Unlocking Business Potential with Private Equity: Successes and Challenges

Imagine an Indian textile company struggling to stay competitive in the global market. The company has outdated machinery, inefficient production processes, and limited access to capital. Its competitors are innovating and expanding, leaving it behind. The company is stuck and in desperate need of a turnaround.

In situations like this, private equity (PE) can be the solution. PE firms specialize in providing the capital and expertise necessary to revitalize struggling businesses. By stepping in, these firms can help transform outdated operations, introduce new leadership, and make companies profitable again.

How Does Private Equity Work?

Private equity firms follow a structured process to help companies grow or recover from financial distress.

1. Raising Funds from Investors Private equity firms don’t use their own money; instead, they raise funds from institutional investors like pension funds, insurance companies, and high-net-worth individuals. These investors contribute to a PE fund, which the firm then uses to buy stakes in companies. For instance, when Everstone Capital raised its India-focused fund, it gathered money from global investors to invest in sectors like healthcare and education across India.

For example, in 2022, Multiples Private Equity raised $640 million for its fourth fund, focused on opportunities in India. The firm has invested in companies across healthcare, financial services, and technology.

2. Identifying Target Companies PE firms look for businesses with growth potential or those that are underperforming but have valuable assets. These companies often need operational improvements, better management, or financial restructuring.

Example: In 2020, Kedaara Capital invested in API Holdings, the parent company of PharmEasy. The online pharmacy was poised for significant growth but required capital to scale and enhance its technology infrastructure. Kedaara’s investment helped API Holdings expand its reach across India.

3. Acquiring the Company Once a suitable target is identified, the PE firm acquires it through a leveraged buyout (LBO), which uses a mix of the PE fund’s capital and borrowed money (debt).

Example: In 2021, Blackstone acquired a controlling stake in Simplilearn, a leading Indian online learning platform, in an LBO deal. Simplilearn used the resources to expand its courses and grow its user base globally.

4. Restructuring and Improving Operations After acquiring a company, the PE firm focuses on making it more efficient and profitable:
   • New Management: PE firms often replace existing management with experts who have experience in improving company performance. For instance, when Warburg Pincus invested in Shaadi.com, it helped the company revamp its digital platform and expand its market share through better leadership.
   • Cost-Cutting and Efficiency: PE firms look for ways to reduce operational costs. When TPG took over Vishal Retail, it shut down unprofitable stores, negotiated better deals with suppliers, and optimized logistics.
   • Technological Upgrades: PE firms help companies modernize by adopting new technology. Everstone Capital’s investment in Sahyadri Hospitals, one of India’s largest hospital chains, led to technological improvements in medical facilities and patient care systems, making the chain more competitive.
5. Exiting the Investment The ultimate goal of a PE firm is to exit the investment by selling the company at a higher value. They typically hold onto a company for 4-7 years before selling it through:
   • Initial Public Offering (IPO): Taking the company public by selling shares. PE-backed Indian companies like Matrimony.com (which owns BharatMatrimony) went public after PE firms helped them grow and improve operations.
   • Selling to Another Company: The firm might sell the company to a larger competitor or another PE firm. For example, Blackstone sold its stake in Intelenet, a business process outsourcing (BPO) company in India, to a global player for a significant profit.

Why Do Companies Turn to Private Equity?

1. Capital for Expansion Businesses that need capital to expand often turn to PE firms. A great example is Byju’s, India’s largest ed-tech company. After securing funding from investors like Silver Lake, Blackstone, and Tiger Global, Byju’s used the capital to acquire smaller education startups and grow internationally.
2. Turnaround Expertise Struggling companies benefit from PE’s expertise in turnarounds. In 2020, V-Mart Retail, a discount retail chain, secured investment from Faering Capital. The firm helped V-Mart restructure and enhance its store-level operations, turning around its fortunes.
3. Expert Management PE firms bring in experienced management to help businesses grow and thrive. For instance, when Warburg Pincus invested in Havells India, it helped the electrical goods manufacturer improve its global supply chain and expand internationally by bringing in new leadership.
4. Innovation and Modernization Companies that need to modernize their processes and adopt new technology often turn to PE for help. Everstone Capital’s investment in Burger King India is an example. The firm helped modernize operations, expand outlets across the country, and implement technological upgrades to make Burger King a strong competitor in India’s fast-food industry.
5. Financial Restructuring Companies burdened with debt look to PE firms for financial restructuring. When Blackstone took a stake in Mphasis, an Indian IT company, it helped restructure the company’s debt and streamline operations, making it a leader in the Indian outsourcing industry.

What are the Types of Private Equity Firms?

There are many different types of private equity firms, but they can generally be categorized into two main groups: venture capital firms and buyout firms.

• Venture Capital Firms: Invests in early-stage companies with high growth potential. They typically provide funding for these companies in exchange for a minority ownership stake. 
• Buyout Firms: Invest in mature companies that they believe can be improved through restructuring or operational changes. They typically acquire these companies with a combination of debt and equity, and they often take a controlling interest in the company.
• Growth Equity Firms: These firms invest in later-stage companies that have already achieved some success. 
• Mezzanine Capital Firms: These firms provide debt financing to companies that are too risky for traditional banks. Mezzanine debt is typically secured by the company’s assets, and it often has a higher interest rate than traditional debt.
• Distressed Debt Firms: These firms invest in companies that are in financial trouble. They typically buy the company’s debt at a discount, and they then work with the company to try to turn it around.
• Real Estate Private Equity Firms: These firms invest in real estate assets, such as commercial properties, hotels, and apartments. They typically buy these assets with a combination of debt and equity.

Advantages of Private Equity

1. Access to Capital Private equity provides the necessary capital for growth, acquisitions, or restructuring. For example, Delhivery, India’s logistics startup, raised over $400 million from PE investors like Carlyle and SoftBank, helping the company grow into one of India’s logistics leaders.
2. Expert Guidance PE firms bring expert knowledge and strategic insights. Temasek Holdings’ investment in Zomato provided strategic support that helped the food delivery company grow internationally..
3. Long-Term Growth Unlike short-term investors, PE firms focus on long-term growth. Matrimony.com benefited from years of private equity backing before going public in 2017, with its valuation significantly enhanced due to sustained investment in product development..
4. Enhanced Efficiency PE firms identify inefficiencies and make companies leaner. When Everstone Capital invested in Modern Foods, the firm worked on improving its distribution and product portfolio, resulting in higher profitability..
5. Exit at Higher Valuations PPE firms aim for profitable exits. In 2022, Tata Group bought BigBasket, a company that had previously benefited from private equity funding from Alibaba and others, for a significantly higher valuation.

Challenges Faced by Private Equity Firms

1. High Debt Levels Leveraged buyouts (LBOs) come with the risk of high debt. For example, Future Retail, backed by private equity firm Samara Capital, struggled under debt and eventually faced bankruptcy in 2022 due to competition and market pressures
2. Exit Strategy Risks Timing the exit can be challenging due to market volatility. Carlyle faced hurdles when exiting its investment in SeQuent Scientific in 2021 due to changing global demand in pharmaceuticals, which impacted the company’s valuation.
3. Operational Failures Not all operational improvements succeed. Despite PE backing, Jet Airways failed to revive its operations post-2020, ultimately ceasing operations due to mismanagement and operational challenges.
4. Regulatory Challenges PE firms operating in regulated sectors face additional scrutiny. Blackstone’s 2021 investment in Emami Cement faced delays due to environmental and regulatory concerns.
5. Public Perception PE firms are often criticized for cost-cutting measures. Ola, which received PE backing from Softbank, faced public criticism for layoffs and reducing driver commissions in the aftermath of the pandemic, despite the need for financial sustainability.

What are the Factors Affecting the Performance of Private Equity Investments?

There are many factors that can affect the performance of a private equity fund, including:

• Stage of the Investment: Private equity investments typically invest in companies at different stages of their lifecycle, such as early-stage, growth-stage, or mature-stage companies. 
• Industry Sector: The industry sector in which the fund invests can also have a significant impact on performance. Some industries, such as IT, are more cyclical than others, and this can affect the fund’s performance.
• Geographic Location: The geographic location of the investments can also affect performance. Some countries or regions are more attractive to private equity investors than others, and this can also affect the fund’s performance.
• Investment Strategy: The investment strategy of the fund can also have a significant impact on performance. Some funds focus on a particular industry sector, while others focus on a particular stage of investment. 
• Management Team: The management team of the fund is also an important factor that can affect performance. A strong management team with a proven track record can help to improve the fund’s performance.
• Market Conditions: Market conditions can also have a significant impact on the performance of a PE fund. If the stock market is bullish, then the fund is more likely to perform well. However, if the stock market is bearish, then the fund is more likely to perform poorly.

Conclusion

Private equity plays a vital role in the growth and transformation of businesses in India and globally. PE-backed companies such as Lenskart, Nykaa, and Delhivery have demonstrated the potential for significant growth when provided with the right capital and strategic direction. However, private equity investments also come with risks, such as high debt, operational failures, and regulatory hurdles. While the rewards can be substantial, careful management is essential to navigating the complexities of private equity investment in today’s dynamic business environment.

For a detailed guide on how SME IPOs in India are helping small businesses grow, check out our blog, “Understanding SME IPOs: A Gateway for Small and Medium Enterprises” and “SME IPOs in India: A Path to Growth for Small Businesses”