When Warburg Pincus sold its remaining 5.65% stake in Bharti to Vodafone for $847.

5mn in October 2005, it ended up making a whopping $1.92bn from a investment of $300mn made in Bharti Tele. since 1999.

India has emerged as one of the hot destinations for large global private equity firms in the recent years. Hordes of private equity professionals, venture capitalists and investment bankers are making a beeline to identify lucrative business opportunities in India.
Warburgs profitable exit announced on the global PE stage , the arrival of the Indian market as a hot destination with immense potential for PE funds, and its readiness to embrace the global Private Equity with open arms. Today, some of the worlds leading private equity firms like Blackstone Group, Carlyle Group and General Atlantic Partners, and Actis Partners are firmly established in India. Not to be left out, the Indian firms like ICICI, IDFC and Kotak are also increasing their investments. And many new foreign PE funds like Lightspeed Venture Partners, Providence Equity Partners and Apex Venture Partners are also planning to venture into India.

But what exactly is private equity In simple words and at a very basic level PE funds are just like anyother Investment funds (eg. Mutual funds), the primary difference being the source of funds and the time horizon. While mutual funds raise money from the general public, PEs gather money from financial institutions, big business houses as well as other funds like pension funds and high net worth individuals. While relatively small PE funds generally target young companies with a promising future but in need of money, big PE funds also buy stakes into established businesses expected to grow faster and yield super normal returns. PE funds normally have a long investment horizon, anywhere between 7-10 years, though in the Indian context, many funds are looking for a smaller time horizon of 3-5 years. PE funding is a sort of partnership wherein the PE firm acts as the managing and working partner. PE firms raise money by approaching investors like HNIs and others mentioned earlier and taking commitment for the amount they are willing to invest through the fund. Once the firm has obtained commitments and has an estimate of the funds raised, it starts seeking investment opportunities (mostly Leveraged Buy-outs). The firm collects the money from the investors in the ratio of their commitments as and when an investment is actually made. Needless to say, the firm gets the management fees as well as the extra bonus on profit (the firms generally keep a decent share of the profit they make in the deal). A typical PE fund generally makes some 15-20 investments over its life span. It acquires a substantial share of the firm and also negotiates

for having some representation on the Board. It invariably targets unlisted companies with a medium to long term focus. The stage at which the PE firms invest is (Growth or Expansion) generally next to the Venture Capitalist, seeking a little more mature bet. Apart from all the complicated analysis, the basic feature upon which the firm decides whether to invest or not in a particular company is the Return on Investment (ROI) they can get at the time of exit. Since the risk associated with such investments is huge, the returns they seek (30-40%) are also very high. The exit routes generally available to the firm are Initial Public Offers (IPOs), strategic sale, buy backs and sale of stake to another PE fund (PEPE). While IPO is the most preferred exit route, the current trends show that PEPE (PE to PE deals) are gradually picking up in India, which is a sign of the growing maturity of the market. According to the Monthly Newsletter Fund Raising Special.(January 2006), Private Equity Intelligence London, some $261bn was raised world over in private equity in 05. This comes after the time when PE funds appeared to be losing out to hedge funds few years ago: in 2002 and 2003, only $93bn and $87bn were raised respectively. But the years 2004 and 2005 have proved to be the turning point for PE funds with an approximate growth of 50% & 100% respectively. It appears a little strange as to how can there be competition between Hedge Funds & PE funds considering that they have a completely different focus. While PE funds go for equity stakes, Hedge funds invest in equity as well as debt. Also while PE funds have a long term focus, Hedge funds look for short term investments. The answer lies in the fact that the target group from whom these funds receive money is more or less the same and therefore they are seen as competing with each other. Returns of PE funds are linked to the performance of a company in which they invest with a long term focus, while Hedge funds look for short term speculative kind of gains. Analyzing global scenario Global trends show that the PE industry was once dominated by North America but recent years have seen global emergence of the PE industry. US still contributes a humongous twothirds of the total funds raised globally and it does not seem to be changing in the near future. However, an interesting fact is that the proportion of the investment going back to US is gradually decreasing every year. Till the last few years, almost 60% funds were invested back in US with only 25% going to Europe and remaining landing in Asia Pacific. But the current trends present a different picture with US and Europe grabbing equal shares of around 40% and the remaining part going to the Asia-Pacific region. In the Asia-Pacific region, Japan is a clear topper in the use of the PE funds because it has utilised PE funds for rescuing banks. India makes it to the top five but there is not much of a difference among

the four countries following Japan. However, the trend is only upwards and the next few years should see aggressive growth and some interesting developments in the PE fund industry. Coming back to India Considering the Indian scenario specifically, the PE industry is in a very nascent stage right now, but in the recent past these funds have shown keen interest and raised Indiadedicated funds. The average deal size and the average number of deals both have shown a phenomenal increase of about 1.5 times over the last year Private Equity (PE) and Venture Capital firms crossed the historic figure of $3.47bn in the first six months of 06. The break-up for this half is - $1.38bn from first quarter and a record $2.09bn from the second quarter. This signals the optimistic attitude of PE funds about India , and what makes the figure even more attractive is the fact that $2.2bn was the total PE investment in the whole of 05. The largest deal (H1 2006) was struck by Kohlberg Kravis Roberts, which took 85%stake in Flextronics Software for $900 million. Next, Singapore based PE fund Temasek acquired 9.9% equity share in Tata Teleservices from Tata Group for $360mn. These funds are so keen on entering the Indian market that they are ready to invest despite disproportionately high valuations. For instance, when KKR picked up 85% stake in the Indian software firm Flextronics Software Systems, experts found it strange that KKR was willing to invest more than 2.5 times of what Flextronics International had paid two years ago ($226mn for 55%) to acquire the same company (hitherto known as Hughes Software). There are several factors in favor of India due to which such a remarkable growth has been witnessed in the recent years. What is guiding this growth? Economic Scenario- India is one

of the fastest growing economies in the world, with enormous growth potential in many industries. This means that capital requirements are high, translating into an ideal hunting ground for PE funds .

Abundance of skilled labor- India offers a huge advantage in the form of its highly talented and skilled labor pool, which can lead to the success of the firms in which investment is made through the private equity route. The funds are not just bullish about the businesses in India but have also grabbed a fair share of highly rated managers like Vivek Paul, Rajeev Gupta, AvnishBajaj, Akhil Gupta, Nikhil Khattau. PE funds are invariably on the lookout for high profile managers, not only to manage their own funds but also as their representative on the board of companies in which they have invested.

Success of several sectors- India has firmly established itself as the worlds IT superpower with almost all major software development companies having an Indian development centre. It is also becoming the the hub of back office operations, and a leading provider of BPO and KPO services. This has led to greater confidence in the future growth potential of Indian companies.

Mature Financial markets- Capital markets have stabilized in the recent past with regulators like SEBI keeping a firm watch on the market development. This means both increased opportunities as well as an easier and painless exit route for PE funds. The emergence of entrepreneurs in India who consider PE their full time occupation is also a positive sign. Besides, there are well established corporate houses diversifying their surplus investment, as a strategy for their assets allocation, through PE funds without involving themselves directly in the operations of target companies.

Successful M&As- A recent spate of mergers and acquisitions has given rise to yet another way of exiting from Indian companies for private equity investors.

Successful track record- The first generation of private equity players have realized significant success in the last several years. For instance, Warburg Pincus earned huge returns out from its investments in Indian companies like Bharati Telecom.

But the picture is not as rosy as it seems on the face of it. There aresome impediments to sustain and improve the current growth. The road is still bumpy Failure to invest in infrastructure-Although India has changed itself from an economy concentrating on self-sufficiency to being an integral part of the global economic chain; its plans are not always matched by its ability to implement change. There has been a sense of apathy in developing infrastructure at a rate commensurate

with the growth of the economy. Even cities like Bangalore and Hyderabad await basic improvements. There are grave transportation infrastructure issues and need for a reliable supply of energy. Political condition - India, being divided into a number of states, causes an investment decision to be affected by politics. Changes in regulation and infrastructure development are often sidelined due to friction and conflict between the state and the federal government. Lack of promotion in investment across sectors- PE funds are being channelised into only a few sectors like IT, infrastructure & real estate and telecommunications, to the exclusion of the remaining industries, desperately in need of funds for growth. Competition from China- China is a direct competitor of India and most of the private equity investors eyeing the Asian region draw a comparison across both the countries to decide where their money should be parked. The new state-of-the-art airports in China bear a stark contrast to the abysmal conditions of the terminals in Indias main cities. Political and regulatory aspects The activities of PE funds have not attracted much political attention in India, unlike Korea and Germany, where these foreign funds are facing a strong political backlash. Recently, in Korea, a US-based fund Lone Star helped rescue the Korea Exchange bank and was planning to exit with a profit of about $3bn. The contention was that since the investment was made for the rescue of the Bank, a tax-free deal was designed; but now demands have been raised by political parties for levy of tax with retrospective effect in view of the huge profits made. Similarly, in Germany, the PE funds were raised as an issue for discussion at the time of elections. However, with more and more countries realizing the merits of PE investments, such political attention can be viewed only as a minor aberration and PE funds will continue to rule the roost as the investment of choice for mature and maturing economies. However, of late VC funds have received some attention of the regulator. It was only in the year 2000 that SEBI came out with a regulation for the Foreign Venture Capital Funds. Until then there were regulations for just the domestic funds. The new regulation (Securities & Exchange Board of India,(Foreign Venture Capital Investors Regulations, 2000) lays the guidelines for the registration of the foreign VC funds and eligibility criteria for the same, investment conditions and restrictions, general obligations and responsibilities, inspection

and investigations procedure etc. What seems strange is that although the PE funds have been so active here in the recent past, there is no special regulation for PE funds. PE funds are left with an option of either routing money in as FDI (Foreign Direct Investment) investor or as a FVCF (Foreign Venture Capital Fund). Registered FVCFs have an advantage over the FDI route because FDI investments are subject to restrictive pricing guidelines as per RBI and also the FVCFs receive benefit of free entry & exit pricing. While domestic VCFs are exempt from tax on income from venture fund undertakings (although the investors have to pay tax on income derived from a VC fund), no such exemption is available to the foreign funds. However, these funds can exploit the benefit available under DTAT (Double tax avoidance treaty) with Mauritius and this is precisely the reason why most of the investment by these funds is routed through Mauritius. Conclusion Although India offers great advantages in terms of buoyant economy, immensely skilled work pool, maturing equity markets, increasing standards of living and success stories of recent private equity investments, it is still ailed by bureaucracy, regulatory limits in certain sectors, hitherto indifference towards infrastructure etc. Nevertheless, there have been signs of India gradually improving on these fronts. Other practical problems such as differences in business practices and culture, lack of know-how about the legal and tax environment and the conversion of the Indian financial statements from Indian GAAP to US GAAP can be handled by consulting firms. There is no doubt that as of now these big players are falling over each other to get a share of the Indian pie. With their long term perspective firmly in place, these players are bound to reap of the benefits of investing India. It is a win- win situation for both the parties and this golden handshake is expected to sustain over a long period of time.