Private Equity in India

The Indian capital markets are now in the developing stage. Ever since the economy of the nation was liberalized in 1991, different types of investors have tried their hand in the Indian capital markets. Private equity investors are one such class of investors. Back in 1991, the industry was almost non-existent. However, now in 2019, there is a full-fledged private equity sector which invests in all stages right from seed capital to leveraged buyouts.

The sector has grown rapidly during these years. However, it still faces a lot of challenges, many of which are uniquely Indian. In this article, we will have a closer look at some of the growth of the private equity industry as well as some of the challenges that it faces.

The growth of the Indian Private Equity Industry

The Indian private equity industry has grown by leaps and bounds. The total market capitalization of the entire industry stood at a mere $2 billion in the year 2004. Within 15 years, the size of the market has grown over 20 times. The current value of the entire private equity market is estimated to be in the ballpark of $40 billion.

This massive growth in the market has been largely driven by the sudden increase in deal size. Private equity investors claim that in the year 2004, a deal valued at $100 million was extremely rare. However, now in 2019, almost 70% of the deals which happen in the private equity space are worth more than $100 million.

The reason for the increase in these private equity deals is manifold.

  • Firstly, Indian capital markets are maturing. This means that family-owned companies are now not being simply passed on to the next generation. In many cases, family-owned businesses are selling their stake and allowing professional managers to run the show
  • Secondly, a new generation of entrepreneurs is now present in India. These are people with a deep understanding of technology and business. However, a lot of these people do not have the capital required to create a business. This is where private equity companies come in. Some of the biggest start-ups in India have been created by founders who have invested very little wealth of their own.
  • Lastly, there are several conglomerates which had diversified into unrelated businesses during the 1990s. These diversifications were made because there was no competition at the time and inefficient companies could also hold on to market share. However, now since global companies have come to India, a lot of these businesses have become unviable. Conglomerates are therefore looking to sell off these businesses. Such spin-offs account for a large chunk of the private equity activity which is happening in India at the moment.

Issues Faced By Private Equity Companies

There are several issues which are being faced by private equity companies in India. Some of them have been listed below.

  • Lack of Well Developed Market: In the United States as well as in Europe, private equity companies are known for making leveraged deals. Hence, they use the debt markets to augment their own equity. However, in India, the debt markets are not so mature. The creation of credit is mostly controlled by the government and a few private banks. These entities are not comfortable investing money in private equity transactions. This is the reason why such transactions are not highly levered in India as they are in other countries.
  • Opacity Issues: Also, there is a uniquely Indian problem of the promoters not being ethical. Across the world, private equity firms constantly assume that the founders (promoters) are most invested in their companies. However, in India, private equity firms have to be careful not to overvalue the firm. If the firm is overvalued, there is a high chance that the promoter itself may try to exit the firm. Many high profile Indian businessmen have simply left the country after they were able to obtain more loan for their companies than the company was worth! The moral hazard is always present. However, it is higher in the case of Indian companies.
  • Regulatory Changes: The government of India also has a habit of making ad hoc changes to the regulatory environment which ends up changing the feasibility of the entire industry. For example, after private equity funds had invested heavily in the microfinance industry, the government changed some rules. As a result, a lot of the borrowers simply stopped paying back the loans. The end result was that the private equity companies had to mark down a lot of their investments.

The same case has happened with e-commerce companies as well. A lot of foreign investors have already invested billions of dollars in the Indian e-commerce business. However, the government decided to change the rules suddenly. This left the private equity companies in the lurch, and they suffered massive losses. In some cases, the government of India has also introduced back taxes.

The bottom line is that there is still a lot of scope of improvement. If the Indian government is able to address some of the issues mentioned above, the size of the private equity industry may increase at an even more rapid pace.

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