A Private Equity (‘PE’) fund is a fund which invests its money in private equity, usually to gain control over companies in order to re-structure the company. When the fund takes control of a company, it normally takes the company off the market (that is if the company is not private already), restructures the company, and then relists it on the stock market.  A PE fund is raised and managed by investment professionals of a specific PE firm. Typically, a single PE firm will manage a series of distinct PE funds and will attempt to raise a new fund every 3 to 5 years as the previous fund is fully invested.  PE is an asset class of equity shares that are not publicly traded on a stock exchange. It is medium to long-term finance provided in return for an equity stake in potentially high growth unquoted companies. Some commentators use the term PE to refer only to the buy-out and buy-in investment sector.  Others, in Europe, but not the USA, use the term Venture Capital (‘VC’) to cover all stages of PE. In the USA, VC refers only to investments in early stage and expanding companies.  To avoid confusion, the researcher has used the term PE throughout this project to describe the industry as a whole, encompassing both VC and management buy-outs and buy-ins. Foreign VC funds have been permitted to operate in India since 1995. India’s PE sector has shown tremendous growth rates. To look at figures, there had been a dramatic increase in fund sizes from US $10 to US $25 million just a few years ago, to between US $400 million and US $ 1 billion in 2007 (before the global economic crisis). The average deal size was around US $25 million, as opposed to US $8 million in 2002. These figures clearly indicate the tremendous global interest in the Indian market  . In the course of the project, the researcher would first try to analyze the sufficiency/insufficiency of the law relating to the PE investment in India. Thereafter, the managerial structural set up of a PE fund shall be discussed. The researcher will then look into the advantages and disadvantages of PE investment, especially in regard to the Indian investment scenario. Regulation of the PE Industry in India – Venture Capital Regulation Until 2000, SEBI only regulated the domestic funds vide the SEBI Venture Capital Fund Regulations, 1996 and there was no mechanism to regulate the foreign investors. This put the domestic investors at a disadvantage, especially since foreign investment in most sectors was through the automatic route (i.e. direct exposure by offshore PE funds in shares of unlisted companies was treated as a foreign direct investment and had to be approved in line with the Government’s general policy on foreign investments). The Government realized the need to regulate the same. In September 2000, SEBI issued a new set of regulations applicable to offshore funds, called SEBI (Foreign Venture Capital Investors) Regulations, 2000 (‘the 2000 Regulations’). The 2000 Regulations are based on the recommendations of the Chandrashekhar Committee on Venture Capital (January 2000). These regulations were subsequently amended a number of times. As of now, with respect to investment by a foreign VC investor, it is mandatory for the investor to disclose its investment strategy. Prior to the 2004 amendment, the investor was not allowed to invest more than 25 percent of the funds committed for investments to India in one VC undertaking. However, after the amendment, an investor can now invest its total funds committed in one venture capital fund. Another significant amendment was made to sub-clause c of clause 11. Before 2004, an investor had to invest atleast 75 percent of the investible funds in unlisted equity shares of VC undertaking and not more than 25 percent while subscribing to an initial public offering (‘IPO’) of a VC undertaking. The investments were also subject to a lock-in period of one year. However, subsequent to the 2004 amendment, the percentages have been changed to 66.67% in the first case and 33.33% in the latter. The amendment has done away with the lock-in period requirement and has also introduced a provision for preferential allotment of equity shares of a listed company.  However, currently there are no legal or regulatory differences between venture capital and PE firms. SEBI is considering the idea of regulating PE funds.
PE funds have a general partner which raises capital from institutional investors, such as high net worth individuals, pension plans, insurance companies, endowments etc. These economically sound institutional investors invest as limited partners in the fund. This partnership is normally a fixed investment vehicle that is usually ten years in addition to some extensions. Also, a yearly payment has to be made by the investors in the PE fund to the fund’s manager to pay for the firm’s investment operations. Moreover, a relatively smaller share of the profits of the investments made by the fund has to be paid (as performance incentive) to the PE fund’s management company. The remaining profits are paid to the fund’s investors. However, this payment to the fund manager is subject to the crossing of the hurdle rate (which is the minimum rate of return which must be achieved before the fund manager can receive any carried interest payments). Advantages of PE funds Low Level of Regulation – As there is no public trading involved the regulation levels are low.  For example if one were to raise funding through a public offering one would have to satisfy several requirements under the SEBI. In addition to management benefits the current regulatory requirements have increased the desirability for many companies to either go private or postpone going public.  For example, especially in the USA, many business owners cite the costly, inflexible, and invasive disclosure requirements introduced by the Sarbanes Oxley legislation as reasons for forsaking publicly traded status.  Attractive valuation – PE transactions are an excellent way for owners wanting to remain private and obtain significant liquidity at an attractive valuation without having to transact an outright sale. In reality, not all PE investments are structured as complete buy-outs or even majority share purchases. Some investments are simply a capital infusion in exchange for a minority stake.  This is often referred to as growth capital as these investments help provide the necessary capital to get companies to the next level without having to turn to the public markets. All of these investments generally result in the PE firm obtaining a seat on the board of directors of the company. Functionally, this not only serves an important monitoring role but also provides added expertise to the board. PE firms either place their own primaries on the board or assign highly qualified business colleagues who provide valuable advice and perspectives. Additionally, since many of these appointees sit or have sat on multiple boards, they can provide the traditional advantages of inter mixing of ideas between companies to bring out better results.  In a typical PE transaction, the management team will still own a large percentage of the business through a combination of retained ownership and new stock options granted by the investor. Therefore, in three to seven years when the outside investor is ready to exit their investment, the management team will receive substantial additional value for the business.  Low level of interference- In a typical PE transaction, all shareholder guarantees are eliminated and day to day control remains with the management team. While most investors prefer to purchase over 50% of the equity, they have no interest in running the business on a daily basis. In addition to providing liquidity for the selling shareholders, PE firms will provide additional debt and equity capital for internal and external growth opportunities  . In most PE dealings, the management team has tremendous expansion plans but does not have the resources. These expansion plans could include opening new branch offices, entering a new line of products or services etc. PE investors are more than willing to provide the resources necessary to execute such expansion plans that are strategically sensible. Disadvantages of PE funds Lack of Liquidity- It is very hard to reconvert shares and this usually ends up as a disadvantage to share holders who invest in PE. It cannot be bought and sold at any time. Since PE funds are not open to investment on the stock market, anybody who wants to sell stocks of a PE fund finds it difficult to locate a buyer. Since PE returns derive from an appreciation in the value of the acquired asset or company, PE investments are often followed by efforts at restructuring to revive loss-making companies or substantially improving the performance of profit-making ones. These efforts are aimed at adding worth to the investment before PE investors exit with a profit. Less appreciated forms of intervention by PE firms are those in which bought out firms are stripped of assets or are broken up so that their parts can be sold to the highest bidder for an aggregate sale price that exceeds the purchase price. PE investments are relatively illiquid, especially in the early years. The usual life of a standard PE fund investment averages three to seven years. Investors in private securities by and large exit their investment and get returns through an initial public offering, a merger, or a recapitalisation. Since the companies are unlisted, investors wishing to exit their PE holding do so by selling the holding to someone else through the secondary market.  Control- One of the major disadvantages of financing through private equity is that the creators must give up some control of their business, which essentially means that in situations where investors have dissimilar ideas about the company’s strategy, or routine operations, they can be problematic for the business man. Furthermore, some sales of equity can be very intricate and expensive to manage and may need complicated legal work and a great deal of paperwork to ensure compliance with various regulations, which may necessitate procuring the services of attorneys and accountants.  Conclusion Private equity investment in India fell by almost sixty percent in 2009 as a consequence of the global financial crisis. However, looking at the state of investment prior to the crisis, and the kind of investment that has been flowing in after the markets have revived, the same is a clear indicator of the rapid expansion of private equity in emerging markets like India which have huge growth potential. However, the question that needs to be answered at this juncture is whether India is ready to handle such investments. The researcher suggests the affirmative in this regard, as there is sufficient evidence to see that the size of such investments has grown steadily, not only from domestic but also from foreign investors, over the last decade. The most recent examples of such investments involving massive infusion of capital would be Singapore-based Temasek Holdings investment worth Rs. 880 crore in GMR. Another example would be that of Summit Partners, a 25-year-old US based private equity fund (that has $11 billion under management), which made its first investment in India with an infusion of $30 million in agricultural biotech firm Krishidhan Seeds Ltd. In conclusion, the researcher would like to submit that the need of the hour is to ensure a smooth and transparent functioning of such private equity investments to facilitate their robust growth in India. With such rapid expansion in private equity there is a necessity for the regulation of the same. While venture capital is regulated by the SEBI there is a need to regulate all other forms of private equity by framing laws and regulations for the same.
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