Four years ago one of the world’s biggest private equity (PE) funds paid over $600 million to get a foot into the door of one of India’s most respected financial services conglomerates. After the two heads duly paid tributes to the eminence of the other’s institution at the time of signing up, the partnership was expected to blossom. Perhaps it did – until some six months ago when the financial services house abruptly stopped inviting the PE firm’s representative to its board meetings.
The problem: the head of the financial institution and the PE firm executive could just not hit it off. That’s just one reason — a distinct lack of chemistry — for relationships between PE firms and their investee companies going awry. Other reasons include differences over objectives and how to attain them; and breakdown of trust between the two sides.
PE industry circles are abuzz with stories of PE fund managers and promoters who have stopped talking to each other; of PE heads getting irked because the funds they provided are being used for purposes that weren’t mentioned at the time of signing the deal; and of investors discovering enough holes in the books of investee companies to sink an armada.
A few months ago, three representatives of as many PE investors stepped down from the board of KS Oils, a maker of edible oils, after the management failed to appoint a new auditor to examine the company’s books.
More recently, two PE investors in Lilliput Kids wear accused the company of accounting fraud – not dissimilar to what ICICI Ventures did with retailer Subhiksha a year ago.
FINANCIAL FRAUD Investors discover that promoters are cooking up the books
INABILITY TO ADD VALUE
Promoters get frustrated with PE fund’s inability to add value
SLOW PACE OF PROMOTERS: Promoters go slow on projects after promising a faster pace of execution when signing up
RACE FOR VALUATIONS
With an exit in mind, PEs make haste to prepare for a bumper IPO
None of the Parties Willing to Accept There are Differences Between Investors and Promoters
Almost none of the parties involved are willing to accept that there are differences between investors and promoters.
In the case of KS Oils, the resignations of the PE representatives leave the company with little to hide. But the management's story is different from that of the investors.
Ramesh Chandra Garg, chairman & managing director, says an income tax raid on the company triggered the resignations.
But Jacob Kurian, partner of New Silk Route, one of the three PE investors in the company, says: “We believe KS Oils has fudged its accounts. So we had no option but to step down from its board.” Citigroup Venture Capital and Baring Private Equity Asia are other two PE investors in the company.
According to a senior executive at a PE fund, varying goals of investors and promoters can trigger tensions. Typically, a PE investor has a three to five year horizon to maximize profits – and valuations. In that frenzied rush, the fund might suggest a strategy that is at odds with the promoter’s original game plan.
In the case of Lilliput, the executive adds, it is quite possible that the investors started losing faith in the business model.
When Bain and TPG came on board Lilliput, the two along with company owner Sanjeev Narula changed the strategy from opening 1,000 sq ft stores to larger formats between 6,000 and 8,000 sq ft. The idea may not have been bad – but that they opened several such stores in quick time sent the company’s fixed costs spiraling.
As Lilliput told the Company Law Board – which it had approached a week ago to restrain the PE investors – it had agreed to pay Rs 33 lakh per month as rent for a property in South Extension. “The two sides may blame each other for such a decision but the fact is the company took it. With this kind of rent, it is impossible to break even, forget making profits,'' says a retail sector analyst on the condition of anonymity.
Investors are often in a hurry to push growth as they are keen to build a valuation that will enable a timely exit. That may have been the case with Lilliput; it expanded furiously opening a store a day, began advertising on the business channels and also held discussions with Aishwarya Rai's agent to rope her as a brand ambassador—all this was done to build up to an IPO.
“A PE investor’s investment horizon often differs from that of the promoters,” says Rahul Bhasin, managing partner, Baring Private Equity Partners India. If there are PE funds that are making haste to exit at handsome valuations, there are an equal number of promoters either not keen or unable to maintain time lines decided at the time of investing. Kurian of New Silk Route attributes conflicts to poor governance, dishonesty and lack of integrity on the part of the promoters. He feels a rift is inevitable if a PE sees his investee company getting involved in fraudulent practices.
“Conflicts are guaranteed when a promoter enjoys economic interest disproportionately more than his equity interest. Many Indian promoters don’t adhere to regulation, which does not go down well with global PE funds,” adds Bhasin. The flip side is that promoters lose faith in the fund’s ability to bring that extra to the table. According to the former head of a large fund who is now setting up his own venture, one big reason for conflict lies in the PE investor’s inability to add substantial value to the investee companies. Rather, there are PE funds that introduce a heap of systems and processes that are more likely to curb growth than add value. If the relationship becomes irreparable, PE investors who think investee companies have flouted the agreement can take recourse to legal remedies, including arbitration.
“If an entrepreneur does not honour the contract, the PE investor can go to arbitration and it can also take legal steps. Generally, most PE players do the arbitration outside India, mostly in Singapore and London,” says Akhil Gupta, chairman of Blackstone India. The best way to avoid such a scenario is of course to start well – by choosing the ‘right’ partner. That may be easier said than done but it isn't difficult to spot the initial tell-tale signs of trouble on the horizon.
Sanjay Nayar, CEO, KKR India Advisors, says his company takes at least seven months to seal a deal. “We take our time to understand the promoters,” he explains. Nayar says that with so many PE funds in the fray, there is often “an auction like situation when a deal is up for grabs.” This could well prove to be a recipe for looming disaster, adds New Silk Route’s Kurian, as a PE investor may well promise more than it can deliver to seal the transaction.
In some sectors, like retail for instance, a review of the business can be a tricky affair. Anil Khatri, director at the Delhi-based Coralbay Advisory, which is advising Koutons Retail on a debt restructuring package, says all PE investors do a reality check but the review is generally time bound and limited; so due diligence at times does not bring out all the exact details – and devils – in businesses.
Source: Economic Times
