Contractual Risks

in
Private Equity Investments

Dr. Kishore N.K.

M.Com., ACS., MDBA., Ph.D., LLB

BEKEM Infra Projects Private Limited

Scheme of discussion:
• PE and related investments

• Investment strategies of PE

• Process of PE and Fund’s Life cycle

• Valuation Methodologies of PE

• Contractual Risks in PE Investments:

– Liquidity Preference Rights
– Equity Ratchet Rights

• Risks in Pre and Post Money valuation

• Risks in 20 Pressure Clauses of PE

• Brief case study on PE investment

• Recent statistics of PE
PE and related investments
 Private Equity – Broadly Defined

• Technically refers to any type of equity

investment in an asset in which the equity is not
freely tradable on a public market.

• Therefore, PE is:
– Less liquid
– Long Term in nature
 Introduction to private equity

"Hedge
"Angel" "Venture Capital" "Growth" "Buyouts" "Distressed Investing"
Funds"

2nd & 3rd Emerging Leveraged Mezzanine Distressed Distressed

Seed 1st Round Hedge Funds
Round Growth Buyouts Debt Equity Debt

Age of
0 years 0-1 year 1-3 years 3-10 years 10-50 years 10-50 years 10-50 years 10-50 years 5+ years
Company

2nd or 3rd
Stage of 1st generation Established, Established,
Idea Prototype generation Stressed Stressed Public
Company product slow growth slow growth
product

Public or Private or Private or Private or Private or Private or

Private Private Private Public
Private? Public Public Public Public Public

Equity
$0.2-0.5m $1-2m $2-5m $5-20m $10 - 250m $10 - 250m $10 - 250m $10 - 250m N/A
Requirement

Return
70%+ 50-70% 50-60% 40-50% 25-40% 20-30% 30-50% 30-40% 20%
Expectations
 Angel Investors
• Angel investor is typically a wealthy individual

• Often with a technical industry background

• Able to judge high-risk investments

• Invests in early stage companies up to Rs. 50 lacs

• Expects investment through IPO or subsequent

financing rounds
Financial VCs
• Most common type of VC

• Is an investment firm, capital raised from

institutions and individual investors

• Being formal VC funds, have limits on size,

lifetime and exits

• Are entitled to carried interest

• Fund size ranges between Rs. 100 crores to

Rs. 50,000 crores

• Exits from IPOs, mergers & acquisitions, and

selling on stock exchanges
Strategic VCs
• Typically a small division of a large
technology company

• Invests in companies whose success may

increase revenue growth of the VC

• May not concern only about the return on

investment

• May provide investees with valuable

connections and partnerships

• Usually takes a back seat role in funding

 Why Angels Invest
• The Person
– Familiarity with the integrity and abilities of the management team
OR
– Friends, Family & Fools

• The “Cause”
– The company is doing something that contributes to a social cause
that is meaningful to the angel…
• Curing cancer, improving the environment
– The company is targeting a market segment in which the angel
has experience and insight

• Perceived BIG opportunity

– The Angel perceives the technology to be disruptive and does
some cursory due diligence that confirms his / her suspicions
Investment strategies of PE
 Private Equity strategies

Private Equity
Private Debt
Corporate Finance Venture Capital

Leveraged Buyout Mezzanine

(LBO) Early Stage
Growth Capital Distressed Debt
Late Stage
Turnaround Infrastructure
 Private Equity – Corporate Finance Strategies

Finance type Strategy

Leveraged Acquisitions of operating companies that are financed with
Buyout equity and debt

Growth Capital Expanding companies in need of capital to finance high

growth or acquisitions

Turnaround Acquisitions of underperforming businesses or businesses in

out-of-favor industries in need of either financial or
operational restructuring
Private Equity – Venture Capital Strategies

Finance type Strategy

Early Stage Companies that are in the process of

developing business plans, products /
services have been developed and are
marketed to a limited number of
customers

Late Stage High growth companies, nearing

profitability
 Private Debt – Financing Strategies

Finance type Strategy

Mezzanine Investments in subordinated debt issued by operating
companies; frequently issued in conjunction with a buyout
acquisition and with equity kickers attached, such as
warrants or options in order to enhance returns
Distressed Debt Investments in public and private debt securities that are
trading at discounts to par value due to financial stress of the
underlying company

Infrastructure Investments used to finance the construction or

enhancement of distribution networks for electricity, water
and gas, and certain transportation assets such as toll roads,
bridges and tunnels
Process of PE & Fund’s Life cycle
 Process of PE fund

(7) Liquidate / Sell

Portfolio Companies (1) Raise Capital

(6) Nurture
Portfolio Companies (2) Evaluate
Market Segments

(5) Negotiate and

Structure Investments
(3) Generate
Deal Flow
(4) Select Investment
Candidates
 Private Equity Fund Lifecycle
Period Activity

The first phase of a fund’s life cycle is the

Fund raising fundraising period, during which a fund is
(6 – 18 marketed to potential investors who commit
months) capital. Capital commitments from investors are
essentially promises to fund future investments as
a fund manager identifies them.
Private
Once fundraising is complete, the fund closes and
Equity Investment begins its investment period, which typically lasts
Period five years. During the investment period the fund
(5 – 6 years) manager calls capital from commitments provided
by investors to make investments

After the investment period, the fund enters the

Realization realization period, which lasts five to eight years
Period on average. During the realization period,
( 5 – 8 years) investments are sold or liquidated, and proceeds
are returned to the investors
Valuation Methodologies
of Private Equity
Valuation methodologies
• Price of recent investment

• Earnings multiple

• Net assets

• DCF or earnings (of business)

• DCF from investment

• Industry valuation benchmarks

Price of recent investment
• Since the previous investment was
made recently, the same price may be
adopted for the current investment as
well

• The validity of the valuation obtained in

this way is inevitably eroded over time.

• To adopt price as above, background to

the previous transaction and investment
must be evaluated (such as volume,
rights, strategic considerations etc)
Evaluation of previous investment
and business
• Performance and prospects of the business
against the assumptions / terms of previous
investment

• Extent of compliance with the terms and

conditions of investment documents

• Present business environment, including

technical, market, economic, legal and
regulatory, in comparison with previous
investment
Earnings multiple
• Is applying an earnings multiple to the
earnings of the business to derive the
value of the business.

• This methodology is appropriate for

investing in established businesses
with identifiable stream of
maintainable continuous earnings

• The earnings figures for a number of

periods may be averaged using a
forecast level of earnings or applying
a sustainable profit margin to current
or forecast revenues.
Essentials to apply earnings multiple
• Multiple should be appropriate,
reasonable, and commensurate with the
earnings growth prospects of the
underlying company.

• Earnings should be adjusted for the

surplus assets or excess liabilities and
other relevant factors to derive
enterprise value for the company

• This methodology may even be applied

to companies with negative earnings if
the losses are considered to be
temporary and one can identify a level
of normalized maintainable earnings
 Various multiples

Multiple Applicability
Price / Earnings of comparative company may be used. It signifies the
P/E price market is willing to pay for the Company based on its earnings
(EPS). Theoretically the company can be purchased at the MPS on the
stock exchange
EV, Enterprise Value, is the sum of net worth and net financial debt of
EV / EBIT the Company. EV / EBIT indicates the multiple of EV for the total
earnings of the Company

EBITDA is the total cash earnings of the Company.

EV / EBITDA EV / EBITDA indicates the multiple of EV for the total cash earnings of
the Company
 Caution required while applying multiples

Multiple Caution

P / E is a market based approach.

Market capitalization of a quoted company may not reflect the value of
P/E the Company but only the price at which ‘small parcels’ of shares are
exchanged.
The comparative companies should be similar in terms of business
activities, markets served, size, geography and applicable tax rates.
This multiple ignores the benefit of depreciation, particularly in case of
EV / EBIT assets depreciated for accounting purpose over a limited period but
practically have a longer economic usable value.

This multiple removes the impact on the value of depreciation of fixed

EV / EBITDA assets and amortization of goodwill and other tangibles. The need of
replacement of highly depreciable assets, need for expending additional
amounts to be amortized over a limited period have to be factored in.
Net assets
• This methodology involves deriving the
value of business by reference to the value
of its net assets

• This is likely to be appropriate for a business

whose value derives mainly from the
underlying value of its assets rather than its
earnings. Ex., property holding companies
and investment businesses.

• This may also be appropriate if return on

assets is inadequate and greater value can
be realized by liquidating the business and
selling its assets
Caution required while applying
Net assets method
• Contingent assets and liabilities may
also be included while valuing assets
Net and liabilities of the Company
Assets
• An appropriate marketability discount
should be applied to arrive at a
realistic value of the assets

• The value of the redeemable

instruments, if any, should be
deducted to arrive at the available
value of the assets
DCF from the underlying business
• Discounted Cash Flow (DCF) methodology
involves deriving the value of a business by
calculating the present value of expected
future cash flows

• Is flexible as it can be applied to any stream

of cash flows or earnings

• This methodology may be applied for

businesses going through a period of great
change, such as a rescue refinancing,
turnaround, strategic repositioning, loss
making, or is in its startup phase etc.
DCF from the investment
• Unlike the DCF from the business earnings,
this methodology applies DCF technique to
the expected cash flows from the
investment itself.

• Where pricing for the return on the

investment or floating Initial Public Offer
(IPO) is / to be agreed at the time of
making investment, this is the appropriate
methodology.

• Is particularly suitable for valuing non-

equity investment in instruments like debt,
mezzanine debt etc since the value of such
instruments derives mainly from the
instrument-specific cash flows and risks
than of the underlying business as a whole
Caution for applying DCF
methodology

• Cash flow forecasts, estimation of terminal

value, and selecting risk-adjusted discount
rate should be appropriate

• Ideally DCF based valuations should be

used as a cross-check of values estimated
under market based methodologies and
should be used in isolation of other
methodologies only under extreme caution
Industry valuation benchmarks

• Industry specific valuation benchmarks are used

as per the prevailing practice of the industry

• Examples: price paid per bed for hospitals, price

per seater for BPO, price per head for schools,
price per subscriber for cable-television, mobile,
internet companies etc

• These industry norms are based on assumptions

that investors are willing to pay for turnover or
market share and that the normal profitability of
business in the industry does not vary much

• This may be used as a sense-check of values

produced using other methodologies
 Duration of Private Equity/ Venture Capital
Investment normally ranges from 3-7 years

EXIT OPTIONS:
EXIT • IPOs
OPTIONS • Mergers & Acquisitions
AVAILABLE
• Management Buy-out
TO
• Sale to Another Fund
PRIVATE
• Buyback by Promoter/ Company
EQUITY
• Stock Market
FUNDS

In case of Buyback by Promoter/Company , the value at

which PE Fund would exit is IRR or market-based and is
pre decided at the time of investment on a certain valuation
 Popular Investment instruments of PE
(For issue to PE by investee companies)
Equity shares at a premium
Optionally Convertible Preference
Shares
Fewer no of equity shares (with
disproportionately higher voting
rights) and substantial portion in
Preference shares
Cumulative Compulsory
Convertible Preference Shares
with participating rights
Mix of Equity + convertible equity
warrants + preference shares
Debentures convertible into equity
shares at the time of IPO at the
IPO price
Traditional pricing. Ratchet rights may not be
involved
ECB guidelines apply and foreign PE / VC may
not find it attractive.
Pricing can be in favour of PE. Ratchet rights
may be stipulated.
Market pricing. Deal in favour of PE. Voting
control is provided to PE with the differential
voting rights. (Present version of new
Companies bill bans DVRs)
Prospective pricing. Participating rights in
residual income. Very popular instrument
and widely used in the recent past.
Multiple convertible instruments. Very complex
to structure. Pricing can be manipulated as per
the agreement between the parties.
Pricing can be fair and neutral. Comfort to PE
with the periodical interest cash flows and
comfort to Investee Company with the non-
equity control by PE (till conversion into equity)
 Contractual rights and
corresponding risks in PE
investments
Liquidity Preference Rights
(and Risks)
Liquidity Preference
• Liquidity preference right applies for
liquidation, merger, acquisition,
takeover, sale of asset of company,
IPO, or any other exit

• If company is liquidated the PE

investors (holding liquidity
preference rights) will be entitled to
get their money back in 1 or more
multiples as per the liquidity
preference right
(ex: Invst x 1; invst x 1.5; invst x 2)
 Liquidity Preference distribution

Liquidity preference distribution if liquidity realization is Rs. 14000 lacs

PE Invst Liquidity Liquidity pref Capital share

PE % prefer amt distributed Total
Rs lacs shareholding X distributed# * distributed
2500 5% 1 2500 575 3075
2500 5% 2 5000 450 5450
2500 11% 1 2500 1265 3765
2500 11% 2 5000 990 5990
2500 26% 1 2500 2990 5490
2500 26% 2 5000 2340 7340
# PE invst x Liquidity Pref
* PE shareholding % x (Liquidity realization – Liquidity pref amt distributed)
 Liquidity Preference distribution

Liquidity preference distribution if liquidity realization is Rs. 8000 lacs

PE Invst Liquidity Liquidity pref Capital share

PE % prefer amt distributed Total
Rs lacs shareholding X distributed# * distributed
2500 5% 1 2500 275 3075
2500 5% 2 5000 150 5450
2500 11% 1 2500 605 3765
2500 11% 2 5000 330 5990
2500 26% 1 2500 1430 5490
2500 26% 2 5000 780 7340
# PE invst x Liquidity Pref
* PE shareholding % x (Liquidity realization – Liquidity pref amt distributed)
 Liquidity Preference distribution

Liquidity preference distribution if liquidity realization is Rs. 4500 lacs

PE Invst Liquidity Liquidity pref Capital share

PE % prefer amt distributed Total
Rs lacs shareholding X distributed# * distributed
2500 5% 1 2500 100 2600
2500 5% 2 5000 0 4500
2500 11% 1 2500 220 2720
2500 11% 2 5000 0 4500
2500 26% 1 2500 520 3020
2500 26% 2 4500 0 4500
# PE invst x Liquidity Pref
* PE shareholding % x (Liquidity realization – Liquidity pref amt distributed)
Liquidity preference equations
Liquidity Liquidity realization amount x
preference PE % shareholding x liquidity
amount to PE preference number
Capital share on % PE shareholding x (Total
liquidation liquidity realization – liquidity
preference distribution amount)

Total distribution Liquidity preference amount +

to PE on capital share distribution
liquidation
Amount available Liquidity realization amount –
to other total amount distributed to PE
shareholders
Equity Ratchet Rights (and Risks)
Anti-dilution price protection provision
(Equity ratchets)

• Ratchet is the structure of resetting (adjustment)

of equity price and shares allocations depending
on subsequent equity allotment price, future
performance of company or the rate of growth etc.

• Anti-dilution price protection gives PE the benefit

of reduced effective price per share if the
company issues its shares at a lower price in a
later round (down round)

• Later round price is considered as lower if it is

lower than the share value projected to prevail at
the later round price
Types of equity ratchets

• Weighted ratchet anti-dilution price protection

• Narrow based weighted average anti-dilution price
protection provision
• Broad based weighted average anti-dilution price
protection provision

• Full ratchet anti-dilution price protection

Nature of ratchets
• Weighted ratchet: The resetting allotment
price is lowered to a price that is a
weighted average of the price at which
the company issued shares valuing the
company at the pre-adjusted price. It has
two sub-types viz., narrow based
weighted average ratchet and broad
based weighted average ratchet

• Full ratchet: The resetting allotment price

is lowered to the lowest price, that is
lower than PE’s purchase price,
regardless of the number of shares
issued (but not weighted average price)
Kinds of weighted average ratchets

• Narrow based weighted ratchet: Narrow

based weighted average anti-dilution price
protection provision might include only
equity share capital and convertible
preferred shares then outstanding

• Broad based weighted ratchet: Broad based

weighted average anti-dilution price
protection provision includes equity shares
outstanding and issuable upon conversion,
warrants, convertible debt, options and any
other contingent right to equity shares or
equity share capital
 Share price adjustments with Ratchets

Share price adjustments with weighted average ratchets

After adj %
No of Allot Before adj % After adj shareholdin
Investor shares price Invest amt shareholding no of shares g

Promoters 10,00,000 80 8,00,00,000 64.52% 10,00,000 63.73%

Private
Equity 50,000 125 62,50,000 3.23% 69,095* 4.40%
New Invst -
1 2,00,000 90 1,80,00,000 12.90% 2,00,000 12.75%
New Invst -
2 3,00,000 85 2,55,00,000 19.35% 3,00,000 19.12%

Total 15,50,000   12,97,50,000 100.00% 15,69,095 100.00%

* Rs. 62,50,000/90.45; Rs. 90.45 = (Sum invst amt of PE + NI 1 & 2)/(Sum of no. of shares to PE, NI 1& 2)
 Share price adjustments with Ratchets
Share price adjustments with Full ratchets

After adj %
No of Allot Before adj % After adj shareholdin
Investor shares price Invest amt shareholding no of shares g

Promoters 10,00,000 80 8,00,00,000 64.52% 10,00,000 63.55%

Private
Equity 50,000 125 62,50,000 3.23% 73,529* 4.67%
New Invst -
1 2,00,000 90 1,80,00,000 12.90% 2,00,000 12.71%
New Invst -
2 3,00,000 85 2,55,00,000 19.35% 3,00,000 19.07%

Total 15,50,000   12,97,50,000 100.00% 15,73,529 100.00%

* Rs. 62,50,000/85; Rs. 85 = Lower of Allot price to PE, NI 1 & 2)

 Ratchet flow chart
PE 1 invests Company
@ x price (Equity Issuer)

If issue price If issue price

is > x, Proposal for
is < x,
no ratchet Follow on Issue
ratchet kicks-in

Weighted Full

Reset the price: Reset the price:

Sum invst amt PE 1 invst amt
PE 1 + new shares Lowest new issue price

Total eligible shares to PE 1 @:

PE 1 invst amt
Reset price as above

Ratchet exercise completes; PE investor gets additional shares

 Ratchets in connection with
book value of equity shares
In addition to the ratchets connected with down-rounds, ratchets are also structured in
connection with book value of equity shares. While ratchets of former type protect the
control interests of PE investor, the latter protects the monetary interests of the PE
investors even if no down-rounds are made. The following is one of the practices to
structure these kinds of ratchets.

• Optionally convertible cumulative participating redeemable preference shares will be issued

at premium to equal the determined value at the time of PE investment for the equity shares
of the Company.

• The intrinsically prevailing value of the equity share will be arrived at at the end of each year

• If share value as in 2 is greater than in 1, no ratchet kicks-in; If share value as in 2 is lower

than in 1, no ratchet kicks-in.

• As per the ratchet, either of the following two or a mix of the following two will be effected at
the option of the PE investor:

i) for the payable preference dividend amount, PE investors will have to be allotted equity shares at value
that will compensate the PE investor in value terms for his total investment and this dividend receipt.

ii) Convert the preference shares into equity shares at the relevant valuation as on the date of opting for
conversion
 Risks in
Pre-money and Post-money valuation
Pre-money and post-money valuation

• The following are the two valuation

concepts in connection with
computing the % of shareholding a
PE gets for its investment in the
company:

• Pre-money valuation

• Post-money valuation
Pre & post money valuation equations
Pre-money Post money valuation – PE
valuation investment
Post money PE investment / PE ownership
valuation percentage or Pre-money
valuation + PE investment
Share price Pre money valuation / no of pre
money shares; or
Post money valuation / no of
post money shares
New shares PE investment / share price
issued
Total Pre money shares + new
outstanding shares issued
shares
Pre money and post money valuation
- illustration - 1

Pre money Rs. 100 crores

valuation
Investment Rs. 25 crores
amount proposed

Post money Rs. 125 crores

valuation
PE’s percentage Rs. 25 / 125 x 100 = 20%
shares
Pre money and post money valuation
- illustration - 2

Post money Rs. 100 crores

valuation
Investment Rs. 25 crores
amount of PE

Pre money Rs. 75 crores

valuation
PE’s 25 / 75 x 100 = 25%
percentage
share
Rights and Risks associated with
20 Key Pressure-Clauses
in PE investments
1/20 Key pressure clauses of PE investment

Dividend Rights:

• Dividend policy of the investee company during the

period of PE investment is influenced by PE.
• The dividend policy is formulated in a tax efficient
way
• Usually, on account of taxation, PEs do not
encourage periodical dividend payments
• PE investor holds an overriding right to veto the
payment of any dividend.
2/20 Key pressure clauses of PE investment
Nature (kind) of shares for PE investors:

• PE investors usually invest in either Equity or

preference depending on the legal provisions
prevailing in the host country

• Since ratchet rights have to be accommodated,

generally PE investors prefer convertible preference
shares over equity shares. However, since veto rights
are available only for equity shareholders, PEs prefer
to hold a mix of preference and equity.

• PEs also prefer to hold golden shares (with additional

rights).

• Differential Voting Right (DVR) shares are considered

in India. However, the new companies bill prohibits
issuance of DVR shares.
3/20 Key pressure clauses of PE investment

Liquidation Preference:

• Liquidation preference accords a right to the

PE investors to receive certain amount of
the realized amount out of liquidation of the
Company in preference to other
shareholders.

• This preference amount may be equal to the

amount of the original amount invested by
the PE investor or a multiple of it.

• In India liquidation preference rights may not

be possible on equity shares and hence PE
investors prefer ‘cumulative participating
preference shares’
4/20 Key pressure clauses of PE investment
Redemption Rights (Equivalent to sell-back right in
India):

• PEs demand that the Company shall buy back its

own shares from investors. PEs insist that the
other shareholders (usually promoters) should
not participate in the buy back scheme thereby
facilitating their shares to be bought back by the
Company.

• Valuation of the buy back of the shares is subject

to the guidelines issued by the competent
authorities.

• Alternately and / or simultaneously, as per the

terms of the investment agreement, promoters
will have the obligation to purchase the shares
from PE investor at a price to yield the required
rate of return
5/20 Key pressure clauses of PE investment

Anti dilution (Price protection ratchets /

Price protection rights):

• PEs hold anti-dilution protection

rights to protect the value of their stake in
the Company if new shares are issued at
a valuation which is lower than that at
which they have originally invested. Such
subsequent or follow on issue round is
termed as ‘down round’.

• These rights are termed as ratchet

rights. Ratchets could relate to price of
follow on issue price or valuation of the
equity share even in the absence of a
subsequent equity issue.
6/20 Key pressure clauses of PE investment

Right of first refusal (ROFR):

• ROFR right provides that if any

shareholder (usually promoter) intends to
dispose of shares, such shares must be
first offered to the PEs (if ROFR right is
held) at the same terms and conditions the
shares are intended to be sold.
• These rights ensure that the promoters
do not sell their shares to persons whom
PE would not like to be shareholders of the
Company.
• These rights also ensure that the promoters
do not sell their shares at unusual terms to
their preferred persons
7/20 Key pressure clauses of PE investment

Drag along (Bring along) rights:

• A drag along provision creates an obligation

on the other shareholders (usually promoters)
of the Company to sell their shares to a
potential purchaser if and when PE
shareholder votes to sell its shares to the
potential purchaser
• These rights will be useful in the context of a
sale where potential purchasers intend to
acquire substantial majority (usually 100%) of
the shares of the Company in order to avoid
having responsibilities towards minority
shareholders after the acquisition.
8/20 Key pressure clauses of PE investment

Tag along (Co sale) rights:

• A tag along provision creates an obligation

on the other shareholders (usually
promoters) of the Company to ensure that
the potential purchaser agrees to purchase
an equivalent percentage of PE’s shares at
the same price and under the same terms
and conditions.

• This right may have the effect of making the

shares more difficult to sell.
9/20 Key pressure clauses of PE investment

Pre-emption right :

• Preemption is the right of PE investor to

participate in a financing to the extent
necessary to ensure that, if exercised, its
percentage ownership of the Company’s
shares will remain the same after the financing
as it was before.

• In Indian term sheets, it could even mean

rights of PE to decide whether certain items
can be taken up by the Board or General
Meeting in the agenda.
10/20 Key pressure clauses of PE
investment
Representations:

PE investors insist on representations from the issuer Company (and

from the Promoters) to be included in the investment agreement /
term sheet confirming about the information disclosed and that
the deal (investment by PE) is subject to the facts, information,
statements furnished by way of representations.

Representations are also stated as recitals. Recitals usually form

part of the agreement. PE investors prefer to include the
representations in the agreement rather than in recitals since as
per the legal interpretation, recitals are considered as jointly
agreed upon statements / situations than a cover to the other
party.

If any representation is found inaccurate subsequently, PE will have

a right to initiate corrective action including accelerating the
investment as per the terms of the investment.
11/20 Key pressure clauses of PE
investment
Warranties:

PE investors insist on warranties from the issuer Company (and

from the Promoters) to be included in the investment
agreement / term sheet to provide the investors with a
complete and accurate understanding of the current condition
of the Company and the past history so that the investors can
evaluate the risks of investing in the Company prior to
investing in the Company.

The warranties typically cover areas such as legal existence of the

Company, financial statements, business plan, assets,
liabilities, material contracts, employees and litigation.

If any warranty is is found inaccurate subsequently, such an event

will be considered as breach of the agreement and the PE will
have a right to be reimbursed for the loss / expenses etc with
an additional right to rescind the investment agreement itself.
12/20 Key pressure clauses of PE
investment

Consent Rights:

PE investors normally hold consent rights which provides that

that certain actions cannot be taken by the Company
without the consent of the PE investors or of a majority %
(as specified)

These consent rights need not confine to only board agenda

items
13/20 Key pressure clauses of PE
investment

Board Seats:

PE investors will require a right to nominate one or more

directors to be appointed on the Board of the investee
Company.

PE investors may also require a right to appoint a Board

Observer who can attend all Board Meetings but will not
participate in any board decisions.
14/20 Key pressure clauses of PE
investment

Information Rights:

PE investors will require right to receive information on a regular

basis concerning the financial condition and budgets along
with a general right to visit the company and examine its
books and records.
15/20 Key pressure clauses of PE
investment
Registration Rights:

These are specific only to USA since SEC requires the registration of the
securities to be eligible for offering for public sale (Offer for Sale).
The registration process involves the Company providing significant
information about its operations and financial condition which can be
time consuming and expensive.

In India this clause is non-existent. However a corresponding clause to

this in India is that PE investors insist that the Company do not
recognize PE investors under promoter group and also should
endeavor to avoid PE investors being recognized as promoters
under law. This will help PE investors not to be subject to the lock-in
requirement of the promoters’ shares at the time of IPO of the
Company.
 16/20 Key pressure clauses of PE
investment

Conditions Precedent:

Term Sheet / Investment agreement of PE investors will include

a full list of conditions to be satisfied before investment will
be disbursed.

Usually Conditions Precedent to signing of the investment

Conditions to be fulfilled
in advance
agreement and Conditions precedent to releasing of the
investment amount to the investee Company will be
separately laid down clearly in the term sheet and the
investment agreement respectively.
17/20 Key pressure clauses of PE
investment

Tranche Disbursements:

PE investors will have a right to release the investment amount

in one or more tranches (stages / phases) dependant on
achievement of targets or milestones claimed to be achieved
in the business plan of the Company.

While the investment price may be determined at the time of

signing of the investment agreement itself, the investment
amount is structured to be released in tranches (stages) to
ensure that the Company is growing as per the growth
guidance issued by the Company / Promoters.
18/20 Key pressure clauses of PE
investment

Exit Options / Rights:

PE investors will reserve right to exist in various ways including:

- Initial Public Offer (IPO)
- Offer For Sale (OFS)
- Merger
- Take Over
- Strategic Sale
 19/20 Key pressure clauses of PE
investment

Non Compete Clause:

PE investors will require the promoters to sign non-compete

Cant agreements so that the promoters will not nurse their
interests to promote and develop other companies which
may eat in to the business of the investee Company or
which may stand competition to the investee company.

Usually the Non-Compete agreements will carry a tenure of

about 5 years from the date of investment.
20/20 Key pressure clauses of PE
investment
Special Audit:

PE investors will require the Company’s financials to be audited by a

special auditor usually appointed by them in addition to the statutory
auditor of the Company.

The costs of the audit and the audit fee for the special auditorr have to
be borne by the Company.

Special Auditor submits his audit report to the PE investor with a copy of
the audit report to the Company. In addition to the usual financial
audit, he may also comment on the status of the compliance of the
conditions of the terms and conditions of the investment agreement
signed by the Company with the PE investor.
Pros and Cons of Private Equity
Advantages for Company Disadvantages for Company

Faster Growth More complex accounting and

reporting

Unsecured Finance Investor veto rights

Employee ownership (in the case Accountability to investor

of MBO)

Strengthens financial position Investor’s involvement in board

decisions

Facilitates obtaining other forms Restrictive covenants for

of finance managers / operations

Funding is committed until exit Warranties to be given by

(unlike bank loans) promoters / company

Management and relationship Investor’s objective / motive is

advise exit at good return
 Challenges to PE in India
Area Challenge

Value of -Important to be an active investor to understand the

Private Equity value add from PE
-Must trade-off value, growth and risk
-Analyzing the relative merits of a potential non-PE
investment
-No relevant experience to guide
Market -Developing business plans and best practices for
conditions privately held and family run Indian firms
-Questions of global competitiveness
-Discarding what is irrelevant and possibly damaging for
Indian companies
Exit Strategy -Market and business tolerance for public offerings
-Family business reluctant to relinquish control
-Inevitability of an Initial Public Offer (IPO)
Others - PE sponsors more susceptible to volatility in the global
debt market
-Increased regulations
-Lower IRR on existing PE portfolios
Case study on PE
Investment and
associated risks
CLSA Private Equity Investment in Apar
Industries Limited

Apar Industries Limited:

USD 250 million Apar is the largest player in transformer oil
division with 50% market share. It is second largest player in the
aluminium power conductor business with 25% market share. It
is largest exporter of aluminium power conductors from India.

The PE Investor:
Credit Lyonnais Securities Asia (CLSA) is Asia’s leading
independent brokerage and investment group. It is active in
equity broking, capital markets, mergers and acquisition, asset
management services, and private equity investments

Investment vehicle:
CLSA CLSA PE Limited, Hongkong  Aria Investments
Partners  Shinny Limited, Mauritius
 The PE Transaction:
Private Equity investment:

In September 2005, CLSA Private Equity was issued 3,445,978 shares as 5.4% cumulative compulsory
convertible preference shares with participating rights for Rs. 185 per share. Convertible on 11 th October 2006
into equity shares resulting in 14.21% equity stake of Rs. 10 each at a premium of Rs. 175 per share
• Number of shares: 3,445,978
• Converted into equity on 11-10-2006: 3445978 equity shares of Rs. 10 each with a premium of Rs. 175 each
• Market Price of Share (MPS): On date of conversion (pre-bonus): Rs. 246; Post-bonus : Rs. 188; Highest till
Jan 2008 (post-bonus): Rs. 450;
• Bonus issue on 18-Jan-2007: 1:3 ratio; Initially issued: 3,445,978 + bonus: 1,148,659 = 4,594,637

Rights & Risks:

• Board seat (Directorship) to be reappointed during the currency of the Investment Agreement
• Right to appoint observers; Right to call for special audit;
• Identified material adverse events;
• Obligation on Company and Promoters to ensure exit by way of strategic sale / FPO
• Tag along and drag along rights
• Information rights
• Pre-emptive rights
• Anti dilution rights (read implied ratchets)
Recent Key statistics related to
PE investments
 PE: funds raised &
investments made (amount in US $ mio)
PE Funds raised

Location 2002 2003 2004 2005 2006 2007

India 160 260 823 2,637 4,859 5,831

Asia 2,991 3,322 11,463 28,010 41,113 50,671

PE investments made
Location 2002 2003 2004 2005 2006 2007

India 1,050 865 1,479 2,424 7,520 17,273

Asia 9,112 17,580 19,010 33,596 62,818 82,955

 PE Investments in India
: FDI & GDP
(amount in US $ mio)
PE Investments versus FDI

Investment 2002 2003 2004 2005 2006 2007

PE 1,050 865 1,479 2,424 7,520 17,273

FDI 5,035 4,322 6,051 7,722 19,531 45,455

PE investments versus GDP

Value 2002 2003 2004 2005 2006 2007

PE Investment 1,050 865 1,479 2,424 7,520 17,273

GDP 495,651 575,245 666,305 778,666 873,659

Most active international players in 2007

Fund manager Nationality Firm Type Deal value

(US $ mio)
Temasek Holdings Singapore Govt affiliate 3,152.2
CVC International US Bank private equity arm 2,057.8
Goldman Sachs US Bank private equity arm 1,883.0
Blackstone Group US Independent VC / PE firm 1,136.8
India Equity partners US Independent VC / PE firm 1,098.9
AIF Capital Hong Kong Independent VC / PE firm 1,008.2
Macquarie Bank Australia Bank private equity arm 1,000.0
Avenue Capital US Independent VC / PE firm 717.8
Carlyle Asia US Independent VC / PE firm 701.0
Dubai International UAE Investment Company 637.8
Capital
 Most active Domestic players in 2007

Fund manager Nationality Firm Type Deal value

(US $ mio)
ICICI Venture Funds India Bank Private Equity arm 1,106.5
New Silk Route Advisors India Independent VC / PE firm 443.0
IL&FS Investment Managers India Independent VC / PE firm 324.6
Beacon India Advisors India Independent VC / PE firm 273.2
IDFC Private Equity India Bank Private Equity Arm 268.8
Indivision Investment Advisors India Independent VC / PE firm 217.0
UTI Venture Funds India Independent VC / PE firm 156.6
Zeus Inframanagement India Independent VC / PE firm 127.5
Jacob Ballas Capital India Independent VC / PE firm 119.3
ChrysCapital Management India Independent VC / PE firm 117.9
 Stage-wise investments
(amount in US $ mio)

Stage 2003 2004 2005 2006 2007 2008*

Bridge loan 0.0 0.0 0.0 0.0 11.3 0.0

Buyout (M/LBO) 126.0 564.9 174.5 1,280.2 967.9 70.0
Expansion 204.2 468.5 1,168.3 3,074.7 7,096.1 4,166.1
Franchise funding 0.0 0.0 0.0 0.0 15.2 0.0

Mezzanine / Pre- 4.7 7.3 112.2 1,236.0 800.4 442.7

IPO
PIPE financing 526.7 438.3 910.6 1,290.3 5,581.2 1,028.6
Seed / R&D 0.0 0.0 0.0 7.0 31.7 0.0
Start-up / early 17.2 0.0 58.4 627.2 2,768.7 1,142.7
stage
Turnaround / 27.2 0.0 0.0 5.1 0.0 0.0
restructuring
Total 906.10 1,479.2 2,423.9 7,520.5 17,272.4 6,850
* First half of 2008
 Investments by Industry (no of deals)
Industry 2003 2004 2005 2006 2007 2008* (HY)
Agriculture / fisheries 0 0 0 1 1 1
Computer related 6 10 8 15 22 6
Conglomerates 0 0 0 0 0 0
Construction 1 1 1 8 11 2
Consumer prod/ servi 0 3 3 20 7 6
Ecology 0 0 0 0 0 0
Electronics 1 2 1 6 16 3
Financial services 8 4 10 39 72 23
Information Tech 6 4 19 28 47 24
Infrastructure 0 3 4 19 13 6
Leis / Entertainment 1 0 7 4 3 1
Manufac – heavy 3 6 18 23 13 17
Manufac – light 1 0 2 4 1 2
Media 2 2 0 6 5 2
Medical 6 8 20 22 28 15
Mining & metals 0 0 0 6 10 3
Retail / wholesale 0 3 2 6 9 5
Services non-fin 11 5 3 22 21 15
Telecommunications 1 3 8 6 23 11
Textiles & Clothing 0 2 10 13 11 5
Transport / distribut 3 3 18 34 30 17
Travel / Hospitality 0 0 7 9 9 8
Utilities 1 4 6 11 9 7
Total 51 63 147 302 361 179
 Select PE transactions in 2007
Investee Ind Amt $ % Investors
mn
Computer Age Mgmt services Computer 90.0 Advent Intnl Corp / South East Asia
related Venture Investment (SEAVI)

ICSA (India) Computer 22.0 Goldman Sachs (Asia)

related
Infotech Enterprises Computer 63.9 13.0 General Atlantic LLC
Divya Sree Developers Construction 100.0 TPG-Axon Capital LLC
Jaypee Infratech Construction 815.3 ICICI Venture Funds Mmgt Co.
Punj Lyod Construction 198.7 Avenue Capital / Blackstone / DKR
Oasis / Kingdom capital / Warburg Pincus
Soma Enterprise Construction 102.9 India Reit Fund Advisors
Heritage Foods Consumer 8.9 Carlyle Asia India
products
BGR Energy Systems Electronics 32.6 4.0 Citi group Venture Capital Intnl
Havell’s India Electronics 112.1 11.2 Warburg Pincus India
Sudhir Gensets Electronics 65.0 15 GE Commercial Finance; Goldman Sachs
AK Capital Services Fin services 9.1 13 Global Technology Investments LLC
Anand Rathi Securities Fin services 22.7 19.9 Citi group Venture Capital Intnl
Angel Broking Fin services 37. 12.5 IFC (world bank group)
ARCIL (Asset Reconstruction) Fin services 13.7 9.2 Ankar Capital Management LLC
Bombay Stock Exchange Fin services 79.8 8.0 Atticus Mgt LLC; Caldwell Asset Mgt,
Urbana Corp
 (contd) Select PE transactions in 2007
Investee Ind Amt $ % Investors
mn
CDSL Central Depository Fin services 4.1 5.0 Croupier Private Equity Partners
Centurian Bank of Punjab Fin services 41.6 5.3 ICICI Venture Funds Mgmt Company
City Union Bank Fin services 18.7 12.5 Argonaut PE, Blue River Capital, FMO
(Netherlands Devpt. Fin Company)
Delhi Stock Exchange Fin services 10.3 20.0 Kuwait Privatization Project Holding Co.,
New Vernon PE, Noor Financial Invst Co,
Passport Capital
Future Capital Holdings Fin services 23.5 10.0 Och-Ziff Capital Mgmt Group
HDFC Fin services 649.9 5.6 3 Logi Capital
ICICI Bank Fin services 598.3 2.9 Dubai International Capital
IDFC Fin services 185.9 10.0 Khazanah Nasional Bhd.
India Infoline Investment Fin services 76.4 22.5 Orient Global Pte.
Karnataka Bank Fin services 36.2 5.0 IFC (world Bank)
Karvy Stock Broking Fin services 44.0 IFC (world bank)
Magma Leasing Fin services 15.0 FMO Netherlands Devp. Fin Corp.
M&M Financial services Fin services 6.6 1.4 Chrys Capital Mgmt. Co
Mahindra Forgings, Mauritius Fin services 4.9 10.0 Promethean Investments LLP
Manappuram General Finance & Fin services 11.8 30.0 India Equity Partners; Sequoia Capital
Leasing Limited
National Stock Exchange Fin services 345.0 15.0 General Atlantic; Goldman Sachs; SAIF
Partners
 (contd) Select PE transactions in 2007
Investee Ind Amt $ % Investors
mn
Religare Enterprises Fin services 15.6 5.0 Merrill Lynch Global Principal Inv.
Shriram Transport Finance Fin services 82.1 5.7 Infinite India
Company
SKS Micofinance Fin services 11.3 IDFC Private Equity Co.
Spandana Spoorty Innovative Fin services 12.0 Blue Ridge Capital; IFC; UTI Venture
Financial Services Capital Funds Mgmt. Co.
YES Bank Fin services 48.6 5.0 Khazanah Nasional Bhd.
Intelenet Global Services IT 200.0 100.0 Blackstone Advisors India; Intelenet
Global Services Mgt. Team
RT Outsourcing Services IT 7.9 Motilal Oswal Venture Capital Advisors
V Soft IT 10.4 iLabs
Ansal Properties – SPVs Infra 29.4 49.0 IL&FS Investment Managers
B. Seenaiah & Company Infra 38.4 7.0 Amansa Capital Pte; IDFC; L&T Capital
Company; L&T Infrastructure Finance;
Lehman Brothers
Indu Projects Infra 33.9 Citigroup Venture Capital Intnl.
KMC Constructions Infra 35.0 Baring Pvt Equity; ICICI Venture
Patil Infrastructure Holdings Infra 56.7 26.0 One Equity Partners
Ramky Infrastructure Infra 28.3 13.5 IL&FS Invst Managers; Sabre Capital
Sea King Infrastructure SKIL Infra 500.0 26.0 Future Capital Holdings
Subhash Projects Infra 61.4 20.0 Citigroup Venture Capital Intnl.
 (contd) Select PE transactions in 2007
Investee Ind Amt $ % Investors
mn
Aparna Constructions Real Estate 100.0 JP Morgan Asset Mgt
DLF Assets Real Estate 400.0 DE Shaw India Advisory Services
DLF Assets Real Estate 200.0 Lehman Brothers
Emaar MGF Land Real Estate 100.0 1.5 JP Morgan Asset Mgt; & others
QVC Realty Real Estate 100.0 IL&FS Investment Managers
Shriram Properties Real Estate 100.0 Infinite India
Vatika Group Real Estate 254.8 10.8 Beacon India Advisors; Goldman
Sachs; Wachovia Capital
Firstsource Solutions Services 22.4 6.0 Galleon Partners;
42.0 4.5 SUN Group
Apollo Hospitals Ent Health 103.5 12.0 One Equity Partners LLC
Fortis Healthcare Health 20.0 3.2 TCK Advisors (Trikona Capital)
GVK Biosciences Health 25.5 Sequoia Capital
Max Healthcare Institute Health 74.0 IFC (World bank)
Great Offshore Shipping 40.8 5.0 Carlyle Asia India
Quipo Infrastructure Equip Infra renting 34.0 31.0 GIC Special Invsts Pte; IDFC PE
Vandana Luthra Curls & Health care 11.3 Indivision Investment Advisors
Curves (VLCC)
Bharti Artel Telecom 2013.5 5.0 Temasek Holdings Advisors India
Bharti Infratel Telecom 1000.0 10.0 AIF; Citigroup; Goldman Sachs; India
Equity Partners; Dubai Invst Corp; etc
 (contd) Select PE transactions in 2007

Investee Ind Amt $ % Investors

mn
Dish TV India Telecom 63.0 4.9 Indivision Investment Advisors
Hutchison Essar Telecom 25.0 IDFC Private Equity Co
Reliance Telecom Telecom 346.5 5.0 DA Capital; Fortress Capital; Galleon
Partners; GLG Partners; HSBC Principal
Invsts; New Silk Route; Soros Fund
Tata Sky Telecom 56.5 10.0 Temasek Holdings Advisors India
Gokaldas Exports Textiles 165.0 70.1 Blaackstone Advisors India
Mudra Lifestyle Textiles 3.3 SIDBI Venture Capital; SBI
S. Kumars Nationwide Textiles 82.0 10.0 Citigroup Venture Capital Intnl
BLR India Transport 11.3 31.0 Reliance Private Equity
DRS Logistics Transport 22.7 Kotak Investment Advisors
First Flight Couriers Transport 26.7 27.7 Temasek Holdings Advisors India
Ocean Sparkle Limited Shipping 18.0 India Equity Partners
Reliable Autotech Shipping 4.6 17.0 BTS Investment Advisors Private
Adani Power Utilities 229.6 8.0 Tano India Advisors
KVK Energy & Infrastructure Utilities 26.0 Old Lane, LP
Lanco Amarkantak Power Utilities 8.0 5.8 International Finance Corporation (IFC)
Moser Baer Photo Voltaic Utilities 100.0 CDC Group; GIC Special Investments
Pte; IDFC PE, IDFC Company
 Select PE transactions in 2008 (first-half)

Investee Ind Amt $ % Investors

mn
Ashoka Buildcon Construction 180.3 15.6 IDFC PE Co.
Nagarjuna Construction Construction 50.0 3.2 Blackstone Advisors India
ICOMM Tele Telecom 12.4 Tano India Advisors
Parag Milk Foods Food items 14.1 Motilal Oswal Venture Capital
Mahindra & Mahindra Fin service Fin services 105.6 11.2 Standard Chartered Private Equity
Totem Infrastructure Infra 7.4 Aquarius Investment Advisors (India)
Mahindra & Mahindra Manufacture 172.4 3.7 Goldman Sachs (India) LLC
Maithan Ispat Manufacture 18.5 IL&FS Investment Managers; Orix Corp
Shakti Pumps (India) Manufacture 0.2 9.1 Mayfield
Anil Printers Media 7.4 Tano India Advisors
Apollo Hospital Enterprises Medical 13.9 1.9 Apax Partners India Advisors
Gland Pharma Medical 30.4 3 Logi Capital
Healthcare Global Ent Medical 20.0 Premji Invest
Parabolic Drugs Medical 7.0 BTS Investment Advisors Pvt.
Sai Advantium Pharma Medical 20.0 12.0 ICICI Venture Funds Mgmt. Co.
Punj Lloyd Upstream Metals 30.0 12.0 IFC (world bank)
DLF Assets Real estate 450.0 Symphony Capital
 Select PE transactions in 2008 (first-half)

Investee Ind Amt $ % Investors

mn
Maytas Properties Real Estate 153.3 Infinite India Investment Management
Vaishnavi Group Real Estate 28.0 Actis Capital LLP
Shriram EPC Services 3.5 1.1 Asiabridge Fund, Bessemer Venture
Partners, Chrys Capital Mgmt. Co., ICICI
Venture Funds Mgt. Company
Aditya Birla Telecom Telecom 640.0 20.0 Providence Equity Partners
Bharti Infratel Telecom 250.0 2.5 KKR Asia
TV 18 Home Shopping Network / Telecom 10.0 25.0 SAIF Partners
HomeShop 18
Reid & Taylor (India) Textiles 209.6 25.4 GIC Special Investments Pte.
TVS Logistics Services Transport 25.1 Goldman Sachs (Asia)
ACME Tele Power Utilities 100.8 3.4 Jacksons Heights Investments, Monsoon
Capital LLC
KLG Power Utilities 50.1 20.0 TPG Growth, LLC
Shree Maheswar Hydel Power Utilities 24.0 Henderson Equity Partners
Sophia Power Utilities 403.8 37.5 DE Shaw India Advisory Services
 Select PE Exit transactions in 2007

Investee Amt $ Deal Seller Investor

mn %
Nagarjuna Construction 16.4 2.1 ICICI Venture Funds Indian investors
Company Ltd Mgmt. Co. Ltd
Punj Lloyd Ltd 54.5 2.2 Standard Chartered PE; Chinese Investors
Temasek Holdings
Godrej Beverages 53.9 51.0 Godrej & IL&FS The Hershey Co. (US)
MTR Foods Ltd 100.0 Aquarius Invst; Orkla ASA (Norway)
JP Morgan Partners
Federal Bank Ltd 10.6 2.2 IFC (world bank) Indian investors
Sharekhan 118.2 85.0 General Atlantic; HSBC Citigroup VC Intnl
PE; Intel India
NIIT Ltd 48.4 10.0 Intel Capital (India) Indian investors
Gammon Infrastructure 17.9 3.5 Och-Ziff Capital Mgt Co. Gammon Cooling
PVR Ltd 3.2 3.7 ICICI Venture Funds Calderys (Finance)
Sintex Industries 256.4 25 Warburg Pincus Indian investors
Apollo Hospitals 30.3 5.3 Temasek Holdings Indian investors
Aurobindo Pharma 23.2 2.5 Standard Chartered Indian investors
Subhiksha Trading 18.6 5.0 ICICI Venture Funds Prudential ICICI
Trinethra Pvt. Ltd 76.8 90.0 India Value Funds Aditya Birla
 Select PE Exit transactions in 2007

Investee Amt $ Deal Seller Investor

mn %
New Delhi Television 7.7 General Atlantic Prannoy & Radhika Roy
Welspun India Ltd 5.0 4.3 ICICI Venture Funds Indian Investors

Deccan Aviation 104.6 20.0 Deccan Aviation, ICICI Kingfisher Radio; UB

Ocean Sparkle Ltd 18.0 APIDC Venture Capital India Equity Partners
Thank
you!