PE Funds’ Invest able cash shrinks
27ht October 2009
The Times of India
Private
Equity (PE) and Venture Capital (VC) funds are facing cash crunch as their
investors, institutional investors, such as insurance companies, pension funds
and high net-worth individuals (HNIs), mostly from US and other such developed
countries, are cutting down on fresh investments.
PE and VC Funds are floated and managed by general partners (GPs)
in which institutional investors join as limited partners (LPs). The GPs themselves contribute only about
5-15% of the corpus of the funds while the bulk of the money comes from LPs.
It appears that the LPs are not happy with the returns shown by
GPs. The investors want, it seems,
better returns and shorter investment cycles.
While there may be little scope for reducing the investment cycle (the cycle is usually 3-5 years) as that much time is required by the beneficiary companies for deploying the funds and start earning returns, better returns can be managed.
Returns are not made when funds sell their stakes and exit. Rather they are made at the time the
investments are made. Correct valuation of the
company at the time of investment holds the key. During a stock market boom, funds chase and offer unrealistic
valuations to the companies seeking investment. This is so as a lot of cash is chasing a few good companies. The investment seeking companies too become
too smart and demanding. In 2006 – 2008
stock market boom, during a top level meeting, when a valuation of 10X of
previous year’s earnings was proposed, the managing director laughed and
produced the latest business magazine and pointed his fingers at the current
P/E ratio on the BSE of his competitor.
It was an astronomical 55 times the earnings. He was expecting nothing less than what his competitor was
enjoying on the BSE. Can a PE fund
investing at such fancy multiples expect to make healthy returns?