An Overview of Private Equity Investments


By

Akhil Bansal
PGDM (2006-08 Batch)
Alliance Business School
Bangalore
 


Preface:

Capital to a company is like life in human body. The companies engaged in the traditional line of business procure necessary financial capital from the public issues, financial institutions, commercial banks, mutual funds, lease financing, debt instruments, hire purchase etc. But the companies face great difficulty while raising capital for newly floated companies as at the initial stages of the business the risk is very high and the return is uncertain.

Similarly, small-scale enterprises (SSE's) are also unable to raise funds because it is highly risky venture, are less profitable and do not possess adequate tangible assets to offer as security. So, they have two options left- either to raise capital through IPO or to obtain loans. But most of the SSE's are unable to fulfill the listing requirements in terms of sales and minimum size of share issues. Moreover, common investors hesitate to invest in such companies even though the growth rate is high because of high degree of risk involved. As far as loans are concerned, lenders charge relatively high rate of interest to compensate for the high degree of risk involved.   

The spectacular success of companies like GE, Microsoft, Federal Express, Infosys and Reliance give a sense that new venture creation is a sign of future productivity gains. So how shall such companies be financed? The Private Equity market is an important source of funds for new firms, private middle-market firms, firms in financial distress, and public firms seeking buyout financing. Over the last 15 years it has been the fastest growing market for corporate finance as compared to bond market, private equity and others. Today the private equity market is roughly one-sixth the size of the commercial bank loan and commercial paper markets in terms of outstandings, and in recent years private equity capital raised by partnerships has matched, and sometimes exceeded, funds raised through initial public offerings and gross issuance of public high-yield corporate bonds.

Here, we will discuss about the foundation of private equity market, analyze the current market scenario, its role in corporate finance and the laws governing the private equity/venture capital investment in India.

INTRODUCTION:

Private equity is a broad term that refers to any type of equity investment in an asset in which the equity is not freely tradable on a public stock market. Private Equity securities are the stocks in companies that are not listed on the stock exchange. The private equity investment include leveraged buyout, venture capital, growth capital, angel investing, mezzanine capital etc. Private equity funds takes the control management of the companies in which they invest, and often bring in new management teams that focus on making the company more valuable.

Leveraged Buyout: The PE funds provide capital for purchasing the company or the controlling stake in it using debt and equity capital. As the term leverage implies it involves using more of debt than equity. The buyout can be Management Buy In (MBI) or Management Buy Out (MBO).

Angle Investing: It refers to investment in small closely held companies by wealthy individuals, in which they generally have some operational experience. They may have substantial ownership stakes and may be active in advising the company, but they generally are not as active as professional managers in monitoring the company and rarely exercise control.

Venture Capital: It refers to long term equity investment in novel technology based projects which display potential for significant growt and financial returns. It provides seed, start up and first stage financing to these industrial enterprises.

Growth Capital: Growth capital is a very flexible type of financing. The money borrowed under a growth capital line of credit can be used for any corporate purposes. There are no requirements to provide invoices or other backup material when borrowing under this type of facility, so administration is simplified as well. Growth capital can be a beneficial way to extend a company's runway between rounds of financing. The extra time can be used to complete additional milestones that will raise the company's valuation, or as insurance to ensure that all intended milestones are successfully accomplished.

Mezzanine Capital: It refers to investment in those companies that have already proven their viability but still have to raise money from the public market. It is associated with the middle layer of financing in leveraged buy-outs. 

Private equity funds are the pools of capital invested by private equity firms. They are generally organized as limited partnerships which are controlled by the private equity firm that acts as the general partner. The limited partnership is often called 'Management Company'. The fund obtains capital commitments from certain qualified investors such as pension funds, financial institutions and wealthy individuals to invest a specified amount. These investors become passive limited partners in the fund partnership and when the general partner identifies an appropriate investment opportunity, it is entitled to call for drawdown i.e. the required equity capital each limited partner contribute to fund on pro rata portion of its commitment. All investment decisions are made by the General Partner which also manages the portfolio.The normal lifetime of a fund is about 10 years. Over its lifetime it make various investments and usually the amount invested in each investment is not more than 10%.

General partners, who are responsible for fund management, are typically compensated with a management fee i.e. a percentage of the fund's total equity capital. In addition, the general partner usually is entitled to carried interest i.e. performance based fee, based on the profits generated by the fund. Typically, the general partner will receive an annual management fee of 2% to 4% of committed capital and carried interest of 20% of profits above some target rate of return called hurdle rate.

A variety of groups invest in Private Equity Market. Public Pension Funds and Corporate Pension Funds accounts for 50% of the total market. Other investors include Endowment Funds, Insurance Companies, Banks, Non-Financial Corporations and others.


The Organized Private Equity market consists of four players:

    1. Issuers - It refers to the companies that cannot raise or have opted to raise capital through the private equity market for various reasons like to develop new product and technologies, to make acquisition or to strengthen the  balance sheet.

    2. Intermediaries- It refers to the fund under management. Typically 80% of the global private equity investment is managed by the funds on the limited partnership model. Other intermediaries like Small Business Investment Companies (SBIC's) accounts for a marginal share of private equity market.

    3. Investors- A wide variety of people invest in private equity funds. Public and corporate Pension Funds accounts for 40% of global capital outstandings. Endowment Funds and wealthy individuals, each accounts for aprox. 10% of outstandings. The other investors include insurance companies, investment banks and non-banking financial corporations.

    4. Agents and Advisors - With the coming up of various private equity funds, the role of agents and advisors are all more important. They act as information disseminators. They perform two functions:

    • They identify the potential private equity funds, evaluate them and provide information to investors.
    • They help funds raise capital. They often negotiate the terms on behalf of their clients to obtain better terms.

HISTORY OF PRIVATE EQUITY

The organized private equity investments started way back in 1946 with the establishment of American Research and Development Corporation (ARD). Its founders are Ralph Flanders, President of Federal Reserve Bank of Boston and General George Doriot, a Harvard Business professor. The basic purpose of ARD was

  • To devise a private sector solution to the lack of financing for new enterprises and new business.
  • To create an institution that provides managerial expertise as well as capital to business.
  • To manage venture capital of wealthy families such as Paysons, Rockefelers and Whitneys.
  • Initially ARD failed to attract much interest among institutional investors. The company was able to raise only $3.5 mn of the $5 mn it hoped to raise in 1946. In 1959, Small Business Investment Companies (SBIC's) are organized. SBIC's are private corporations licensed by Small Business Administrations (SBA) to provide professionally managed capital to risky companies. But they have several limitations:

    • All SBIC's did not provide equity finance to new ventures. SBIC's who took loans to take advantage of leverage are required to meet out their interest obligations. So, they preferred to invest in companies with positive cash flows.
    • SBIC's attracted only individuals rather than Institutional Investors.
    • They failed to attract individual managers of highest caliber.

But inspite of all these limitations, they managed to raise $464 mn of which $350 mn was through public offerings. In mid 1970, the market for IPO's virtually disappeared especially for small firms. The venture capital cooled down due to poor exit conditions. Moreover, they were forced to invest in the companies already in their portfolio leaving limited scope for new investment.

In 1980, the surge in private equity commitments was mainly towards venture capital. The total commitments increased from $600 mn in 1980 to $3 bn in 1984. This big boost was mainly due to successful investment in companies like Apple Computers, Intel, Genentech, Federal Express, Tandem Computers and lot many.

Untill 1980, funds for non-venture private equity came from venture capital partnership and informal investor group organized by investment bank and other agents. Non-venture partnership received a commitment of $1.8 bn in 1983, $6.8 bn in 1986, $14.6 bn in 1987. In the same year, KKR's record $5.6 bn fund was almost twice the all venture capital raised during the same period. Commitment to both LBO and Mezzanine funds peaked in late 1980's.

FUND RAISING

Since, the partnerships have finite lives, the private equity managers who serve as general partners must regularly raise new funds in order to stay in business. In fact, to invest in portfolio companies on a continuing basis, managers must raise a new partnership once the funds from the existing partnership are fully invested. The fund raising-investment cycle last from three to five years.

The fund raising is very time consuming and costly exercise, involving presentations to institutional investors and their advisors that can take from two months to well over a year depending on the general partners' reputation and experience.

To minimize their fund-raising expenses, partnership managers generally turn first to those that invested in their previous partnerships. In addition, funds are often raised in several stages, referred to as 'closings', to get a favorable evaluation of the fund by those that have already committed.

General Partners prefer investors that have a long-term commitment to private equity investing. Because past investors are most familiar with a general partner's ability, general partners face greater difficulties when experienced investors withdraw from the market. For instance, insurance companies drastically reduced their commitments to private equity in 1990 owing to concerns among the public about insurance companies financial condition. More recently, IBM, a major corporate pension fund investor, withdrew from the private equity market as part of a broad reduction in pension staff.

SELECTING INVESTMENT

The success of private equity funds depends on the selection of right kind of investment. General partners rely on relationships with investment bankers, brokers, consultants, lawyers, and accountants to obtain leads; they also count on referrals from firms they successfully financed in the past. Economies of scale apparently play an important role in dealflow: The larger the number of investments a partnership is involved in, the larger the number of investment opportunities it is exposed to.

Partnership managers receive hundreds of investment proposals. To be successful, they must be able to select efficiently the approximately 1 percent of these proposals that they invest in each year. Efficient selection is properly regarded as more art than science and depends on the acumen of the general partners acquired through experience operating businesses as well as experience in the private equity field.

Investment proposals are first screened to eliminate those that are unpromising or that fail to meet the partnership's investment criteria. Private equity partnerships typically specialize by type of investment as well as by industry and location of the investment.

Proposals that survive these preliminary reviews become the subject of a more comprehensive due diligence process that can last up to six weeks. This phase includes visits to the firm; meetings and telephone discussions with key employees, customers, suppliers, and creditors; and the retention of outside lawyers, accountants, and industry consultants.

The private equity funds cooperate with one another through syndication especially because of the restriction of a partnership fund that can be invested in single deal. When deals are syndicated, the lead investor—generally the partnership that finds and initiates the deal—structures the deal and performs the majority of due diligence. While, the majority of later-stage venture capital and middle-market buyout investments are syndicated, early-stage new ventures are more likely to be financed entirely by a single partnership.

MANAGING INVESTMENTS

After investments are made, general partners are active not only in monitoring and governing their portfolio companies but also in providing an array of consulting services. General partners help design compensation packages for senior managers, replace senior managers as necessary, and stay abreast of the company's financial condition through regular board meetings and interim financial reports. They also remain informed through informal contacts with second and third-level managers that they established during the due diligence process.

General partners provide assistance by helping companies arrange additional financing, hire top management, and recruit knowledgeable board members. They also may become involved in solving major operational problems, evaluating capital expenditures, and developing the company's long-term strategy.

They exercise due control by dominating the board of portfolio companies. Even in minority investments, they appoint atleast one member on the board. The other methods can be through acquisition of voting rights and by controlling the additional finance requirements of portfolio companies. 

The degree of involvement varies with the type of investment. Involvement is greatest in new ventures—for which the quality of management is viewed as a key determinant of success or failure—and in certain non-venture situations—for which improving managerial performance is one of the primary purposes of the investment (for example, leveraged buyouts). For these two types of firms, private equity investors typically are also majority owners, so the investors have even greater incentive, as well as authority, to become involved in the company's decision making.

Even when the degree of involvement is lowest—for example, when a partnership is a minority investor in large private or public companies—general partners may spend as much as a third of their time with portfolio companies. A partnership rarely is a completely passive investor; an exception is the case of syndication, when other partnerships may allow the lead investor to take the active role.

Exiting Investments

General Partners have an obligation to return the capital to limited partners within a specified period of time based on contractual agreement. The three possible exit routes are a public offering, a private sale, and a share repurchase by the company.

Public Offering- IPO is a win-win situation for both private equity fund and issuer company. A public offering generally results in the highest valuation of a company and, thus, is often the preferred exit route. The company management favors an IPO because it preserves the firm's independence and provides it with continued access to capital by creating a liquid market for the firm's securities. However, a public offering, unlike a private sale, usually does not end the partnership's involvement with the firm. The partnership may be restricted from selling any or a portion of its shares in the offering.

Private Sale- It is preferred by general and limited partners as it provides payment in cash or marketable securities and ends the partnership's involvement with the firm. But the company's management dislikes the private sale to the extent that the company is merged with or acquired by a larger company and cannot remain independent.

Buyback of Shares by Company - The third exit route is a put of stock back to the firm, in the case of common stock, or a mandatory redemption, in the case of preferred shares. With puts of common stock, a valuation algorithm is agreed to in advance. For minority investments, a guaranteed buyout provision is essential, as it is the only means by which the partnership firm can be assured of liquidity. However, buybacks by the firm are considered a backup exit route and are used primarily when the investment has been unsuccessful.

Sale to another PE Fund- The general partners may liquidate their investments by selling their stake to another private equity fund. General and limited partners generally prefer this route as it provides immediate liquidation of their investments.

GLOBAL SCENARIO

2006 turned to be a remarkable year for the private equity funds. Global mergers and acquisitions received a big boost-topped to $3.8 trillion, a bump of 38% of which 20% was financed by private equity buyers. The large portion of the deals was handled by Goldman Sachs and Citigroup. Goldman Sachs took the crown for advising on the largest volume of global announced deals. It advised on $1.09 trillion in deals, for a 28.6% market share.

Perhaps more surprising was last year's showing by Citigroup, which leaped from fifth place in 2005 to second last year. Citigroup advised on $1.03 trillion in transactions, claiming a 27.2 percent market share (Thomson Financial). Morgan Stanley, which was number 2 in 2005, fell to 3rd slot in 2006, advising on $975 bn in global deals for 25.7% market share.

In 2005, no single investment banker cracked the $1 trillion mark. Goldman Sachs worked on the deals worth $951 bn, Morgan Stanley $720 bn and Citigroup $695 bn.

According to Private Equity Intelligence 2007, a record $401 bn was raised worldwide in new commitments. A total of 612 new funds held a final close during 2006.US-focused funds continued to dominate the market, taking 63% of the global share in terms of new commitments. Europe, managed to hold the second spot with 27% of all capital raised in last being committed to funds in this region. Asian and rest of world funds also grew marginally, raising 5% more than 2005.

In total 311 US-focused funds raised an aggregate $252 bn, while 168 Europe-focused funds raised an aggregate $108 bn. The 133 Asian and rest of the world funds raised an aggregate of $41 bn.

Real estate funds continued to be increasingly popular with investors, while natural resources and infrastructure funds have also been successful to great extent.

There were 175 buyout and co-investment funds raised, attracting an aggregate $204 bn during 2006, with $96 bn of this coming from just 10 mega-funds greater than $5 bn in size. Real estate private equity funds raised an aggregate $53 bn from 79 new funds in 2006.In total 174 venture funds achieved a final close in 2006 collecting $42 bn in new commitments, while 65 Fund of funds raised an aggregate $23 bn.

2006 was a remarkable year for mergers and acquisitions in general. Some of the major deals in the last year are:

  • Equity Office Properties Trust, the US's largest publicly held office-building owner for $36 bn by Blackstone Group.
  • US hospital chain HCA Inc. for $33 bn by syndication of KKR, Bain Capital, and Merrill Lynch Global Private Equity.
  • Radio chain owner Clear Channel Communications for $27 bn by Bain Capital and Thomas H. Lee.
  • Electronics firm Freescale Semiconductor for $17.6 bn by Blackstone and others.
  • Natural gas pipeline company Kinder Morgan for $22 bn by Goldman Sachs equity group, AIG equity group, a private investor.
  • The acquisition of Harrah's, the world's number 1 casino company in $17 bn by Texas Pacific Group and Apollo Management outbidding a strategic buyer , the casino firm Penn National Gaming.

Private Equity deal volumes since 1996


The Private Equity Deal volumes show a continuous increase since 1996. It has increased from $34 bn in 1996 to $137 bn in 2000. But it declined sharply in 2001 due to DOTCOM BUBBLE BURST. The Private Equity investments in the upcoming Information Technology Sector declined to $72 bn in 2001. The PE investments improved in the coming years with the strengthing of global economy. The total PE deal volumes stood at $738.10 bn in 2006.

SECTORAL ANALYSIS OF PRIVATE EQUITY DEALS

INDUSTRY

VALUE ($ Billions)

NO. OF DEALS

Media & Entertainment

154.6

325

Industrials

99.9

513

Real Estate

85.2

100

Health Care

76.8

194

Retail

62.4

210

High Technology

60.7

372

Consumer Product & Services

56.2

448

Energy & Power

53.4

146

Financials

31.9

203

Materials

32.2

272

Total

738.1

3052


Top Ten Private Equity Dealmakers In 2006

Acquiring firms

VALUE ($ Billions)

NO. OF DEALS

Texas Pacific Group Inc.

100

16

Blackstone Group LP

93.1

19

Bain Capital Partners LLC

84.8

12

Kohlberg Kravis Roberts & Co.

77.7

13

Carlyle Group LLC

71.9

32

Thomas H. Lee Partners LP

64.6

7

GS Capital Partners LP

55.8

6

Apollo Management LP

48.7

9

Cereberus Capital Management LP

34.2

9

Merrill Lynch Global Private Equity

32.5

2


PRIVATE EQUITY IN INDIA

A decade ago, India did not figure in most investors definitions of "Asia"- or at least not in a major way. During those times, the investors were attracted to destinations like Indonesia and Thailand. Initially, private equity came into India in the form of early stage/venture capital, particularly in the IT and IT-enabled services, and telecom sectors.

It was telecommunications that ignited interest in India in March, 2005, when the international private equity firm Warburg Pincus sold a $560 million stake in Bharti Tele-ventures, India's largest publicly traded mobile telephone company. Warburg Pincus has made $1.1 billion by selling off two-thirds of its 18% share in Bharti, which was acquired at $300 million, made in stages between 1999 and 2001. The shares, offered in the Bombay Stock Exchange(BSE), was consummated in a breathtaking 28 minutes, which revealed to the world the depth and maturity of the Indian equity market.

This deal ignited the interests of Private Equity firms not only within India, but also around the world. Private equity investors from around the world are increasing their bets on Indian corporates or making new ones. That includes big-name U.S. firms like Blackstone Group, Texas Pacific Group, Kohlberg, Kravis and Robert's (KKR), Carlyle Group and General Atlantic Partners, and Britain's Actis Partners. Local firms such as ICICI Venture Funds Management Ltd. and Kotak are also stepping up investments.

There has been a tremendous increase in the pace in which deals are being made. In the first nine months of 2006, India saw 329 venture capital and private-equity investments worth a total of $5.9 billion -- more than double the tally for 2005 -- with some 60% coming from foreign players, according to researcher Venture Intelligence India. Private equity investment in India shot up by over 230 per cent in 2006, owing to the growing interest of equity funds in domestic companies and high returns from the stock markets here. Private equity fund investment in 2006 was $7.46 billion, up from $2.26 billion a year earlier, according to industry tracking firm Venture Intelligence. The size of deals is growing, too: from around $8 million four years ago to an average of $25 million today.

The record for 2006 was set by Idea Cellular, which in November received $950 million from a clutch of investors including Providence Equity Partners, ChrysCapital, Citigroup, and Spinnaker Capital. The second largest deal was the $900-million buyout by Kohlberg Kravis Roberts and Co, one of the largest PE funds in the US, for 85 per cent in Flextronics Software. Singapore's Temasek bought 10 per cent stake in Tata Teleservices for $360 million, Farallon invested $143 million in Indiabulls Financial and Warburg Pincus acquired 27 per cent stake in Lemon Tree Hotels.

A new benchmark may be on the horizon: Reliance Communications is in talks with private-equity players such as Blackstone, Texas Pacific, and KKR to fund its $10 billion bid for cellular carrier Hutchison Essar.

Private equity emerged as the single largest investor class driving equity deals in India in 2006, overtaking both foreign and domestic strategic investors. PE investment in India also broke through the global average (20%) of investment as a proportion of total merger & acquisition (M&A) deals by accounting for 28% of the total deals in India by value, which touched $28.16 billion in 2006. Some of the sectors that are of interest to the private equity firms recently are micro-finance and real estate. They have also indulged in the purchase of stressed assets, from asset reconstruction companies, who have acquired them from the banking system. The purchase of OCM Textiles by Wilbur Ross from ARCIL is a case in this point.

While the traditional route for private equity firms is to buy a controlling stake in struggling, mature corporations and then try to turn them around, in an emerging economy such as India, these firms act more like venture capitalists. They look for promising companies in industries ranging from tech to textiles and seek to give them a boost, doing everything from injecting more capital for expansion to holding the hand of management and providing strategic guidance.

Private equity investment in India shot up by over 230 per cent in 2006, owing to the growing interest of equity funds in domestic companies and high returns from the stock markets here. Private equity fund investment in 2006 was $7.46 billion, up from $2.26 billion a year earlier, according to industry tracking firm Venture Intelligence. Private equity deals were led by the technology sector with 87 deals for $1.47 billion, up from 46 deals for $434 million in 2005. Private investment in listed companies fell to 22 per cent of total deals, from 34 per cent a year earlier.

There have been a few significant management buyouts in the recent past in the Indian PE industry. Some examples are Actis' acquisition of significant stakes in Nilgiris, Phoenix Lamps, Paras Pharma etc; Navis Capital Partners' acquisition of Nirulas, ICICI Venture acquisition of controlling stake in Tata Infomedia, CDC's Capital Partners acquisition of ICI India's industrial Chemical etc.

Some of the reasons for the heightened interest in the Indian economy are:

    • The Indian stock market is comparatively liquid and transparent. The Bombay Stock Exchange's benchmark Sensex index is up 42% since January, spurred in part by IPOs for 15 private-equity-backed companies that raised a total of $887 million. The Bombay Stock Exchange has the largest number of listed stocks- 7000stocks.
    • Another selling point is an abundance of family-owned companies. Although Indian clans have traditionally been reluctant to give up management control, the younger generation is often prepared to trade away a chunk of the company in exchange for cash and some advice on beefing up sales.
    • India offers investors better trained managers and more corporate transparency in the private sector.
    • The Indian courts are a fairly reliable arbiter of investors' rights.

REGULATORY FRAMEWORK

The SEBI Regulations, among others, specify the investment criteria for venture capital and private equity investors seeking to invest in Indian companies. A foreign venture capital investor proposing to carry on venture capital activity in India may register with the Securities and Exchange Board of India (SEBI), subject to fulfilling the eligibility criteria and other requirements contained in the SEBI FVCI Regulations.

Eligibility Criteria - For granting the certificate to an applicant as a Foreign Venture Capital Investor, the Board shall consider the following conditions for eligibility:  

  • The applicants track record, professional competence, financial soundness, experience, general reputation of fairness and integrity.
  • Whether the applicant has been granted necessary approval by the Reserve Bank of India for making investments in India.
  • Whether the applicant is an investment company, investment trust, investment partnership, pension fund, mutual fund, endowment fund, university fund, charitable institution or any other entity incorporated outside India.
  • Whether the applicant is an asset management company, investment manager or investment management company or any other investment vehicle incorporated outside India.
  • Whether the applicant is authorised to invest in venture capital fund or carry on activity as a foreign venture capital investors.
  • Whether the applicant is regulated by an appropriate foreign regulatory authority or is an income tax payer; or submits a certificate from its banker of its or its promoter's track record where the applicant is neither a regulated entity nor an income tax payer.
  • The applicant has not been refused a certificate by the Board.
  • Whether the applicant is a fit and proper person.

The SEBI FVCI Regulations prescribe the following investment guidelines, which can impact overall financing plans of foreign venture capital funds.

a) The foreign venture capital investor must disclose its investment strategy and life cycle to SEBI, and it must achieve the investment conditions by the end of its life cycle.

b) At least 66.67% of the investible funds must be invested in unlisted equity shares or equity linked instruments.

c) Not more than 33.33% of the investible funds may be invested by way of:

(i) subscription to initial public offer of a venture capital undertaking, whose shares are proposed to be listed.

(ii) debt or debt instrument of a venture capital undertaking in which the foreign venture capital investor has already made an investment, by way of equity.

(iii) preferential allotment of equity shares of a listed company, subject to a lock-in period of one year.

(iv) the equity shares or equity linked instruments of a financially weak or a sick industrial company whose shares are listed.

Apart from tax exemptions, one key advantage of registering under the SEBI FVCI Regulations is that at the time of an IPO of the investee company, a SEBI-registered foreign venture capital investor will not be subject to the one-year lock-in period in respect of pre-issue share capital held by it.

FEMA REGULATIONS prescribe the manner in which a foreign venture capital investor can make investments. A foreign venture capital investor, can through SEBI, apply to the Reserve Bank of India (RBI) for permission to invest in an Indian venture capital undertaking, a venture capital fund or in a scheme floated by a venture capital fund. The consideration amount for investment can be paid out of inward remittances from abroad through normal banking channels. Subject to RBI approval, a foreign venture capital investor can maintain a foreign currency or rupee account with an authorized Indian bank. The funds held in such accounts can be used for investment purposes.

The FEMA Regulations prescribe the sectoral limits on foreign investments into India. A company, which is inter alia engaged in the print media sector, atomic energy and related projects, broadcasting, postal services, defence and agricultural activities, must obtain the approval of the Foreign Investment Promotion Board or Secretariat of Industrial Assistance, depending on the quantum of investment, before issuing shares to a foreign venture capital investor situated abroad.

INCOME TAX ACT, 1961- The income of venture capital companies or funds set up to raise funds for investment in venture capital undertakings is tax exempt, if they are registered with SEBI and in compliance with Indian government and SEBI Regulations. The income of such companies and/or funds will continue to be exempt, if the undertaking in which its funds are invested, subsequent to the investment, gets listed on a stock exchange.

Venture capital companies or funds are exempt from withholding tax in respect of income distributed to their investors. The provisions of the IT Act regarding taxation on distributed profits (dividend), distributed income and deduction of tax at source do not apply to venture capital companies or funds.

PROCEDURE FOR ACTION IN CASE OF DEFAULT- The FIPB has the right to suspend or cancel certificate of registration. Without prejudice to the appropriate directions or measures under regulation 19, it may after consideration of the investigation report, initiate action for suspension or cancellation of the registration of such Foreign Venture Capital Investor:

The board may suspend the certificate-

  • contravenes any of the provisions of the Act or these regulations;
  • fails to furnish any information relating to its activity as a Foreign Venture Capital Investor as required by the Board;
  • furnishes to the Board information which is false or misleading in any material particular;
  • does not submit periodic returns or reports as required by the Board;
  • does not co-operate in any enquiry or inspection conducted by the Board.

The board may cancel the certificate-

  • When the Foreign Venture Capital Investor is guilty of fraud or has been convicted of an offence involving moral turpitude;
  • the Foreign Venture Capital Investor has been guilty of repeated defaults of the nature mentioned in the regulation 21; or
  • Foreign Venture Capital Investor does not continue to meet the eligibility criteria laid down in these regulations.

CONCLUSION

The increased realization among Private Equity players that they will have to look at India and China to drive their future growth shows that there will be increased activity by private equity players in the coming years. The interest in the Indian market is growing as the Indian market is clearly maturing, which will see more players entering the fray, both domestic as well as foreign. It is more likely that Private Equity firms will be targeting Small and Medium enterprises (SMEs). They will primarily focus on Healthcare, Manufacturing and Retail Supply Chain that would take India to the next level in the global economy.

As India's economy continues to open up, private-equity investors are starting to diversify away from telecommunications and outsourcing. These days, health care, food, real estate, travel, and more are heating up. And the opportunities are expanding in newly deregulated industries such as cellular telecom and broadband, airlines, and port infrastructure. It can be expected that with the deregulation of several other industries like retail, etc., the investments by Private Equity firms is likely to increase in a substantial way.

Even with the obstacles, India's compelling growth story forms a powerful counterweight owing to a superior educational system, India boasts a talent pool of more than 23 million young professionals, which is growing by nearly half a million annually. Growth in the IT and outsourcing sector is expected to fuel expansion in disposable income, by 8.5 percent each year through 2015.

As an expanding middle class of 250 million is exposed to western products and culture, demand for consumer products will continue to explode. In September 2006, India recorded a monthly trade deficit in September of $5.33 billion, a reflection of the country's hunger for imports. If current trends continue, India will be among the world's three largest economies by 2050. International PE cannot afford to miss out on what may be the world's most dramatic economic transformation of the next decade.

References:

    1. www.gt-india.com
    2. www.wsj.com
    3. www.businessindia.com
    4. www.economictimes.com
    5. www.hindu.com
    6. www.sebi.com
    7. www.rbi.com
     


Akhil Bansal
PGDM (2006-08 Batch)
Alliance Business School
Bangalore
 

Source: E-mail August 23, 2007

 

       

 

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