Mirror Cap And Investments

Prakash Snacks, Indore received USD 30 Million (Approx. Rs. 150 Cr.) from a Private Equity (PE) Fund in June 2011, Dilip Buildcon, Bhopal raised USD 15 Million (Approx. Rs. 75 Cr.) from another PE Fund in February 2012, JICS Logistics, Indore got USD 8.81 Million (Approx. Rs. 44 Crores) from one more PE Fund in June 2011. There are couple of more deals which have been finalized between Small & Medium Businesses (SMB) from Madhya Pradesh and similar states and Private Equity Funds in last financial year. So few deals from huge source of fund such as PE, does not paint a rosy picture of SMB sector in Madhya Pradesh, which boost of being the second largest state in India in terms of Area and Sixth largest, in terms of population. One can also say that it reemphasizes the fact that MP is still one of the BIMARU states in the country.

The main reason for such a dismal show is the mindset of local businesses and the way they conduct their business! Neither they understand how to make best use of Private Equity funds nor they want to know. This article might help them to clear some of their misconceptions and would also guide them how to make big money, the right way! Before digging deeper in to it, let me take you through some of the basics related with Private Equity.

PE Funds are basically fund managing companies which invest funds from investors such as HNIs, Domestic & Foreign Financial Institutions & Insurance Firms to a host of potential fast growing companies generally in form of Equity in order to provide the investors a minimum ROI (Return on Investments), which are usually much higher compared to what is provided by more common Investment Instruments such as Fixed Deposits, Mutual Funds, Insurance etc. Such investments generally come without any kind of collaterals unlike debt facilities.

PE Funds generally prefer to invest in professional and fast-growing companies having a good track record and core competence in their respective industries. Generally, they seek representation in board with some specific rights and IRR (Internal Rate Of Return) of more than 18%. They generally seek exit through IPOs or strategic buy from another company/ investor within a specific period.

There are a few common reasons why most of the businesses from states like Madhya Pradesh (and similar states) do not “qualify” for PE investments:

1. Company does not have the size. It means that company is not at least a Hundred Crore company in terms of revenues. This entails that Investor would find it difficult to get an exit through their preferred way of IPO as company would simply not be big enough for a successful and attractive IPO. This is true for most of the SMBs.

2. Company does not have the required profitability. This entails that either the company is not making profits at all or it is not showing profit margins around the Industry average mark. That is where our state businessmen score through their proud practices of “showing minimum possible taxes and hence the profitability on the papers” and “doing business in cash”. Though this is not unique to state SMBs but the problem is that most of them simply do not want to avoid such practices in order to clean their books.

3. Professional Management And Promoters. The point mentioned earlier, also shows their professional attitude or rather, lack of it, to run the business. This basically pisses the investor off. More over, their lack of professionalism also reflects through the way they interact with investment community or the intermediaries. They do not have relevant documents on time. They have not even heard of a financial model what about preparing it? They would give you all the documents required but suddenly they change their minds and stop picking your phone or answering your emails! What can anyone do in such cases? Such incidents actually end up creating a poor image of the entire business community and tag them negatively.

4. Company belonging to a fragmented market such as Edible Oil, Manufacturing, Pharmaceuticals etc. and do not have a proper differentiation/ Core Competence/ USP (Unique Selling Proposition). So, although they might boast of hundreds of crores rupees in revenues but they are basically nothing more than a face in the crowd!

5. Company is a trader/ distributor without having a brand name unlike a Hypercity, Reliance Fresh, Shoppers Stop etc. A local kirana shop or a local distributor, however big they may be' simply would not qualify for the PE Investments as it lacks identity. Such guys do not add any value to the offering, rather they are just supplying them.

6. Promoters mentality about sharing ownership with investor. “My family has been running this business since ages. I know the best how to do business in Bhopal and Indore. How would an investor from Mumbai or Delhi would know this? Why should I share ownership with him then?” This is a typical reply from the promoters, without knowing the entire offering from the Investors. Most of the PE Funds are passive investors who seek a representation in Board, which basically means that giving them feedbacks on time to time. The guy who is putting into your business, without any collaterals to fall back upon, would definitely like to know how well the company is growing or whether the promoters require any kind of assistance of sort?

Promoters who want to grow their businesses professionally and aggressively should seek assistance from Private Equity Funds not only for Funds but also for their expertise, skills, experience, network and know-how of latest trends in the sector. When banks would stop funding promoters due to their guidelines, promoters do not have any other option but to seek funding through PE participation; but that is not the ideal scenario for a company having a mindset of the Industry leader. The valuation of the company is minimum at such stage.

Rather, the promoters need to be prudent enough and plan in advance in order to seek the funding through PE route when the valuation is at its peak and hence the promoters have an upper hand in negotiations. If Madhya Pradesh business community wants to grow exponentially and seek unprecedented returns from their business then they must upgrade themselves to higher level of professionalism and seek value not only from money they seek through funding but also the expertise of PE Funds, which actually makes a huge difference in order to make a thriving and successful enterprise in the long run.

But as we all know that Practical businessmen would say, “This is all gyan. Show me the numbers. Show me the money!” Let me give you an example, which is very close to reality. Suppose you are a company having a turnover of Rs. 200 Crores with a Operating Profit Margin of 12% and Net Profit Margin of 9%. You have a debt of Rs. 30 Crores. You want to raise Rs. 50 Crores for expansion; now whether should you consider debt or equity as an option?

First of all, you might hardly get even Rs. 20 Crores more as debt depending on various factors such as your cash flow projections, growth pattern, collateral offered etc. since you already have a debt burden of Rs. 30 Crores. But since you have no other option but to raise at least Rs. 30 Crores as Private Equity (If you get the debt of Rs. 20 Crores), then how would you get benefited if Private Equity Investors do invest in you?

Let us again assume that your company is valued at Rs. 300 Crores and since you like to raise Rs. 30 Crores, then you would be diluting 10% stake from your company. If you, as promoter hold, rest of 90% stake, then it would simply imply that you stake is worth Rs. 270 Crores. In other words, if you chose to sell the company to an interested investor, then you would fetch Rs. 270 Crores, i.e., you would have Rs. 270 Crores in your pocket! Has the Private Equity Investments started making sense to you now?

1. Your Company Is Salable: Since a PE Fund is interested in buying out 10% of your company then it is validated that your company is salable in the market, which could not have been ascertained properly if there was no such fund interested.

2. Greater Valuations Assured: Since PE Fund would roughly expect to double the value of its stake within 3-4 years, then it would also imply that your stake would also be valued at double the price. In other words, for the same 90% stake, you would fetch Rs. 540 Crores (Double Of Rs. 270 Crores), if things go as expected.

3. Better Response To IPO: It is a proven fact that IPO backed up by a PE Fund are far more attractive to investors than the ones which have not been backed up. You can go alone for an IPO, without the PE Fund and try to raise funds but the problem would be that you might not get proper response from the market. If you are a good company then your IPO might be oversubscribe 5-6 times, but with the help of a PE Fund, such a potent company can expect to be oversubscribed much more than that, let us say 10-11 times. It would mean that your valuation would be almost 2 times more. Right?

4. PE Fund Managers Are Seasoned Players: PE Funds have much more knowledge in terms of deciding the right timing of IPO. Which Investment Bankers to chose? How to deal with them? How to market the IPO? Etc. etc.

All this might not be the case if you go conventionally. So if you want to make big money the right way, then the PE Funding is the best possible way for you. I would suggest businesses, who try to do business conventionally is that try the PE way, it might well prove to be the best business decision of your professional life! PE Funded businesses become much more evolved than your conventional businesses. Make money the better way, rather mint money!