Despite the currently pervasive sense of gloom, it is important to acknowledge that in the last decade, the contribution of venture capital and private equity (VCPE) to the Indian economy has been significant. In order to sustain this momentum, the critical imperative for VCPE in India is to achieve greater exits and return more capital back to our Limited Partners (LP) over the next one-two years. If this can be successfully achieved in terms of significant realisations and healthy IRRs (internal rate of return), then the floodgates of additional capital into Indian VCPE will open. If not, question marks will persist over the viability of Indian VCPE, which we can ill-afford given the high dependence on this asset class for the supply of risk capital to Indian entrepreneurs.
In this connection, the inevitable comparisons with China are stark. While many Chinese PE funds boast of significant realisations and returns, the exit story in India has been relatively disappointing thus far. This muted performance can be principally attributable to India becoming more prominent in the eyes of global investors since 2005, fuelling competition for deals, which resulted in valuations being aggressively bid. In this business, entry valuation is a key determinant of ultimate returns on a transaction. Additionally, the enthusiasm to make investments often resulted in compromises on the quality of diligence, inadequate structuring, lack of alignment with promoters, etc., which led to sub-optimal outcomes. The listless state of the secondary markets made exits even more difficult.
The exit environment is expected to remain difficult for the next two years. Of the $50 billion of VCPE investments into India, a significant proportion invested during 2006-2008. Research from Bain indicates that approximately 70 per cent of the capital invested during this time has yet to be returned to LPs.
Given the standard holding period of five years, much of these investments will be actively seeking exits. This translates to a bloated exit pipeline for the next few years, certainly significantly higher than exit values ever seen in India in the past. The sheer pressure to show exits will result in more exits taking place, although at lower than expected returns, which in turn could detrimentally impact future fund raising for India.
In this scenario, will the performance of VCPE in India improve over the next five years? Having gained from experience, investors are more cognizant of pricing the risks of doing business in India and of adding value to portfolio companies. Promoters are more aware of the value that VCPE can provide. This collective maturity and experience should lead to improved performance, in terms of the ultimate yardstick that measures success for the VCPE industry, namely, return on investment.
The author is partner, New Silk Route Advisors
