Private Equity: Funding opportunity for SMEs

By Songbedna Bauri: Private equity (PE) funding has been one of the most significant issues for several entrepreneurs, especially those aiming to start or operating a small and medium enterprise (SME). Not very long ago, the PE funds had a different kind of an image, that of an inaccessible finance option for these enterprises. But with the changing times, the PE funds now make up for huge chunks of investments in India Inc.

Growing importance of PE funding for SMEs

Most analysts are of the belief that the PE funding can be the answer to any SME eyeing investments to scale up. It is strongly believed that a PE investor has got the potential to add value in terms of both capital and expertise. This expertise could come in the form of an acquisition or strategic advice on how to take the firm forward with either regional expansion or an eventual initial public offering (IPO).

It has been found that there are many PE investors looking for opportunities to invest in the SMEs with strong potential in different growth areas. Although, these investors at times find difficulty in identifying these companies, mainly in the present economic environment, but now they are consistently travelling across India meeting the management teams of various SMEs.

The SMEs often have little or no financial advantage to clinch deals on the basis of their balance sheet. The PE funds help them in this regard. Also, the dilution of the equity to buy assets helps in increasing the company's value, which ensures that the PE fund gets higher return when it exits.

Reports suggest that auto components, information technology (IT) and IT-enabled services, and logistics and supply chain management are the key sectors where such deals are most prevalent. It is noteworthy that the Indian SMEs receive the majority of their capital investments for growth from PE companies.

Government too lays emphasis on PE Funding

In the past few years, the Union MSME Ministry has been persistently networking with important PE players with the aim to boost capital infusion in the SMEs which find it difficult to secure timely capital from banks and financial institutions owing to multiple conditions and compliances.

Moreover, the central government is presently working with the Planning Commission of India to bridge the credit gap by offering different routes of easy finance to the SMEs in the 12th Five Year Plan. The Planning Commission has also constituted a working group for the growth of the MSMEs. The group has been working consistently to address concerns around credit and institutional finance to the unorganised sector. According to the Ministry’s estimates, there are 26 million units in India, which offer employment to almost 60 million people. The sector contributes 40% in India's overall exports.

In 2011, the SMEs witnessed 70% surge in PE investments during the first two months. This displays the willingness of the entrepreneurs and also the increased accessibility to these funds in India. According to official data, the PE funds invested $663.9 million in the period January-February last year as compared to $386.19 million in the same period in 2010. Moreover, during the same period, financial sector attained the list of highest PE investments by securing $198 million followed by utilities sector with $132.53 million.

The previous conservative opinion of the PE funds in regard to the investment in the secular sector has started to fade now and PE players have been placing their money in the emerging areas too with strong growth rates. As global economic slowdown continues to threaten India, most of the PE funds have invested in secular sectors such as healthcare, pharma and agriculture industries. Now, the PE Funds are eyeing the high-growth verticals such as technology and renewable energy.

While everyone is gung-ho about PE investors, some SME factions are also concerned of losing independence to them. The investor, in most cases, needs to be engaged operationally when PE funds acquire minority stake in portfolio firms. Hence, it is important for the SMEs to choose the PE funds cautiously.

Conclusion

Over the years, the SMEs have found that PE funds are beneficial in the valuation process, negotiations and transaction structure since they share strong relationships with investment bankers, consultants and advisors. Moreover, PE funding is lucrative for the SMEs since it helps them avoid bank loans.

It is a general trend that PE investors usually stay with a particular firm for 3-5years, while the PE funds give preference to sectors with domestic focus.

Market experts feel that although PE funding may not suit every fast growing SME but in today's dynamic business environment, it is an option worth exploring.