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Coupled with the robust growth of the Indian economy, the Private Equity (“PE”) industry in India has been growing from strength to strength with total PE deals in 2017 valued at around USD 26.4 billion as opposed to USD 16.8 billion in 2016, an impressive increase of 57% (India Private Equity Report 2018 by Bain & Co). Factors propelling this unprecedented growth are positive actions taken by the Government of India to address non-performing assets in the economy, including the introduction and implementation of the Insolvency and Bankruptcy Code (“Code”), taxation reforms through a unified Goods and Services Tax mechanism, stable GDP growth and continuance of policy reforms, especially by way of further easing of sectoral restrictions on foreign direct investment (“FDI”).
Trends in the PE Industry
While PE investments have been made across the spectrum with much success, it is crucial to discuss a couple of trends witnessed over the course of last year in the PE industry, which are: (i) inclination amongst Indian promoters to dilute larger stakes for the right valuation, which wasn’t the case earlier, (ii) significant increase in large-ticket deals like investments by Softbank in Paytm, KKR and CPP Investment Board in Bharti Infratel, GIC in DLF Cybercity, etc., (iii) successful large exits, especially in the banking, financial services, insurance, consumer tech, media and telecom sectors like Softbank, Accel, Naspers and Tiger Global from Flipkart, Qatar Foundation Endowment from Bharti Airtel and Fairfax from ICICI Lombard, (iv) focus on quality over quantity, as evidenced by the fact that the top 15 deals in 2017 accounted for almost half the total PE deal value as opposed to the top 15 deals in 2016 constituting merely 30% of the total PE deal value., (v) Booming consumer business, including consumer-tech, food and beverages, retail and related industry, (vi) Renewed thrust in manufacturing and industries, owing to the Government’s Make in India policy, (vii) Interest in the insurance and defence sectors, which are still not attracting adequate attention owing to a 49% sectoral cap (FDI in defence sector can technically go up to 100% under the government approval route (Requiring the prior approval of the Reserve Bank of India (“RBI”) or the relevant sectoral department/ministry of the Government of India), but the stringent and ambiguous conditions are a major roadblock), whereas foreign investors look for a controlling stake.
It is widely believed that these trends will continue in the near future, and for good reason, since these have been a major contributor to the robust growth in the PE industry and in building confidence amongst the investor community at large.
Regulatory Changes Affecting Foreign Funds
It is pertinent to note that foreign funds have been instrumental in the blitz last year and hence their trepidations towards regulations governing foreign investments into India is quite understandable. The liberalisations introduced by the Government earlier this year to India’s FDI policy through the Press Note 1 of 2018 (“PN”) have been welcomed by the foreign investor community. A few significant changes brought about by this PN are: (i) Permitting 100% FDI under the automatic route (Not requiring the prior approval of the RBI or the relevant sectoral department/ministry of the Government of India) in Single Brand Retail Trading (“SBRT”), where only 49% was earlier permitted and that too under the government approval route. While most of the conditions attached to FDI in SBRT remain, some changes to the conditions have been announced, including permitting non-resident entities to conduct SBRT either directly or through a local entity, (ii) Permitting 100% FDI under the automatic route into an Indian company which is engaged only in the activity of investing in the capital of other Indian companies and in Core Investment Companies (Companies holding not less than 90% of their net assets in the form of investment in equity shares, preference shares, bonds, debentures, debt or loans in group companies and categorised as Non-Banking Financial Companies by the RBI). Earlier, such investments were allowed, but only through the government approval route. However, the automatic route is available only if the above activities are regulated by any financial sector regulator, (iii) Permitting issuance of shares against non-cash consideration for sectors allowing FDI under the automatic route, subject to certain conditions. Under the erstwhile FDI policy, issue of equity shares against non-cash consideration involving pre-incorporation expenses and import of machinery was only permitted under the government approval route. These recent changes should give a fillip to FDI in these sectors.
Way Forward and Factors to be Guarded About
While a lot of industry pundits and soothsayers portray a path ahead for the PE funds to be strewn with roses, one must also keep their ears to the ground and occasionally listen to naysayers as well to correctly ascertain ground realities and the prospective pitfalls and challenges. Below are a couple of factors and issues that I believe ought to be borne in mind while navigating the said path (i) While much euphoria has been created about the viability of distressed deals through the Code, and though it is a welcome move, PE funds ought to tread with caution as opportunities are exciting but fraught with regulatory uncertainties and much work is still needed to be done on this front, (ii) The dispute resolution system in India continues to be painfully slow. While it is important to have clearly drafted contracts, rational mechanisms for dispute resolution outside India shall continue to be relevant, (iii) Investors ought to be wary about tax related representations and warranties and indemnifications due to uncertainties surrounding their enforcement, and (iii) the recent implementation of the General Anti Avoidance Rules, which might make may PE fund houses re-visit their structures.
To sum-up, while the PE investors appear to be prudently optimistic about the Indian market, it is those investors who successfully pass the crucible of unique Indian business and regulatory challenges that shall be triumphant.
Prashant Kataria is a Partner at Lexygen, a Bangalore-headquartered law firm (with an office in Singapore) with a pan-Indian focus on providing services connected with M&As, Joint Ventures, general corporate commercial services, PE/VC and Project Finance. Apart from this, Prashant is an alumnus of the prestigious National Law School of India University, Bangalore.
He has over 15 years of legal transactional experience in the areas of venture capital, private equity, M&A, and infrastructure privatization projects. Over the course of his career, he has garnered significant experience in advising several corporates on diverse corporate-commercial matters, including employment/labor law, real estate leases, trademark licensing, telecom regulatory, and so on.