Session notes: Private Equity Funds

What is a Private Equity Fund?

 Accumulation of capital for investment from a group of investors, who have the ability and willingness to invest the money
 The capital will be invested in companies which require the funds for reasons such as:
o Growing the company through new product development, expansion into new markets etc
o Increase in existing manufacturing capacity to service increased demand for company's products
o Repayment of existing debt and replacement of debt with equity
o Providing exit for existing investors
 Investors are typically institutional investors like pension funds. In case of Venture Capital funds, investors can also include high net-worth individuals.
 Rationale for investors: to facilitate investment in companies to earn a return
o Investment as a group helps reduce the risk for each investor
o Additionally, a single investor would not be able to put in enough funds to fulfil the investment requirement of a company

Typical structure of a private equity fund

 Investors (called Limited Partners or LPs) pool their money into a fund (called
Private Equity Fund)
 The fund is managed by a fund manager (called General Partner or GP)
 The GP advises the fund to invest money into companies which require the
fund
 The GP normally gets fees for the following:
o Management fee for managing the fund and it’s investments
(typically in the range of 1-2% per annum)
o % of realized profits

Hint: think of the structure as being similar to a mutual fund!

Types of Private Equity funds
Private Equity funds can be classified as:

a) Based on stage of investment: Venture Capital funds, Growth Capital funds, Buyout
Funds, PIPE funds
b) Special situation funds: Mezzanine funds, Distressed Funds
c) Sector orientation: Sector focused funds, Sector Agnostic funds

Classification on stage of investment

Type of fund Key characteristics Rationale for companies to ask for Examples
investment
Venture Capital  Invest in early stage companies, which are yet to start  Companies scouting for VC Tiger Global, Sequoia
Funds commercial operations or yet to achieve profitability investments generally don’t have Capital, IvyCap, Matrix
 Ticket size is generally small (upto USD 15-20 Mn) commercial operations Partners, Helion Ventures
 Investment on the basis of “faith” in the company’s business  Hence need money to kickstart
idea and potential for commercial viability operations
 Higher risk appetite as compared to growth capital funds and  Will generally raise money based on a
hence higher return expectations product prototype or just a business
 Additionally, due to relatively smaller size of investee idea
companies, fund might get a higher proportion of shareholding
compared to growth capital funds, for the same amount of
money invested
 Most investments might not work and hence expect to cover
 losses from failed investments through “blockbuster” returns
from few investments

Growth Capital  Invest in companies which have shown commercial viability and  To grow an existing business through Most mid-sized to large PE
Funds revenue growth over a period of time expansion of existing capacity, entry funds such as TA
 Ticket sizes are larger than VC funds into new products/ markets etc Associates, Motilal Oswal
 Investment is on the strength of an established business model  Also partnering with an established PE PE, Kotak PE, CDC Group,
shown by the company and the ability to sustain growth in the will enhance perceived “credibility” Rabo PE, Lighthouse Funds
future
 Every investment is expected to perform with moderate to high Recent deals:
returns Motilal Oswal’s
investment in Ganesh
Flour Mills

Buyout Funds  Investment in established companies with sustained profitability  Generally companies where the IVFA, Everstone, KKR,
and cash flows promoter or the next generation is Multiples PE, TPG
 Investment can be through a mix of debt and equity with the disinterested in carrying on the
company's cash flows used to repay the debt business Eg: TPG picking up
 Potential to increase margins through operational or financial  Special situations exit where a high majority stake in Rhea
improvements value offered by the buyout fund might Healthcare
 Clear path to exit in the future through an IPO or other exit be a motivator for the promoter to exit
options the business
 Higher ticket size than both VC and Growth Capital investments
 However, unlike a VC or a Growth capital fund, the buyout fund
becomes the owner of the company
PIPE (Private  Issuance of primary equity capital by a listed company to a  Motivation similar to that of Eg: Blackriver’s
Investment in private equity fund (not to be confused with an investment by a companies seeking growth capital investment in Future
Public Fund) PE fund through the secondary market)  Easier to get a single PE investor rather Consumer can be
 Can happen by either by straight equity or by a mix of equity and than go through the public market classified as a PIPE deal
convertible instruments route for raising funds (FPOs, QIPs etc)
 Typically investment is for a minority stake, with invested  Also, regulatory requirements will be
amount comparable to that of a growth capital fund lesser than raising money from the
 Higher number of disclosures needed (to the stock market and public markets
general public) as compared to types of investments, due to
listed nature of the company
 Exit can be through sale of securities in the secondary market

Classification on sector orientation

 Sector focused: The fund will invest only in a sector or a specific group of sectors (eg:. Omnivore invests primarily in Agri focused companies. Similarly, ResponsAbility
invests in Agri, Microfinance and Renewable Energy).
  Sector agnostic: The fund will invest in all sectors (eg: most funds such as TA Associates, Tata Capital, Motilal PE etc fall under this ambit ). The fund can have some
exceptions, like it might invest in everything except real estate and infrastructure.

Special Situation Funds

Type of fund Key characteristics Rationale for companies to ask for investment
Mezzanine Funds  Investment through a hybrid instrument (predominantly debt with a potential  Allows a company to get capital without divesting
equity component) equity stake
 Debt component is usually without a collateral, with a higher lending rate as  Also, allows debt funding without collateral which
compared to normal borrowing (for the higher risk) allows the company freedom to sell/ monetize the
 Additionally debt might also have flexibility in interest payment – in case cash asset
flow constriction prevents regular interest payment, the interest can be clubbed  Investment could be at any stage of the company
with the final principal payment lifecycle
 Equity component is usually a convertible (optional) rather than straight equity

Distressed Funds  Invests in companies which are bankrupt or on the verge of bankruptcy  To turn around operations
 Aim to achieve higher returns once the company turns around financially  Sale by promoters who are unable to fix the
 Selective investment on a case to case basis problems with the business
 Risk component can be as high as VC investment; however ticket sizes are larger
than VC investments
 For eg:
o Company A is good operationally, but has a high interest burden on
account of which operations are hampered (no money left for working
capital post payment of interest)
o Distressed fund B decides to put money to pay off A’s debt; hence
money is now freed up to use for operations
o Company A now is able to operate normally, giving Fund B a potential to
exit with good returns post the investment period