The new money merchants

Not just the big funds, many small entrepreneurs are now taking a plunge into the
business of private equity
Prashant Mahesh with Ranjana Kaushal

What started off as a trickle is now swelling into a flood. Investment bankers with
global experience are turning entrepreneurs in the private equity (PE) business in
India. Ajoy Veer Kapoor quitting HSBC to start Saffron Asset Management, Alok Sama
moving out of Morgan Stanley to start Baer Capital, Vinnie Vyas quitting Morgan
Stanley to start Crossover Advisors, Pulak Prasad bidding goodbye to Warburg-Pincus
to kick-start Nalanda Capital and Sameer Sain quitting Goldman Sachs to team up
with retail giant Kishore Biyani, are cases in point. All of them have launched India-
dedicated PE funds.

These ace dealmakers are in the unfamiliar role of entrepreneurs, even if they are
still in the familiar business of PE (Interview: Ashish Dhawan). Many of them are
proving that the transition from working for an investment bank or PE fund, to raising
and managing ones own PE fund, is not such a difficult task.

One of the earliest Indian PE entrepreneurs, Ashish Dhawan, who started

ChrysCapital (formerly Chrysalis Capital) in 1999, has joined the big league.
ChrysCapital manages $2.2 billion under five funds.

Saffron Asset Management has already raised 100 million under the Yatra Capital.
The fund, listed on the Amsterdam Stock Exchange, was fully invested in just seven
months. "We want to have $2 billion of equity under management by December
2010," says Ajoy Veer Kapoor, Founder and Managing Director of Saffron.

New Perspective

Such rapid ramp-ups are fairly common in Indias red-hot PE segment. Baer Capital,
which launched a $200-million PE fund, aspires to manage $1 billion in India in the
next one year. Alok Sama, after spending sixteen years in Morgan Stanley at New
York, Hong Kong, London and also setting up the Indian business of Morgan Stanley,
teamed up with Brij Raj Singh, Managing Director, Private Banking, Middle East and
the Indian sub-continent of Merrill Lynch, to establish Baer.

Similarly, Vinnie Vyas, who teamed up with Ajay Mehta (Deepak group of Pune) to
set up Crossover Advisors, started off in 2005 with an equity investment in the Pune-
based auto parts company Indo Schottle. Two years later, he sold the investment to
ICICI Venture netting 45% returns. That gave him the confidence to launch a $50-
million PE fund. "We shall ask for more money from our investors once we prove
ourselves," says Vyas.

PE is surely a booming business in India. With investments of over $16 billion in over
670 PE and venture capital (VC) deals in the last three years, the sector is now
poised for a take-off. (See article on page 90.) Till about three years ago, the
industry was only in the investment mode. But now, several exits are also happening.
Deals like Warburg Pincus $500-million profit from a $300-million investment in
Bharti Tele-Ventures, Newbridge and Temaseks $396-million exit from Matrix Labs,
Citigroups $593-million exit from i-flex and Actiss $212-million sale of stake in
Punjab Tractors have established that there are high returns to be made in this
industry.

"This business would continue to grow in India and I see the number of private equity
players doubling in the coming two to three years," says Vinod Khosla, one of Silicon
Valleys best-known venture capitalists.

"PE business, at one-tenth the mutual fund industry, is still in its infancy" adds Ajay
Relan, Managing Director of CVCI. The Indian mutual fund industry manages assets
worth about Rs 3,26,388 crore.

"PE business is primarily buyout-driven in the West. As leverage dries up, a lot of
marginal PE players will go out of business and volumes would decline. India is far
more attractive and hence, experienced people are coming here," adds Sama,
President and Founder of Baer Capital.

High Returns

The PE business model runs on a simple thumb rule, referred to as the 2-20 principle.
PE Funds generally get 2% of the funds they raise as management fee and they get
to keep 20% of the profits they generate from the investments. Often, a hurdle rate
or the minimum return of 8% is applicable, after which the 20% profit sharing starts.

This business calls for three key competenciesraising money, identifying and
managing good investments and managing investors expectations. At the moment,
the business environment, especially in a hot growth economy like India, is
favourable to all three. "India offers opportunities to investors with a broad spectrum
on the risk-reward ratio," says Akhil Gupta, Chairman and Managing Director of
Blackstone Advisors India.

"Emerging markets like India present huge opportunities and foreign investors are
more than keen in investing into these markets," adds Anil Chawla, CEO of DE Shaw
India, a large hedge fund that has invested $1 billion in India.

PE funds of all kinds have been able to raise funds. While large funds like Blackstone,
Carlyle, ChrysCapital and DE Shaw have $1-3 billion each at their disposal in India,
mid-sized funds also have their plans in place. JM Financials $225-million JM Private
Equity Fund is scouting for opportunities in the financial sector. Motilal Oswal has
already raised a $100-million fund and plans to increase this corpus to $400 million,
besides launching another fund. Big groups such as Tata and TVS are also getting
into the PE business.

Look Whos Talking

If entrepreneurs have the right credentials and networking skills, they need very little
capital to get the business going. Sometimes, however, in order to build credibility,
small entrepreneurs rope in outside investors. For example, besides Sama, Michael
Baer and Brij Raj Singh (who together hold 50%), Baer Capital also has shareholders
like the Fleming Family which holds 10%, Dubai Holding (15%), with the rest being
held by Shuaa Capital and London-based hedge fund company CQS Management.
"Strong names give the company the chance to scout for deals and attract potential
employees," explains Sama.

The second competence is managing the funds and investments. Here too, big names
like Blackstone, Citigroup Venture Capital and ICICI Venture get the big and the
better deals. So how do funds floated by small entrepreneurs compete against the big
fish? By identifying with a theme or focus.

Take, for instance, 34-year old Vishal Mehta, General Manager and Co-founder of Lok
Advisory Services. He quit a cushy banking job in Washington DC to join Donald Peck,
the former head of Actis India, to promote Lok Advisory. The fund invests mostly in
the equity of micro-finance institutions. By identifying a niche, it has managed to
raise money from leading institutional investors, including the UK-based Actis,
International Finance Corporation, The Netherlands Development Finance Company
(FMO) and Entwicklungs Bank of Germany (KfW). "We have made investments in two
micro-finance institutions in India and expect an IRR (internal rate of return) of 40%
from each," he says. Lok invested $2.25 million in Hyderbad-based Spandana
Sphoorty Innovative Financial Services and another $2 million in Bangalore-based
Janalakshmi. The fund plans to make about 20 investments in the coming 4-5 years.
As a general fund, Mehta may have struggled, but by focusing on the micro-finance
theme, he has given himself a chance.

Similarly, Crossover is looking at financial services and technology due to the

experience of its partners in these verticals. Clearly, real estate is not for them, since
they lack expertise. However, Kapoor of Saffron understands the sector betterhe
worked in the real estate division of Standard Chartered and HSBC.

Ups And Downs

There are many challenges on the investment front too. First, from a cost
perspective, it is good to start off with a large fund. "Bigger fund size gives you
economies of scale," says Sama. But from a deal flow and investor relations
perspective, it may be better to start small and later ramp up gradually. Most PE
firms work with extremely lean teams, outsourcing most of their due diligence work
to consultants and lawyers. Operational costs are generally kept within 2% of the
assets managed.

Second, the PE space is getting crowded and entrepreneur expectations on valuations

are very high. "Promoters ask for sky high valuations. Out of 100 proposals we get, a
mere 25 are worth considering," says Vyas. "Creating a win-win situation for both us
and the promoter is a challenging task," adds Sama.

But here, too, entrepreneurs are seeking out a niche. Over $10 billion of the $16
billion worth of deals struck in the last three years have been late stage deals, private
investment in public equity (PIPE) or pre-IPO deals. Large companies like CVCI, focus
on this segment, leaving the rest to smaller players. "India is a vast country. There is
space for PE funds floated by small entrepreneurs," observes Chawla.

The early stage opportunity in India is still largely untapped. "There is a huge
demand for PEs among SMEs," says Vishal Tulsyan, Managing Director of Motilal
Oswal Venture Capital Advisors. "As we go ahead, the second generation promoters
are taking up control of business and are open to giving up equity for professional
advice and capital," adds Dilip Kothari, Founding Managing Director of JM Private
Equity Fund.

Another strategy for small entrepreneurs is to use big funds as exit options. "The
smaller players do deals of $5-25 million and the bigger players do upward of $100
million," says Sama. "So bigger players like Blackstone could be an exit opportunity
for us," he adds. Thats what Crossover Advisors did with Indo Schottle.

The third competence is managing investor expectations. Most funds prefer long-term
investors, as fund tenures are in the 7-10-year range. "We are in for the long haul
and are selective about the shareholders who invest with us," says Kapoor.

But with the markets having returned as much as 46% last year, investor
expectations are high. "Investors ask for 35% returns, while we gun for at least 50%
internally," says Vyas. "Most PEs look at an exit period of three to five years. This
gives ample opportunity to yield returns of 30-40%," adds Khosla.

But such high returns may not last forever. Many deals are now being done in the
backdrop of a rising Sensex. If the bull-run ends and valuations fall, returns would
take a hit. And thats when investors would have to temper their expectations.