IT's Time For Bottom Up Growth In India

Ajay C. Kulkarni, Designated Partner, Agile Capitals LLP Ajay is a finance enthusiast who wants to make finance fun by adding an entrepreneurial flavour to it.

It’s the most direct way I know for aspiring MBA entrepreneurs to get into business" says H.Irving Grousbeck,a professor of Organizational Behavior who originally conceived the idea of Search Fund. The principle objective behind this investment vehicle is to promote entrepreneurship through acquiring, managing and growing a company. A 2017 study by Stanford Center for Entrepreneurial Studies aggregate pretax IRR for all search funds through the end of 2017 was 33.7 percent aggregate pretax return on investment(ROI) was 6.9 x, down from 8.4x in 2015.2. Aggregate IRR and ROI have declined since the last Search Fund Study in part due to the large cohort of recent acquisitions, while returns excluding the top three funds have increased steadily since 2009, driven by more exits, returning in excess of both 5x and 10x investor capital.

So, what is a Search Fund?
As defined by Standard Business Center for entrepreneurial studies, "A search fund is an investment vehicle,conceived in 1984,through which investors financially support an entrepreneur’s efforts to locate, acquire, manage, and grow a privately held company."It’s an investment vehicle where in experienced professionals are backed by investors who have wide variety of experience and provide a pathway to own meaningful ownership in a company and help him take the company the next level.

The life cycle of search works out as this:
Sadly the attention this vehicle has received in India is next to zero because of the following reasons:

1. Most of the acquisitions done using this vehicle in US or in Canada are almost 100% acquisition.

2. Almost all the investors who backed the search funders are located are not from India which creates whole new complexities regarding the foreign investors belief on India (especially for this vehicle).

3. Weak awareness in India, be it investors or searchers regarding the investment vehicle.

Now, the first question that comes to mind is, “do we need this investment vehicle in India?". The answer is a big YES. Here is why and how it can be made to searched and used in India. According to the survey conducted by Stanford GSB, median purchase price and revenue during 2016-201 was $13.1 million and $10 million. Median purchase price/EBITDA rose from 5.8x to 6.3x in 2018 study. If we do back of the hand calculation, keeping everything else constant, purchase price would be 91.7 crores and 70 crores in Indian rupee terms (1$=70INR). Annexure 12 of budget document, document provides detail split up of the number of companies based on Profit before Tax (PBT).

And the number of companies which are publicly and privately extracted from the document:
If we consider businesses with a margin of 30 percent(PBT)and 70 crore INR as revenue, almost 5514 companies fall in this bracket. 76.2 percent of these companies are private which distills down the companies to 4201 which is still healthy market size for the investment vehicle, considering that most of the companies would be family operated, family managed. Considering average 3 people would be involved in one search fund and considering they end up acquiring 1 of the companies,there could be at least 1680 search funds in India(40 percent success rate of conversion out of number of private companies) which also means 5042 MBA to be entrepreneurs can take advantage of this investment vehicle and formalizing the economy in a much better fashion.

Along with the market availability for the search fund to get introduced, macroeconomics in India area also solid:
1. In 2017, fund-raising in Asia pacific was $66 billion which increased from previous year and India focused funds growing by 48 percent to an aggregated level of $6 billion and Asia-pacific private equity market has been out performing public market consistently from 2013 providing positive cash to LPs.

2. Positive regulations such as Alternative Investment funds(AIF)and distressed asset management have further grown in India.

3. Exit momentum was strong, where the most preferred route is IPO and the number of exits increased by 60 percent from last year.

4. With the increase in business sentiments, stable government and strong public markets, it is expected that exits momentum would increase which also gives momentum to secondary and strategic sales for the portfolio

So how we can make it happen in India?
The theme I would like to propose is Educate the stakeholders. Educating is the only best method that can be used to make entrepreneur driven investment vehicle be used and implemented in India

Investors- Best way to bring in financial vehicle within the system is to be brainstormed within the investors community. The community is most sophisticated community who will have skin in the game.

Colleges- Universities have become completely saturated in India. Sparing few top colleges, most of the education has been driven by outdated topics, lack of teachers understanding of real world and less interested student’s community. There are various ways to bridge this gap, which is why I and Pratik(co-founder) (R.E.S.T)(Unregistered) which is in test phase came up with an idea of bridging this gap using LinkedIn as a case study.

Businesses-This is a different animal. Since it is clear that wide spread market exists for the vehicle to distill into the economy. The best way for search funders to use this vehicle in India is to Re-position it with respect to how India as a country works. Re-positioning the investment vehicle by making it local in the form of having minority stake along with management contract makes it much more feasible in Indian economy context. Currently this vehicle is defined as to a search funder must own almost all of the company, with the acquired company CEO on the board to help run the company. But what I believe is that by acquiring minority stake along with management contract helps in acquiring the stake way quicker than expected.

The three main motivations of sellers of minority stakes are the need to raise capital, the desire for specific expertise,and the desire for the credibility that an independent, professional investor can bring.

Sellers of minority stakes seek more than capital alone. As many as a quarter of the deals that we analyzed explicitly mentioned that an important benefit of the transaction was access to the expertise that PE funds can provide. In particular, companies that sell minority stakes seek deep knowledge about adjacent industry subsectors and expertise about how to spur growth in new regions. Sellers also place a high value on expertise in mergers and acquisitions and initial public offerings.