India fundraising: Uphill battle

"Those last 12 months were the worst I have seen in my career," is Mukul Gulati's unequivocal verdict on institutional investors' appetite for Indian private equity.

As co-founder and managing director of Zephyr Peacock, an investor in small and medium-sized enterprises (SMEs), Gulati was on the road until September, marketing his firm's third fund. The vehicle launched in November 2011 with a target of $150 million and reached a second close of $70 million in April. A final close is expected by the end of the year. Fundraising for Zephyr's second fund took less than six months in 2009, coming in at $75 million.

Gulati is back in the office overseeing a recently launched trade sale process, which is drawing interest from strategic players and is expected to close in early 2014. But overall the GP hasn't prospered in terms of exits, with two in the last two years. It was hoped that two more would follow in 2013 but they didn't happen.

"It has been disappointing," Gulati adds. "One of the exits we wanted to do was going to be an IPO but the market has been dead for medium-sized issuers. You can list but you just won't get a good price."

Zephyr Peacock is to some extent a microcosm of the challenges facing Indian private equity. But at least the GP is on course to raise a fund; plenty of others are not. According to AVCJ Research, Zephyr is one of only 19 India-focused managers to reach any kind of close in 2013. Fundraising for the year stands at $1.7 billion, trailing the 12-month figure for 2012 by nearly $600 million. It is almost certain to be the weakest fundraising year since 2004.

The root cause

There is a litany of contributing factors: India's slowing economy, the dramatic slump in the rupee, regulatory uncertainty ranging from the tax treatment of offshore funds to PE investors ability to enforce put options, and policy paralysis ahead of next year's general election.

But the story for private equity is ultimately the same as it was 12 months ago: not enough capital from earlier vintages is flowing back to LPs. A staggering $24.3 billion was pumped into India funds between 2006 and 2008. Five years on, those funds should be making distributions, but exit proceeds for 2011-2013 stand at just $12.1 billion - and this includes investments made by regional and global funds.

A shrinking GP base may see the survivors thrive as they deploy capital in a less competitive market with more reasonable valuations. But even those LPs actively looking for managers to back in the country are wary of jumping in.

"We put most of our money to work in India between 2010 and 2012 so we are just waiting," says Menka Sajnani, senior vice president at Auda Asia. "Distributions from the funds in 2007-2008 have been minimal. We have money on the ground that is not yet deployed so we might as well wait and see how that plays out. These are 2011-2012 vintage funds with dry powder."

As Zephyr Peacock's experience suggests, fundraising periods are lengthening. AVCJ Research has records of 21 funds launched in 2012. Of those, 16 are still in the market and 12 have yet to reach a close of any kind. From the 2011 vintage, 17 of 31 continue to fundraise and 10 are without a close to their name. It is possible some of these have effectively given up.

Sunil Mishra, a partner at Adams Street Partners, estimates that the number of funds launching over the next 12 months will be "somewhere in the high single digits to early double digits," and he doesn't expect any of them to reach a full and final close within a year under the current economic scenario. Indeed, he predicts the bulk of them will not be successful at all.

In a difficult fundraising environment, however, a few GPs have managed to break through. The nine funds that have reached a final close in 2013 include two first-timers: Kedaara Capital, which raised $540 million in 17 months, beating its $500 million target; and Tata Capital's Tata Opportunities Fund, which spent more than two years in the market and ended up with $600 million, short of the planned $1 billion.

In the case of Kedaara, LPs highlight a compelling investment narrative and early fundraising momentum. The GP plans to focus primarily on buyouts and formed a partnership with UK-based Clayton, Dubilier & Rice to develop an operationally-oriented approach; then Ontario Teachers' Pension Plan came in as anchor investor, helping the fund to a first close of $325 million within six months of launch.

One LP adds that the significant members of Kedaara's investor base are not traditional backers of Indian PE funds, with several making their first foray into the country.

In this respect, the GP has much in common with Tata, which deliberately cultivated a narrow range of investors. This was in part an acknowledgement of the nature of the fund - it is backed by Tata Group and makes investments within the Tata family of companies as well as targeting other India-based assets - and the broader macroeconomic climate.

"We only have about 10 investors and the LP universe we reached out to was much smaller than for a traditional fundraise," says Bobby Pauly, a partner at Tata Opportunities Fund.

"It was a bigger challenge because we are a first-time fund trying to raise money at a time when the macro environment is the weakest in 10 years. Our strategy was to find a select few investors who were here for the long-term so could look beyond the macro, who were interested in co-investment and who could write large checks."

Size matters

Both Kedaara and Tata Opportunities Fund are looking to punch above their fund size through co-investment, claiming they have a fair number of sizeable control deals in the pipeline.

For most GPs, though, ambitions are moderating, with many of the current vintage of funds coming in at best only marginally larger than their predecessors. It would appear that Mishra of Adams Street's fear that Indian PE firms will follow many of their Chinese counterparts in doubling in fund size with each vintage is not being realized. After the blow-out of the mid 2000s, the amount of capital available is falling back in line with the economic opportunity.

ChrysCapital Partners, for example, restricted its sixth vehicle to just $510 million - little more than half the size of Fund V - in order to focus on growth capital transactions rather than the larger mid-market space that it felt had become too congested. Samara Capital, having raised $250 million for its first fund in 2007, set a hard cap of $300 million for its second, while Gaja Capital is seeking $250 million, having raised $200 million the first time around.

Sajnani notes that Auda now prefers managers with $300 million or below. Pratima Divgi, vice president at FLAG Squadron Asia, adds that her firm was quite active in 2012 and the start of 2013 when several VC players raised new funds - there have been no final closes in excess of $270 million in this segment. It has since identified a few funds in India and depending on due diligence may make a commitment or two in 2014.

"Structurally, I see the market consolidating with select mid-market players and a few quality GPs at the smaller end of the market with niche strategies," Divgi says.

These reportedly include Motilal Oswal Private Equity's India Business Excellence Fund II, another of the nine final closes in 2013, which raised $158 million.

According to industry sources, among the bigger names likely to launch new funds in the next 12-18 months are India Value Fund Advisors, CX Partners and Everstone Group, each of which raised in excess of $500 million for its previous vehicle. Fund sizes will come under scrutiny, but so too will exits.

Dhanpal Jhaveri, partner and CEO at Everstone, declines to comment on fundraising plans but he admits that returning capital to investors will be a key area of focus over the coming year.

"The first fund was invested in 2007-2009 and over that period we made 17 investments and have so far made two exits," he explains. "Our strategy is largely to stay invested a bit longer, but we are crossing the five-year threshold with a number of our investments so there will be further exits."

With little in the way of capital markets activity, Everstone is increasingly looking at private market exits to trade and financial buyers. In certain situations - even as a minority investor - the GP has an agreement that it will help grow a company for 3-5 years and then seek a strategic buyer. Jhaveri says this is possible because Indian entrepreneurs are now younger, often first-generation operators, and generally more open to strategies in which they cede ownership.

Much is made of the uptick in sales to other PE firms, and the numbers support this. Secondary transactions total $963.4 million for the first 11 months, having reached $1.58 billion in 2012, much higher than in previous years.

It represents an alternative exit route for GPs who need to return capital to LPs, but how much they manage to distribute is still a function of the amount they spent getting in.

"Even if a company is good enough to be exited, you might have paid a very high price so it won't be a very profitable exit," says Adams Street's Mishra. "Secondly, all exits are set back by huge currency depreciation if you have been investing between 2006 and 2009. Even if you managed to generate a 3x return on a deal, which is not easy, 1.5x is gone because of the currency at current exchange rates."

The consensus is that a GP raising Fund II might still get the benefit of the doubt from patient LPs. By the time Fund III comes around, the first vehicle should already be returning capital and if it is not then a re-up is unlikely. Even on Fund II, though, negotiations can be fraught.

"If you are raising your second fund the negotiations will be difficult with existing LPs who agreed to one set of terms last time but want to change them this time," says Sidharth Bhasin, a partner with Shearman & Sterling.

There is anecdotal evidence of push back on fees, while hurdle rates are being moved up and, if they were previously calculated in local currency, into US dollars. The trade off is that LPs still want managers to be able to retain talent and be sufficiently incentivized to chase carry.

At the other extreme, a couple of Indian GPs that are struggling to raise funds are said to be in negotiations with large institutional investors to become dedicated investment platforms - essentially managed accounts, complete with the less favorable economics.

A tough sell

As several LPs attest, the weeding out of underperforming managers has made life easier for investors that are willing to back India-focused funds. Comparisons are drawn with 2004-2005 when there were fewer players in the market and less competition for deals, which meant lower entry valuations and stronger returns.

SAIF Partners India, currently investing its 2011 vintage fourth fund, is among those GPs that claim to benefit from the changing dynamic. Managing Partner Ravi Adusumalli notes that deployment has accelerated in 2013 despite the volatility created by rupee depreciation. "My guess is that 2014 will be even larger for us, given there are fewer funds chasing deals," he says.

The challenge for those in the market with new funds is persuading LPs to see this potential. This means looking beyond the current problems facing India's economy and the past performance of its private equity industry. It is not an easy sell.

Tata Opportunities Fund's Pauly recalls two institutional investors - one North American and one Asian - that made due diligence trips to India and came very close to committing to the fund but ultimately couldn't win over their respective investment committees.

"It wasn't as much about our fund as much as the macro and the performance of India funds in general," he says. "It came down to China versus India. The investment committee decided that China seems to be safer."

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• Topics
• Fundraising
• South Asia
• Exits
• India
• Fundraising
• Exit
• Everstone Capital
• Zephyr Peacock Management
• Kedaara Capital
• Tata Capital