PE players need 'patient capital' of 11 to 20 years to maximise valuations

PE funds are increasingly exploring longer investment options beyond the standard five- to 10-year template

Seven years after it was set up by two entrepreneurs, private equity player Multiples Alternate Asset Management has helped Vastu Housing Finance — in which it has a controlling stake — on to a sustained growth path. Renuka Ramnath, founder and CEO of Multiples, thinks the company has the potential to become a financial behemoth, but it will take many more years to reach runaway growth.

But Multiples has to exit the company as the funds through which it invested have a limited tenure. “It has crossed my mind that we need to find alternative models to overcome this inflexibility that puts an artificial cap on the tenure of the fund,” Ramnath said.

In this traditional funding model, a private equity (PE) firm, which is known as the general partner (GP), is given the right to manage the PE fund and invest in a portfolio of companies by investors who are known as limited partners (LP) with the promise of returns. The funds, however, have a tenure for exit that ranges from five to 10 years.

But a consensus is building among PE players that start-up entrepreneurs need “patient capital” — or investments of 11 to 20 years — to maximise valuations. That is much beyond the purview of the traditional investors such as pension funds, university endowments, foundations and insurance companies that need returns much earlier.

However, the votaries of this change are already in action. Last month, for instance, global VC player Sequoia Capital surprised the private equity world when it announced that it would take a break from the traditional fixed-tenure fund structure. LPs will now invest through an open-ended liquid portfolio in a single permanent structure with no limit of time or tenure.

In India, there have been some experiments with more extended tenures. Serial investor Sanjeev Bikhchandani, for example, has floated a Rs 750 crore fund through Info Edge Ltd, his listed entity, with a long tenure. “We have the longest tenure VC fund in the country. It is for 12 years, plus an additional two years. We have only two LPs in the fund, both of whom have a long-term view of India,” Bikhchandani said.

Bikhchandani, whose Info Edge famously invested early in Zomato in 2010 and made a bonanza when the food delivery app listed earlier this year, said it was between the ninth and the eleventh year that the company reached its real valuation, after which it raised money through an initial public offer. So typical PE funds with, say, an eight-year horizon would have not earned the full value of the investment, he pointed out. His model works on the principle that it will not chase capital from outside investors but generate it from his company’s balance sheet.

This is the model that Prosus follows. The digital investor arm of South Africa’s Naspers, a publishing, online retail and consumer internet investor, does not operate by floating funds but on the strength of its balance sheet and prefers to take a 10- to 20-year horizon. That is why despite investments of $10 billion committed in India with stakes in Byju's and the recent acquisition of BillDesk for $4.7 billion, Prosus has not exited any of its investments except Flipkart (and that’s because Walmart wanted control).

“We are not a venture capital fund so we stay invested for decades. Our most important criterion is that we can add value to the company; it is not money as there are plenty of people with money,” said CEO Bob van Dijk adding that he does not see Prosus making any meaningful exits in India in the next two years.

Among the other models of “patient capital”, Ramnath said Multiples is considering the concept of the “continuation fund”, which is catching on in global markets. This model entails fund managers picking from the traditional 10-year-tenure portfolio two or three assets that have the potential to fetch higher returns over a longer time period and parking them into a five-year continuation fund. The permission of current investors is required, of course, but fund managers could bring in new investors too.

THE LONG GAME

• Info Edge has launched a ~750 crore fund with a tenure of 12 + 2 years. It has raised most of the money through its balance sheet
• Prosus invests in companies for up to 20 years. Has not exited any of its investments in India except one. Does not believe in pressuring companies to list
• Domestic family offices and sovereign funds could be key sources of “patient capital”
• PE funds are eyeing alternatives such as listing, setting up a “continuation fund” and creating vehicles to get permanent capital

The second model Multiples is looking at is to create a structure to bring in a pool of permanent capital to supplement PE funds that take 10- to 20-year positions in building a company. In fact, such potential long-term investors have been identified. One is the family office of big industrialists and the other is sovereign wealth funds. As Bala Deshpande, founder of MegaDelta Advisors, pointed out, “With family offices expanding their investments, they could park three to five per cent of their net worth for long-term capital investment beyond 10 years with PEs, which will provide them higher returns. And sovereign funds have a longer term view of a country and are not looking at quick exits.”

Another option for alternative asset management firms is to raise money from the stock markets by listing themselves, a route that would provide them with a war chest for value investing as Info Edge has done. Opinion on this fund-raising route differs, the principal constraints being that the Indian PE market is still not as mature as it is in the US where giants such as Blackstone, KKR, Apollo Global, and Carlyle are all listed entities.

But others prefer to keep the structure simple, as ICICI Venture CEO Puneet Nanda explained in this context. “On one side you have the investors who put in the money and on the other side are the entrepreneurs; and we create the pipe. The flow is better if there are no restrictions in between,” he said.

Then there are investors who think the 10- to 20-year tenure provides fund managers alibis to hide bad investment decisions. “The long tenures beyond 10 or 20 years means there could be no discipline in fund managers or pressure on returns. They could be hiding bad assets in a fund instead of realising the losses early and returning money to investors,” a senior executive of a leading PE fund pointed out, adding, “This could lead to a major injustice for investors, as cash on cash is the only holy grail of the PE business.”

As a relatively untested model in India, patient capital clearly demands patience first.

This is the first of a two-part series on trends in PE and venture capital investment. 

The second part appears tomorrow