicly, like Kohlberg Kravis Roberts, do provide information on realized and unrealized profits from their investments. The realized profits are significant. According to PEGCC, through 2009, private equity companies have returned close to $400 billion in cumulative net profits to their investors. Chapter 11 Private Equity 6 Top 10 Private Equity Companies in India . Private equity funds--investment funding made without stock being issued--have raised over $17 billion since the year 2000, according to the research agency Preqin. The private equity sector in India declined about 60 percent in 2009 due to recession in overseas markets, but as of 2010, the Indian markets have stabilized despite volatility and uncertainty in global finances. When determining the top 10 private equity companies in India, one measure of success is the amount of funds raised. 1) ICICI Venture o ICICI Venture Fund management, headquartered in Mumbai, has raised funds to the tune of $3 billion over the last decade. o As one of the largest funds, it is a subsidiary of ICICI bank, the largest private sector bank in India. 2) ChrysCapital o This New Delhi-based fund launched in 1999 and has raised $1.9 billion in private equity funds. o It has made more than 45 investments since its inception, according its website. 3) Sequoia Capital o Sequoia Capital India, formerly known as WestBridge Capital Partners, mainly invests in consumer, energy and financial services in India. o Headquartered in Bangalore, it focuses on investment in the seed, early and growth stages of industry. Chapter 11 Private Equity 7 4) India Value Fund o India Value Fund, a Mumbai-based fund, was established in 1999 and boasts more than $1.4 billion distributed across four funds. o It was formerly known as GW Capital. 5) Kotak Private Equity Group o This company stands as one of the early investors in Indian private equity, launched in 1997. o Kotak pumped $1.4 billion into the Indian market mainly in the infrastructure and health care sectors. 6) Baring Private Equity Partners o Established in 1998, Gurgaon-based BPEP has over $3 billion invested mainly in the American, Latin and Indian markets. o It generally invests in manufacturing, pharmaceutical and information technology. 7) Ascent Capital o Ascent Capital, as one of India largest private equity funds, has invested $600 million across three funds, helping more than 40 entrepreneurs access its funds. Chapter 11 Private Equity 8 8) CX Partners o CX Partners promoted by former Citigroup Venture Capital Investment made "a final close of its debut fund in excess of $500 million," according to a July 7, 2010, report from Reuters. 9) Everstone Capital o Everstone Capital, the equity subsidiary of Future Holdings, raised its first fund in 2006, for $425 million, and set its sights on a $550-million fund in 2010, reports AltAssets.com. o Everstone invested in engineering companies, a renowned children clothing producer and other industries. 10) Blackstone Group o Blackstone, a U.S.-based firm, remains an emerging player, announcing plans to invest as much as $1.5 billion in Indian infrastructure. In April 2010, it invested $50 million in a regional Indian newspaper, "Jagran Prakashan." Chapter 11 Private Equity 9 11.3 Venture Capital . Venture Capital is part of the private equity market. In return for the venture capital, companies have to offer a share in their ownership. Venture capital investments can be in different stages of business. However, it is usually made in the early stages because those investments are more likely to yield high returns. To compensate for some likely venture failures, high returns on some of these investments are required for venture capitalists to be willing to take on the risks associated with these high growth businesses. Chapter 11 Private Equity 10 11.4 Stages of Venture Capital Financing Seed Money Start-up 1st Round 2nd Round 3rd Round 4th Round Chapter 11 Private Equity 11 1) Seed-money stage . Seed money is the initial equity capital needed to start a new business. The initial capital money is used to develop a product or prove a concept. It is usually a small amount of financing and does not include marketing. 2) Start-up . Financing for companies that were started within the past year. The funds usually include marketing and product development expenditures. 3) First-round funding . After the company has spent the start-up funds, additional capital is provided to begin sales and manufacturing. 4) Second-round funding . Funds provided for the working capital needs of a company whose product is selling but still losing money. 5) Third-round funding . Financing for a company that is at least breaking even and is considering expansion. This is also known as mezzanine funding. 6) Fourth-round funding . Funds provided to companies that are likely to go public within half a year. This is also called bridge financing. Chapter 11 Private Equity 12 . An IPO is the next stage after venture capital financing. As mentioned before, venture capital funds are significant players in the IPOs. It is the norm that venture capitalists do not sell their shares when one of their portfolio companies goes through an IPO. Instead, they usually sell out in subsequent public offerings. The maximum number of companies need seed capital. Then as they progressively move up the pyramid, number of companies requiring funding reduces. And they move up the pyramid, the investment size increases. An informal survey shows that most of the companies die off in the seed financing stage itself. Current trends indicate that only 27% of companies that are seed funded actually raise the required angel round. 16% of the companies shut down at the Seed stage. Chapter 11 Private Equity 13 11.5 Venture Capital Process . Venture Capitalists invest in private businesses to make profit. They attract most of their financial resources from sophisticated institutional investors.