With private equity (PE) fund of $75 billion yet to be exited and returned to investors, about 45% limited partners say performance of Indian private equity funds has been significantly poorer than expected. However, according to a McKinsey report, about 33% limited partners plan to increase allocation to India.
“With a strong economic growth, the private equity industry in India, on an average, realised gross returns of 21% till 2007, but following the global economic crisis of 2008, the environment changed. After 2007, returns at exit dropped to 7%, well below the capital market benchmark, fundraising stalled and exit options became scarce”, notes a McKinsey report, published in June.
An increasing level of dry powder leads private equity firms to invest in big ticket capital-intensive sectors. But lack of profitable exit options coupled with a weak rupee dampened dollar-based returns. “Quality assets suitable for investment were limited in India and came with high levels of intermediation, forcing investors to pay richer valuations,” says report.
Between 2007 and 2014, the number of PE firms in India rose from 65 to 137. The mismatch of demand for good quality assets and an increasing supply of capital, stoked valuations to unwarranted levels, and private companies, in several cases, commanded a premium over similar public companies. McKinsey research indicates that approximately 75% of investments in this period were made at valuation higher than the median for the past 15 years.
“Private equity investors responded by negotiating structured deals with downside protection clauses and put options, but these structures often led to misalignment among stakeholders, broken agreements and poorer returns for the private equity firm”, explains the report.
At the same time, private equity firms invested over $100 billion in more than 3,100 companies between 2001 and 2014. McKinsey’s analysis of revenue and profit growth data since 2007 indicates that PE portfolio companies have outperformed companies without private equity funding.
“In general, private equity firms selected companies with high growth potential and worked with them to exercise and expand their corporate capabilities to exploit this potential. A look at revenue and profit growth data since 2007 shows portfolio companies consistently outperformed peers without private equity funding,” the report said.