India’s reputation as an assault on the senses is well deserved. Visit any of the country’s 29 states, nearly 8,000 cities and towns, or over 600,000 villages, and one is typically confronted by an onslaught of vibrant colors, musical sounds, rich smells, diverse languages, and, quite frequently, utter chaos. Navigating this chaos has become a way of life in India, and by extension for its business and finance community.
Private equity in India has had a bumpy ride over the past two decades as fund managers have learned the hard way how to access India’s promise amidst the turmoil. However, today’s crop of GPs have successfully endured a number of cycles and now carry a robust tool chest of lessons learned, which may help them pave the way toward a new, more favorable era for the industry ahead.
A Brief History
India’s earliest private equity pioneers launched their initial funds in the late 1990s. Facing the dual challenge of convincing both prospective limited partners and entrepreneurs—most of whom had never heard of the asset class—that the private equity model could work in India, these forerunners nonetheless enjoyed relative prosperity amidst limited competition.
Between 2000 and 2005, however, the landscape dramatically changed as India began to take its place on the world stage. Economic liberalization policies implemented in the 1980s and 1990s were beginning to take effect—the GDP growth rate was rising, inflation was dropping, and new markets were opening up for investment. Then in 2001, Jim O’Neill, formerly with Goldman Sachs, famously identified India as one of the BRICs— a group of countries that promised to eventually overtake the developed world in leading the new global economy. The world wanted to grab a piece of the action and private equity investors were no exception.
Firms in the market continued to perform well. “Private equity firms enjoyed healthy returns in India from investments made between 2004 to 2006, or the Golden Era,” recalls Ashley Menezes, Managing Director of ChrysCapital. “You could invest in companies at cheaper valuations because there was less competition, and these companies benefited from intrinsic growth within the system. Even if you made bad investments, you could still do well.” CX Partners’ Jayanta Kumar Basu, Partner, echoes this sentiment, “Prior to 2007, the markets were friendly and it was a relatively simple business. You could identify companies early, get a reasonable multiple and then effectively ride some part of the market beta. Multiple expansion was the primary driver of value.”
Money began to pour into the Indian private equity market. Dr. Archana Hingorani, CEO and Executive Director of IL&FS Investment Managers Limited, one of the oldest private equity fund managers in India, notes, “Fundraising pre-2005 was difficult because India was an unknown entity. We raised four to five funds of small magnitudes, raised every three to five years, where LPs kept changing over each fund, so you always started from scratch. It’s only from 2005 onwards when the investment committees of LPs approved an allocation to India that you saw an ease of raising capital. Certainly in the euphoric years that followed, there were periods when it took less than a year to raise a fund, even though the due diligence process was as rigorous as before.”
Indeed fundraising for India-focused private equity funds reached an all-time high by 2008 with US$8 billion in commitments raised (see Exhibit 1). As EMPEA’s statistics exclude funds allocated to India via pan-Asian or global vehicles, this number understates the total amount of capital that was flowing into the subcontinent. Alongside this increase in capital came an explosion in the number of GPs operating in the market—all within a relatively short period of time. Many of the global firms had already made forays into India, including Blackstone, The Carlyle Group, KKR and Warburg Pincus, while several new entrants, including Apax Partners, Apollo Management and Bain Capital, which established its local office in 2008, took interest. Numerous country-dedicated funds were raised by both local and global firms in the years leading up to the global financial crisis, including many first-time funds that were able to close on vehicles over US$150 million in size. According to EMPEA’s database, over 100 firms launched new private equity vehicles specifically targeting India between 2006 and 2009.
By 2009, however, the party came to grinding halt as the aftermath of the global financial crisis hit India. Dry powder became an enormous issue for the market as firms struggled to invest the funds they had already raised, particularly as valuations had become— and remained—quite high. Furthermore, the slowdown exposed several cracks in the foundation of India’s private equity model beyond the mismatch in buyer and seller expectations.
A failure to create value in portfolio companies, the lack of exits and macro challenges, including government inaction, currency depreciation and weakness in the public markets, all added up to a comedy of errors, with the end result being that India’s private equity performance did not meet expectations and both GPs and LPs lost money. Not surprisingly, a consolidation was about to take place across the Indian private equity industry. Numerous GPs that had raised their first funds in 2007 and 2008 found themselves with minimal track records and were unable to raise follow-on funds. Several funds did not survive the upcoming years; those that did had to pause for introspection and reflect upon what went wrong during the last cycle.