May 2016

THE INDIA SPECIAL 2016 A special supplement Leading private equity into new territory Catching the distressed asset wave Private debt is ready to pounce India by numbers ...and more

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Approaching fever pitch ISSN 1474–8800 MAY 2016

TOBY MITCHENALL EDITOR'S LETTER

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m ay 2016

On the evening of 31 March, two teams stepped onto the turf before a capacity crowd at the Wankhede Stadium in Mumbai. A sea of cricket fans buzzed with anticipation of the treat that awaited them: the ICC World Twenty20 semi-final between India and the West Indies. In cricket-obsessed India, this is a very big deal. A few hours earlier, three key players from India’s private equity industry gathered at a smaller, but no less important venue: the ILFS building in the Bandra Kurla Complex. It is a credit to Private Equity International’s web editor, Victoria Robson, that she managed to steer the conversation away from the subject of cricket and on to the important business at hand. As analysed in our roundtable, the centrepiece of our India supplement this year (p. 6), the Indian private equity market is facing some fairly universal issues: high entry multiples, difficult legacy portfolios and LPs that want greater control over their underlying investments and lower fees. The latter of these is resulting, as elsewhere in the world, in more demand for co-investment, direct investing and separately managed accounts. There are, however, some India-specific issues that those in the market are grappling with.While managers hold out hope for some currency management to support the fluctuating rupee, foreign exchange volatility remains one of the most significant topics in GP-LP discussions. “There have been instances where GPs have clocked attractive returns in local t he india s pecial 2 0 1 6

currency terms, but have lost a good share of those returns when converted to dollars,” notes Krishnar Kumar of IL&FS Investment Managers Limited (p. 11). While challenges abound, there are pockets of opportunity that institutional investors cannot afford to ignore. Most notable is the impending wave of restructuring, into which a number of hopeful investors are preparing to dive. As we explore on p. 13, Reserve Bank of India governor Raghuram Rajan has warned lenders in the country to brace themselves for a year of “deep surgery” as it increases measures to tackle the country’s bad debts. Couple this with a regulatory overhaul that is set to make restructuring capital structures in India a simpler, quicker process and the opportunity for investors with the right skillset looks compelling. There is now estimated to be between $3 billion and $5 billion in capital raised for this purpose, but as Apollo’s Mintoo Bhandari warns: “There’ll be a whole spectrum of players, but this is a really specialist area.” As the PEI roundtable drew to a close, all these topics and others had been put under the microscope by our experts and we hope you enjoy the analysis. Unusually for an event such as this, there was little time to chat off the record with our participants after the session. Why not? There was a cricket match to get to, of course. Enjoy the supplement,

Toby Mitchenall

e: [email protected]

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CONTENTS

THE INDIA SPECIAL 2016 4

News in brief Some of the biggest stories in India’s private equity industry, as reported on privateequityinternational.com

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Roundtable: Treading new ground As the government of Narendra Modi finds its feet, domestic private equity marches on into new territory. Three of India’s leading industry professionals discuss the challenges and rewards of investing in one of the world’s most intriguing markets

13 Catching the wave India is home to an estimated $110bn of distressed assets. With a little help from the government, private equity firms hope to capitalise

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15 Private debt: Ready to pounce India’s top 10 percent of companies borrow 90 percent of the corporate debt, and if the banks won’t lend to the rest of the country’s entrepreneurs, there are others who will 18 By the numbers A statistical snapshot of the country’s private equity industry from PEI Research & Analytics 20 Funds in market The country’s top 50 funds broken down

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NEWS IN BRIEF

ROUND-UP

Moves, deals and fundraising Some of the biggest stories in India’s private equity industry, as reported on privateequityinternational.com

stressed assets business. According to the Reserve Bank of India, the country’s bad loans and written-off assets rose to $131 billion as of September 2015.

IPOS MAKE A COMEBACK

... AND BOOSTS INVESTMENT TEAM

Source: sarangib

Indian private equity firms have begun to exploit buoyant public markets as a route to exit. Portfolio companies owned by Everstone Capital and Gaja Capital applied in early April for regulatory approval to stage an initial public offering (IPO) of shares, while Tata Opportunities, a Tata Capital buyout fund, has two portfolio companies considering an IPO. Everstone’s commercial vehicle finance company Hinduja Leyland Finance has also applied to list. Gaja Capital plans to list CL Educate, an education and training services provider that owns private education company Career Launcher. This would follow the IPO last month of another Gaja Capital portfolio company, staffing firm TeamLease.

Air Canada: CDPQ is looking to invest in Indian wind power companies

more than $16 billion. The transaction, which could end up as much as $1.1 billion, is expected to close in the second half of 2016 after regulatory approvals.

BLACKSTONE ACQUIRES

EVERSTONE DIVES INTO

MPHASIS

DISTRESSED ASSETS ...

Blackstone agreed to buy a majority stake in Bangalore-based information technology services provider Mphasis Limited from HewlettPackard Enterprise (HPE) for about $825 million. In what is one of the biggest M&A transactions in India, Blackstone is buying at least 84 percent of HPE’s 60.5 percent stake in Mphasis. It will buy the remaining 26 percent through a tender offer, required by India’s takeover laws. The deal was structured through Blackstone Capital Partners VI, a 2011-vintage vehicle that raised

Singapore-headquartered private equity firm Everstone Capital Partners has said it will start investing in distressed assets in India. It has hired former director of Advent International Avnish Mehra to head its new stressed assets business. As managing director, he will also be responsible for the firm’s investments in healthcare and technology, media and telecoms where he has significant experience. Everstone joins private equity firms KKR, TPG and Apollo Global Management in investing in India’s

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$131bn

Value of the country’s bad loans and writtenoff assets, according to the Reserve Bank of India

private equity international

In addition to diversifying its asset base, the firm has been boosting its senior leadership team following the close in September of its $730 million fund. It appointed Rajesh Mehta as executive director in March and added Avnish Mehra to lead its new stressed assets business unit. It made a string of new hires from April to May 2015, including new managing directors Roshini Bakshi, a former vice-president and managing director at Walt Disney; Rajev Shukla, a former vice-president at Unilever; and new head of capital markets and exits, Bhavna Thakur, formerly of Citibank. Everstone managing director for private equity Dhanpal Jhaveri said they are strengthening their team with “leaders who have had deep and varied experience across different asset classes and verticals”. The team will help deploy dry powder totalling $1 billion. IFC COMMITS $41M TO MULTIPLES

The World Bank's private investment arm International Finance Corporation (IFC) has committed up to $40.6 million to Mumbai-based private equity firm Multiples Alternate Asset Management’s second fund. It is also considering making coinvestments, it said in its filing. Plenty may 201 6

NEWS IN BRIEF

Private Equity Fund I seeks to raise $550 million-$600 million, of which $150 million is earmarked for India’s financial technology sector. The fund targets mid-market companies in consumer, healthcare, IT and financial services. In April 2015, the firm raised the target of its second fund from $500 million to $600 million and held a first close on $400 million. The Canadian Pension Plan Investment Board has committed $140 million to the fund. PARAGON PARTNERS HOLDS FIRST CLOSE ON DEBUT FUND

Mumbai-based Paragon Partners has held a $50 million first close on its debut fund, Paragon Partners Growth Fund. It began fundraising in 2015 with a target of $200 million, which it plans to achieve by December 2016. The firm has already made its first investment from the fund in engineering, procurement and construction service provider Capacit’e Infraprojects for $10 million. Founded in 2015 by Siddharth Parekh and Sumeet Nindrajog, Paragon invests in high growth midmarket private companies in India. It focuses on the financial services, infrastructure, consumer, industrials and healthcare sectors. GAJA CAPITAL CLOSES THIRD FUND ABOVE TARGET

Mid-market private equity firm Gaja Capital has closed its third fund on $240 million. Gaja Capital III, which exceeded its $225 million target, will add healthcare to its existing focus on domestic education and financial m ay 2016

services. The Mumbai-based firm had been fundraising for two years and announced a first close on $140 million in 2014. It has made two investments from the fund, in confectionary producer Bakers Circle and sports consultancy SportzVillage. Fund III will invest $20 million-$25 million in up to 10 companies, targeting control or significant minority stakes. Its two largest investors are an Asian and a global fund of funds. The International Finance Corporation re-upped from Fund II, as did some other investors from the 2007-vintage vehicle that raised $180 million.

CDPQ OPENS FIRST OFFICE IN INDIA

Anita Marangoly George: joins CDPQ from the World Bank

GOLDMAN SACHS PE VETERAN TO RETIRE

Sanjeev Mehra, one of the pioneers of Goldman Sachs’s private equity business, will retire this year, ending a 30-year run with the firm. He will step down from his role as vicechairman of the private equity group and become an advisory director. Mehra began his career at Goldman Sachs in 1986 in the corporate finance division and was named partner in 1998. He was formerly cohead of the Americas private equity business and started the firm’s buyout unit in India in 2007. Mehra led some of the bank’s biggest deals, including the $7 billion buyout of business services company Aramark and the $3.3 billion deal for private jet maker Hawker Beechcraft. More recently, he worked on the $950 million acquisition of custodial services provider GCA Services Group from the Blackstone Group. Goldman Sachs has not said who will replace him.

Canada’s second largest pension fund CDPQ opened an office in New Delhi. Former World Bank senior executive Anita Marangoly George will head the new office. CDPQ will invest $150 million over the next three to four years in renewable energy in India, its first investment of this type into emerging markets. The pension fund is looking to partner with leading hydro, solar, wind and geothermal power companies in the country. Earlier this year, it entered into a joint venture with Tata Power and ICICI Venture to buy out distressed power assets in India. CDPQ has over C$248 billion ($187 billion; €170 billion) in assets under management. AION CAPITAL ACQUIRES GE CAPITAL

$825m

Cost of Blackstone’s majority stake in Bangalorebased IT services provider Mphasis Limited

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Number of offices CDPQ runs in India after the Canadian pension fund opened its doors in New Delhi

t he india s pecial 2 0 1 6

AION Capital Partners, a joint venture of Apollo Global Management and ICICI Venture Funds Management, has bought the financial services businesses of General Electric (GE) Capital India. The investment came from the firm’s maiden special situations fund AION Fund, a 2014-vintage vehicle that raised $825 million. Former GE Capital executives Pramod Bhasin and Anil Chawla also bought stakes in the company. The acquisition includes GE Capital India’s auto-leasing business, healthcare financing and corporate lending. The new owners said they will keep the current management team and pursue a strategy of stability and growth for the company.The deal is expected to close by October 2016, subject to statutory and regulatory approvals. n

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INDIA ROUNDTABLE

From left: Krishna Kumar, Ajay Pathak and Pavan A Gupte

Treading new ground As the government of Narendra Modi finds its feet, domestic private equity marches on into new territory. Victoria Robson met three of India’s leading industry professionals to discuss the challenges and rewards of investing in one of the world’s most intriguing markets

Just days after Private Equity International sat down in Mumbai with our Roundtable participants, Blackstone gave India its unequivocal stamp of approval, announcing its largest local acquisition yet. The global fund manager is acquiring Bangalore-based information technology provider Mphasis from Hewlitt Packard Enterprise for a cool $825 million. The total could rise to $1.1 billion following a mandatory tender offer. The panel, as yet unaware of this vote of confidence, describes a market slowly coming of age. “LPs need to take a fresh look at India,” says King & Wood Mallesons international funds partner Ajay Pathak.

Some legacy issues still remain, he says, referencing high valuations that will have an impact on the returns of funds raised immediately post-crisis and a challenging exit environment, but, “I think the landscape has actually changed and you can say that we are now seeing version 2.0 of the private equity industry in India.” General partners are “much more experienced, more hands on, and increasingly putting in place mechanisms so that they can get involved with their portfolio companies at the operational level”. Companies are also more receptive to private equity buyers “and in some cases they almost see it as a sort of kudos that they are able to sell part of the business to

SPONSORED BY IL&FS INVESTMENT MANAGERS, KING & WOOD MALLESONS AND SAMENA CAPITAL

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INDIA ROUNDTABLE

private equity. It’s a reflection of success”, Pathak says. “Quality and success,” qualifies Pavan A Gupte, Samena Capital’s managing director for its India Credit business. However, not all the excesses in ’08 and ’09 have flushed through the system. A large number of managers, which ballooned to 350-plus at the peak of the market, are still around. “Typical fund lives of 10-12 years have kept many of these alive.” Of the large number of GPs operating in the Indian market, going forward “we feel many of them would consolidate or begin to rejig their business model”, says Krishna Kumar, senior managing partner, IL&FS Investment Managers Limited, who oversees its infrastructure investments.

As a result, the industry is also expecting an interest rate cut, to the benefit of earnings and industries with high capital expenditure, such as manufacturing. The Reserve Bank of India has also instigated a clean out of non-performing loans from the banking system, a policy that has been in circulation for years. It is an example of an acceleration in decision-making and a willingness to act. “There were two specific issues that repeatedly came up in the discussions [prior to the election],” says Pathak. “The first was concern over government inaction. On that, the Modi government has made some strides. There has been a

The IPO window is, as in most emerging markets, a narrow one that opens and shuts very quickly. If your portfolio company is not prepared to optimise on that window it can get pretty challenging Pavan A Gupte

LEADERSHIP

Pathak, Gupte and Kumar are veterans of a local private equity industry that is no stranger to volatility, buffeted as it is by domestic, emerging market and international economic cycles. However, two years on from the election of Prime Minister Narendra Modi, there are signs of stability. “In the last two years, investors have taken a lot of comfort with a single party government at the centre, the first time in 28 years,” says Kumar. Its strict fiscal policy has reduced inflation, which now stands at around 5.7 percent – down from the highs of 10.9 percent in 2013 – although a drop in prices has hit domestic company earnings and slowed nominal GDP growth. Real GDP growth is forecast by the World Bank at 7.8 percent for 2016. At the macro level, the fall in commodities prices, especially crude, has helped the country. “The savings in lower crude prices have been used by the government to address the issue of fiscal deficit,” says Kumar.

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t he india s pecial 2 0 1 6

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INDIA ROUNDTABLE

push to streamline regulatory and other approvals and a general move toward greater transparency and accountability. The central government seems to also be actively encouraging healthy competition among the various states. This has led to the state governments looking at ways in which they can improve the ease of doing business in their respective states.” The other issue? “Tax uncertainty.” Since the government began its pursuit of hundreds of millions of dollars in backtaxes from Vodafone connected to the use of offshore structures and an outsourcing arm based in India, there has been continued uncertainty among managers and LPs regarding the direction of the anti-tax avoidance regime.

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Domestic capital has not been very forthcoming. Due to regulations, commercial banks are unable to invest in alternative assets. Similarly, insurance companies are prevented from committing large pools of capital Krishna Kumar

private equity international

The tax cases involving Vodafone are well publicised, but they are not alone as a number of other similar claims make their way through the courts, Pathak notes. “The concern is to what extent the authorities will revisit transactions that have already taken place. And, going forward, how widely will the general anti-avoidance rules be interpreted? The government finds itself in a difficult position to some extent. It recognises tax uncertainty is an issue for investors, but it doesn’t want to be seen interfering with ongoing judicial proceedings.” For investors looking at India, ambiguity about the future direction of the tax regime is matched by tainted memories of past performance. Although Pathak says LPs are more willing to discuss India than they were five years ago, past disappointment still hangs over decision making. “From an LP perspective, particularly if you have already made allocations to India historically, you can’t get away from the fact that performance hasn’t been as great as you might have expected and there haven’t been as many exits as well. But then on the flip side, at a global macro level, if you are an LP looking at making allocations to emerging markets, you cannot ignore the fact that the growth story is in India.” Gupte agrees that LP motivations depend not only on a fund’s track record but, more importantly, on their own experiences and current portfolio constructions. “Did they invest in the late 90s? Did they succeed or did they burn their fingers? What’s their maturity horizon? What’s their existing-to-proposed exposure? Which structures and/or advisors do they use to access investments? Are they fresh investors or are they older? What is their liability profile? How is their asset profile constructed broadly and specifically with regards to the EM [emerging market] exposure and, within that, India. All these complex and multifarious factors play into a decision to invest.” may 201 6

INDIA ROUNDTABLE

Crucially, though, the global flood of capital into alternatives powered by record distributions will have to find its way to India. “The wall of capital is exploding,” Gupte says. But fundraising remains tough as always. “You need to educate the LP community in terms of what the market offers, what are the different risk return characteristics of each strategy and, crucially, how a particular strategy or offering is accretive to their existing portfolio. I’ve seen some very good managers with interesting track records and yet they struggled to raise capital because of their inability to articulate how their product fitted into a LP’s portfolio.” A rapport with international investors is key, as the domestic investor base remains shallow, constrained by allocation limits and incentives. “Capital from domestic investors has not been very forthcoming,” Kumar says. “Due to regulations, commercial banks are unable to invest in alternative assets. Similarly, insurance companies have internal guidelines which prevent them from committing large pools of capital.While on a global fund raise, if we are able to demonstrate meaningful capital being raised from the domestic market, it helps the fund raise significantly. It’s a huge validation of domestic commitment towards funding infrastructure.” One positive, Kumar says, is that domestic private insurance companies, which have growing asset pools, are now closely evaluating participating in alternative assets.

There has been a push to streamline regulations and a general move toward greater transparency and accountability. The central government seems to also be actively encouraging healthy competition among the various states Ajay Pathak

However, not everyone is geared up to assess opportunities and respond quickly, Pathak adds. “As a result, there is a much greater focus from the GPs in terms of making sure that there are clearly defined parameters and timelines associated with co-investment opportunities.” And large institutional investors who have been active in the Indian market through fund structures are now pursuing direct investments, says Kumar. “However, for a large part of the investor universe, who are yet to commit capital to India, pursuing a direct investment strategy is still some time away.” Gupte agrees there are obstacles. “It can be very rewarding, but is quite risky if an investor doesn’t have the ability

CO-INVESTMENT

Perhaps because of the small domestic LP base, public scrutiny of carried interest has yet to erupt in India. But all LPs committing capital are sensitive to fees and costs. “In order to bring down costs, LPs are splitting their commitment between the fund bucket and the co-investment bucket,” Kumar says. m ay 2016

t he india s pecial 2 0 1 6

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INDIA ROUNDTABLE

to manage risks. The challenge is that you can say you want to invest directly, but unless, like the CPPIB [Canada Pension Plan Investment Board] in India, you are setting up a team and bringing on board the right talent and skill set and aligning them correctly, it is very difficult to do it sitting elsewhere [outside India]”. Another way for an LP to get direct access to transactions at lower costs is to enter into managed accounts with GPs. “It enables investors to have perhaps a greater say on the investments that are made, tighter investment policies and restrictions, much greater reporting, and transparency,” Kumar says. “And at much reduced fees.” “One of the reasons some LPs are looking at separately managed accounts is because they are prepared to take a longerterm view,” Pathak says. “And although in theory they would usually have the right to terminate even earlier than under a typical closed-end fund, in reality it means they can monitor the investment and give the GP flexibility to hold onto investments for a longer period.” This can be an interesting way to entice investors, but it’s not without its own challenges, Gupte says. “It’s very hard for a GP to be negotiating with an entrepreneur or counterpart and at the same time managing the LP, which has an effective veto on every investment decision as well,” he notes. “I’ve seen at least two examples for Indian strategies where accounts were not well thought through or structured and as a result, the LP-GP relationship has floundered.” LPs can also tend to have rigid investment parameters that are not structured to adapt to changing market dynamics; emerging markets like India have shorter economic and business cycles relative to developed markets and need to adapt investment strategies a lot more frequently, Gupte says. “I’ve seen an example where the team was frustrated, and said, ‘We believe the opportunity set has shifted marginally and

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we should now shift strategy accordingly, but our mandate doesn’t allow us to change; we’re trying to convince our LP but it’s tough for various people and portfolio reasons.’This is compounded by the fact that for a large LP, India occupies a small part of their focus.” EXITS

However, it is at exit – not investment – that the alignment of interest been GP and LP becomes the most critical for fund managers, which are still typically minority stakeholders. “One of the criteria to make the investment in the first place is whether or not the GP and the promoters are aligned when it comes to the exit options,” Pathak private equity international

says. “There is also a recognition that just having contractual protections, such as put options, in itself is not sufficient. This is another example of a changing landscape.” In order to carve out a successful exit, GPs need to constantly work with investee companies toward creating value, build a strong relationship with sponsors who would help support the exit and constantly evaluate multiple exit opportunities, Kumar says. IL&FS has achieved 22 exits in the infrastructure space with only five through capital markets and the rest via strategic sales and trade sales, he notes. Samena Capital, a regional special situations fund, has tended to be an may 201 6

INDIA ROUNDTABLE

CURRENCY CONCERNS

opportunistic investor in India and, therefore, exited mostly through the public markets “because we had the flexibility to do it”, Gupte says. “Most of our peer group that plays only in the PE side haven’t had the best experience. The IPO window is, as in most emerging markets, a narrow one that opens and shuts very quickly. If your portfolio company is not prepared to optimise on that window it can get pretty challenging. You can’t rely on it.” Complicating the exit decision is the dislocation between hold periods and investment maturity. “Fundamentally, the three, four, five-year holding period just doesn’t work in markets like India,” Gupte m ay 2016

says. “There is a huge execution challenge on the ground. What you think you’ll accomplish in five years, usually takes six or seven years. In year four, five, six, there’s usually an inflexion point in terms of the growth of the company, but that’s the time when the fund structure forces you to exit. LPs need to fundamentally rethink these structures for the Indian market.” STRATEGIES

The market is also evolving in terms of new strategies. Although controlling stakes are more prevalent, Pathak does not see a proliferation of buyout funds on the horizon. Investment in more typical growth strategies, too, has actually fallen in the last t he india s pecial 2 0 1 6

While managers hold out hope for some currency management to support the fluctuating rupee, foreign exchange volatility remains one of the most significant topics in GP-LP discussions. “One of the major factors affecting returns is the devaluation in currency,” says Krishna Kumar. “There have been instances where GPs have clocked attractive returns in local currency terms, but have lost a good share of those returns when converted to dollars.” The rupee has been on a rollercoaster ride in recent years, trading at 49.45 to the dollar in January 2012. It started 2015 at 61.57 and undulated to 66.52 rupees to the dollar by the end the year, where it was still trading around this March. “Building a constant devaluation rate in the business model helps one gauge returns in US dollar terms, and thereafter, putting in place short term hedging strategies could mitigate this risk to a large extent,” Kumar says, adding that a constant running yield in your portfolio would also help mitigate this risk. For the manager, the declining rupee hits their own pay packet.With a hurdle typically measured in dollar returns, it can reduce or eliminate the chance of any carried interest. There is tremendous scope for aligning LPs and GPs in India better, says Pavan A Gupte. “International investors are effectively handing over dollar capital to a local manager who is investing in rupees with their hurdle in dollars,” he says. “LPs don’t give the manager the ability to hedge or not. If the belief is we’re aligned, then let the manager take the call.” n

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INDIA ROUNDTABLE

MEET THE ROUNDTABLE Pavan A Gupte is managing director of Samena Capital’s Indian Credit business, which he joined in February. He has previously worked as chief strategy officer at CVCI Private Equity in Singapore and as co-head of Asia at Adam Street Partners London before returning to India as founder and managing partner of Bombay Central Advisors LLP. At Samena Capital he manages its India credit fund, along with private credit/direct lending solutions and co-investments alongside other stakeholders.

Krishna Kumar is a senior managing partner at Mumbaibased IL&FS Investment Managers and one of the founding members of its private equity practice, which includes growth private equity, real estate and infrastructure. He heads the infrastructure vertical in IL&FS Investment Managers. Over the past 20 years, the firm has raised $3.5 billion in third party capital and has made about 175 investments, about 90 of which it has exited.

Ajay Pathak is a London-based partner in the international funds practice at King & Wood Mallesons, where he has worked for the past 14 years. He specialises in fund formation across alternative strategies, including private equity, infrastructure, debt and credit. He oversees KWM’s India business, where he has been active since 2000 advising both international and domestic managers looking to raise capital.

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couple of years due to competition for capital from venture capital, he notes. Instead, more niche players have arrived on the scene. “The credit space is particularly interesting in India.” This is exactly where Gupte focuses. “During 2008-12, companies entered into a capital structure on a set of growth assumptions that haven’t really panned out in the past cycle, he says. That is clearly the biggest opportunity set for us as mezzanine providers. Across sectors, companies need to realign their balance sheet and need more breathing room in the next few years as they do this.” Gupte is spending time with the 2,000plus mid-market companies which are underserved by the banking system. “There has been some consolidation in the non-bank finance space that has reduced capital supply to the market and we are stepping in there.” Its new thrust is on the “private equity take out thesis”, he says. The firm identifies situations where minority investors and company owners no longer want to be in partnership. “We are seeing multiple situations where we are looking at lending to the company or the entrepreneur himself to buyout the private equity investors and give the business a bit of breathing space to normalise the capital structure.These situations are fully secured, fully collateralised, and offer very stable yields.” Also outside of the scope of traditional private equity, infrastructure is alive with investment opportunities. “Infrastructure is one of the best investment themes in India today,” Kumar says. Moreover, the government is also taking steps to ensure there is more funding for the sector and is playing the role of a facilitator, he says. IL&FS is currently raising $1 billion, split between a fund and matching co-investments, targeted at Indian assets. It follows previous funds it has invested with significant Indian infrastructure exposure. private equity international

Its strategy is to invest in both infrastructure platform companies and infrastructure operating companies. “We feel that there is significant opportunity to invest at the platform company level for some of the larger developers who require capital, one to deleverage, and other to grow,” Kumar says. “Platform companies have the ability to generate higher returns over a medium to longer term, while single asset operating companies have the ability to generate stable long term returns. If one were to blend both these investment strategies toward building a portfolio of infrastructure assets, one could generate returns which are commensurate to the risk return profile of emerging markets, together with a current yield. “Especially in the current vintage, infrastructure sector valuations look attractive to generate such returns.” Currently, IL&FS sees a lot of acquisition opportunities in the road sector. “The discounting rates on operating toll roads hover between 15-18 percent. If you can strike some good acquisition opportunities with ticket sizes of $75 million-$100 million, from a portfolio perspective this sector could alone see $300 million-$500million of commitments over the next one to two years.” Looking ahead, one significant development that boosts the opportunity across the Indian private equity landscape, is that the distance between valuation expectations held by company owners and fund managers is narrowing. This means for “the more recent vintages, the expectation is they will deliver better returns”, Pathak says. “And the exit environment is also slowly improving. If you look at where the problem lay, the funds that were pre-2005 vintage, a number of them did deliver quite attractive returns. It’s that vintage in between where the greatest challenges lie, however that is washing through now.” n may 201 6

DISTRESSED ASSETS

BAD DEBTS

Catching the wave India is home to an estimated $110bn of distressed assets. With a little help from the government, private equity firms hope to capitalise, writes Carmela Mendoza India’s stressed assets situation moved into the spotlight in the wake of the Reserve Bank of India’s (RBI) latest budget announcement in March. RBI governor Raghuram Rajan warned Indian lenders to prepare for a year of “deep surgery” as it increases measures to tackle the country’s bad debts. According to an India Ratings & Research report, as much as one-third of Indian companies have stressed or non-performing loans, accounting for 21 percent of total bank stressed credit, with the bulk of it on the books of state-owned banks. The report also expects bad loans to grow by 12.5 percent in 2017. As a whole, India’s stressed loan pile is estimated to have hit more than $110 billion. “It’s the desire to use debt to fund growth that has made Indian corporations the most highly leveraged in the world and therefore the most susceptible to slowdowns or dislocations,” Mintoo Bhandari, managing director of Apollo Global Management India Advisors tells Private Equity International. “If you are a promoter in India and you say, ‘Look, I got a trillion dollars of gross domestic product coming down the pipe over the next decade for India’, you ask yourself, ‘Do I want to dilute my equity or would I rather take on debt to grow and to keep my share of that pie?’ “This has been the modus operandi of companies in India – to use debt to the extent that they can and hope that it will all work out.” The banks are now in a position to rid themselves of troubled assets and private m ay 2016

This is really a specialist area. It’s not an arena where someone can just decide they are interested in it, walk in and do it well Mintoo Bhandari

equity firms have come in buying, with deals mostly in businesses that had suffered through the commodities crunch and the weakening of the Indian economy post-2007. “It’s a good time for distressed assets players,” says Parveet Gandoak, an associate at law firm Debevoise and Plimpton. “A lot of the private equity firms have mandates from their global or pan-Asian funds to invest into these situations.” t he india s pecial 2 0 1 6

About a dozen funds are focused on the distressed assets market in India, lured by the prospects of buying at significant discounts. According to asset management consultancy Alvarez & Marsal’s (A&M) latest Outlook for Stressed Assets Market in India, the total funds available are estimated to be between $3 billion-$5 billion. These include global funds managed by KKR,TPG, Apollo Global Management and regional funds from Clearwater Capital and SSG Capital. TPG is among investors vying for a stake in Indian state-owned lender IDBI Bank, while KKR had recently won approval to own a majority stake in Mumbai-based International Asset Reconstruction Co. Apollo has been present in India for more than five years and in 2014 entered a joint venture with ICICI Venture to establish AION Capital Partners. The fund had raised $825 million to invest in special situation opportunities in India. Bhandari claims that when Apollo started thinking about this space, it was seen as an outlier, but this has now changed as the opportunity has been more widely recognised. Everstone Capital said it will start investing in stressed companies in India and has hired a former director at Advent International, Avnish Mehra, to head the new business unit. Indian billionaire Ajay Piramal, chairman of the $4 billion Indian conglomerate Piramal Group, has also said he wants to set up a $1 billion fund to invest in distressed assets. A CLEAR CHANGE

The RBI deserves credit for generating investor interest in distressed assets. It has made clear that it is open to external capital and will support the restructuring of enterprises in India.

13

14

Road to reform: making good long-term returns remains a challenge in India

Source:wikimedia/Nichalp

Fearing that the country’s system would be weighed down by bad loans, in February RBI launched an asset quality review and required commercial banks to clean up their balance sheets, declare nonperforming assets and make provisions by March 2017. It has introduced a debt-forequity swap tool to enable creditors to take control of the company and effect change in management when necessary. Investors are also hopeful that the country will successfully pass a proposed bankruptcy reform bill by the end of May. The bill would be transformational, streamlining India’s scattered insolvency laws into a single piece of legislation. This would make it easier for creditors to take a company to bankruptcy and take control within three to six months, instead of cases dragging on for several years, as has been the norm. The government has also eased rules on foreign ownership of asset reconstruction companies (ARCs buy bad loans from lenders and work on revitalising the business). An earlier rule capped foreign ownership at 50 percent. Puneet Bhatia, managing director and country head for India at TPG Capital says that India has “turned a corner” based on the government’s “constructive stance”, but that “it has seen a build-up of distressed assets over the cycles which will require concerted efforts to resolve”. While the stage is set for a boom, players already in the market warn that investing in distressed assets in India is no picnic, even with the introduction of restructuringfriendly government reform. “There’ll be a whole spectrum of players,” says Apollo’s Bhandari. “But this is really a specialist area. It’s not an arena where someone can just decide they are interested in it, walk in and do it well.”

Source: binpage

DISTRESSED ASSETS

Driving forward: investors are hoping reforms to bankruptcy laws will be soon passed

Asset management: India’s central bank is seeking to reassure investors health of the banking system

Debevoise’s Gandoak says that even with the new “streamlined approach” – which will undoubtedly attract private equity investors to bid on assets – this is still a “watch and wait” space. This is a sentiment echoed by Vikram Utamsingh, co-head of Alvarez & Marsal in

India: “This [investing in stressed assets] is yet one more avenue of opportunity, but are there really businesses that people will want to buy? Which of the sectors are fully viable?” As is often the case in India, and as Utamsingh puts it: “The devil will be in the detail.” n

private equity international

may 201 6

PRIVATE DEBT

LENDING MARKET

Ready to pounce India’s entrepreneurs are sitting on one of the world’s most enticing markets, and if the banks won’t lend to them then the private debt market can, writes Siddarth Poddar Pity the typical Indian business owner. Of the country’s 3,000 listed firms, the largest 10 percent hold 90 percent of listed corporate debt, according to Goldman Sachs, leaving the others to share the rest. With such low leverage – a result of a banking sector systemically diverted from its core function of providing credit to business – it is not surprising that local and foreign investors are jumping to create a private debt market in India. KKR is one of those betting big on the debt space and the global investment firm has a second dedicated vehicle in the market. Closer to home, a host of domestic firms have raised capital for debt funds across a range of strategies – including Piramal, Religare, Motilal Oswal and Aion Capital, a joint venture between Apollo Global Management and ICICI Venture. Pankaj Karna, managing director of Maple Capital Advisors, an investment banking and advisory firm, says businesses are gearing up

People now acknowledge that regulation should be designed such that borrowers have clear disincentives if they do not meet commercial obligations they have wilfully entered into Prashant Purker m ay 2016

as they put together capex and growth plans to exploit an economy finally settling down after years of turbulence. A lot of this activity is in the mid-market, particularly in companies addressing consumer needs, says Karna. “In that area, corporates are looking to either expand or consolidate their positions and that’s the biggest opportunity. They expect the next two to three years to be good, and they want to be ready to capitalise on it,” he says. The fact that India has an entrepreneurial community adds to the demand for capital, and private debt is a significant alternative to private equity, says Venkat Ramaswamy, executive director at Edelweiss Financial Services. Edelweiss’s first private debt fund – a 2009 vintage vehicle – is almost fully harvested and has provided a return of just over 20 percent in gross rupee terms. The firm is currently investing out of Edelweiss Special Opportunities Fund II. According to Ramaswamy, the biggest advantage of private debt is that the company can postpone dilution and still raise capital needed by the business. “Using this kind of capital in the initial stages as growth capital leads to postponement and, therefore, reduction of dilution – which is one of the primary motives of Indian and Asian entrepreneurs,” he says. One of the key reasons why investors are backing the growth of private debt is the failure by banks to meet demand for capital. According to Prashant Purker, managing director and chief executive of ICICI t he india s pecial 2 0 1 6

Venkat Ramaswamy: private debt is a significant alternative to private equity

Venture, “the commercial debt market is a bit clogged and growth in credit off-take is lower than desired levels”. He says that in a few sectors, such as real estate, the corporates require far more than can be supplied by the banks. Considering the size of the Indian economy, the local credit market is still “very, very small”, adds Saleem Siddiqi, managing partner at London-based MUSST Investments, which plans to launch a credit business this year with backing from a US endowment. MUSST will be working with Karna of Maple Capital and they plan to buy a defunct non-banking financial company (NBFC) this year to give them the necessary licences. While the biggest 10 percent of Indian companies accounts for most of the corporate debt, a large number are left ››

15

PRIVATE DEBT

17%

Non-performing loans held by public sector banks as of 30 September, 2015 Source: Reserve Bank of India

underserviced by banks that are “either unwilling or unable” to finance them due to their own constraints, says Siddiqi.These banks are also taking longer to finance companies, many of which are unable to meet the eligibility criteria, says Shujaat Khan, managing director at Blue River Capital. This financing void is being filled by a steady creep in new debt financing structures and Purker expects more firms and investors to launch initiatives in this area. “Post-financial crisis, there was a slowdown in this activity, as a lot of the banks had to tighten what they were doing. So NBFCs and funds are stepping in to fulfil the unmet demand in recent times,” he says. There is also a supply side factor to why private debt is becoming more prominent. ››

REWRITING THE RULEBOOK

NOTHING VENTURED…

Venture debt is another up and coming market. In the last five to 10 years it has emerged as a significant asset class in India, with more than $5 billion raised by venture capital-backed businesses in 2015. “The tenures are short for venture debt… it’s a pretty healthy market, and the underlying dynamics are growth-oriented,” says Shujaat Khan of Blue River Capital. According to Rahul Khanna, managing partner of Trifecta Capital, a venture debt firm that has raised more than 200 crores rupees in commitments from Indian institutional investors as part of a 500 crore Rahul Khanna: VC-backed businesses have debt needs that are not serviced by rupee fundraise, venture capital-backed traditional institutions businesses also have debt financing needs that are not serviced by traditional financial institutions. Khanna says that equity financing is typically more expensive than debt: “While venture debt is not a complete substitute for raising equity capital, a healthy mix of equity and debt financing helps reduce the dilution impact on the founder and, more importantly, brings down the blended cost of capital for the business.” Moreover, as these small businesses scale, their needs include capex or acquisition financing, where debt is preferable but not available from traditional lenders. Lastly, he says, many companies see venture debt as supplementary to an equity capital raise. As it is largely non-dilutive, it extends the runway between two rounds of funding. n

16

Institutional investors are contemplating private debt strategies on the back of disappointment with the private equity industry. One debt investor says that most private investment funds in the country have been private equity constructions, but over the last 10 years or so “private equity has struggled to deliver real returns and sometimes even the prominent names have struggled to even return capital”. Where private equity has failed, private debt is moving in. India is expected to be one of the few sources of growth among the emerging markets, and private debt is becoming an effective way for investors to access the strong growth anticipated in the country.

private equity international

The appetite is there and the corporate demographics certainly match up.Yet, lending in India is not without its challenges. One of the biggest issues is the poor regulatory framework, with little protection for lenders in the event of bankruptcies. So while there is an open field for lending, alternative players face the same problems that Indian banks have experienced, says Khan: “While the risk profile of businesses is lower [in traditional lending], regulation is still to be had in terms of if the promoter does default and the business does go down.What is your process for getting the money out?” One of the challenges in India is the mindset of business owners who will agree to almost any terms just to get the capital through the door, adds Khan. This can be combined with assets that are not as liquid as lenders would like, particularly real estate which is often used as collateral. The result is that if a borrower goes into liquidation the workout can often be complex, making loan and collateral structuring key to success. However, the common view is that the regulatory framework is improving. may 201 6

PRIVATE DEBT

Earning their stripes: the challenge is to ensure new debt structures require borrowers to have 'skin in the game', says Pankaj Karna

BANKING SECTOR WOES

The intent from the Reserve Bank of India is very clear – foreign investors are being invited in and domestic alternative lending encouraged. Much of this is because of the struggling local banking sector, which is heavily regulated with large chunks of balance sheets mandated for lending to government and infrastructure projects. Large slices of public sector bank books were ploughed into infrastructure financing when the times were good. Now lenders find themselves with rapidly increasing non-performing asset ratios, particularly in their power and steel exposures. Non-performing loans within public sector banks stood at 17 percent as of 30 September, according to the Reserve Bank of India, and research by Credit Suisse suggests that the public lenders have continued to double down on loans to the most stressed sectors. With their balance sheets dedicated to financing government and infrastructure, banks effectively ignore most of corporate India – particularly the family-owned medium-sized businesses that make up the bulk of the country’s economic activity. But private credit providers aren’t complaining. n

m ay 2016

t he india s pecial 2 0 1 6

Purker says “people now acknowledge that regulation should be designed such that borrowers have clear disincentives if they do not meet commercial obligations they have wilfully entered into”. To that end, the latest regulations have “clear guidelines for funds and things like rupee borrowing from foreign sources being allowed”, he adds. One major legislative change expected to boost alternative lending is the new bankruptcy and insolvency code currently making its way through parliament. The bill will allow creditors to take control of the assets of bankrupt borrowers, as well as quicken the insolvency and liquidation process. It is the passage of this legislation, which has cross-party support, that prompted Indian businessman Ajay Piramal to announce in January that he would list a 6,000 crore rupee ($885 million; €820 million) fund to invest in distressed loans. Given the circumstances and the opportunity on offer, Edelweiss’s Ramaswamy expects private debt funds to raise anywhere between $1.5 billion and $2 billion per year for the next three years. To put that in perspective, total corporate debt provided by funds so far stands at around $1.5 billion, he says. According to Karna, the biggest challenge now is to ensure that the structures mean the borrower has “skin in the game”. The second is to back business owners with the right mindset and a track record of engaging with lenders positively, rather than just swallowing attractive growth figures. There’s more to it than just capital, he adds. “I’ve seen that 90 percent of the market is lending money and that is where the story ends, but the onus has to be on delivering value and not just money. In short, I would say that managing relationships, mindsets and the right structures are the key.” So while challenges still abound, private debt is here to stay. n

17

DATA ROOM

By the numbers A snapshot of India's private equity industry, according to PEI Research & Analytics HIGHS AND LOWS

LOOKING UP

India-focused fundraising by closed-ended vehicles

Average size of India-focused funds No

$bn

$bn 20

21

20

18

18

12

11

5.21 2008

1.05 2009

3.76

4.19

2.49

1.93

1.46

4.57

1.45

2010

2011

2012

2013

2014

2015

2016 YTD

Source: PEI Research & Analytics

260.3

95.4

179.2

232.6

138.3

160.7

145.9

228.6

2008

2009

2010

2011

2012

2013

2014

2015

Total capital raised ($bn) Number of funds closed Source: PEI Research & Analytics

AMERICAN ALLIES

132 funds

Regional base of India-focused funds since 2008

14%

3% 25%

North America

10

Asia-Pacific (excl. India)

Europe

4%

Middle East/ Africa

54% India

Source: PEI Research & Analytics

18

private equity international

may 201 6

DATA ROOM

CONSUMER NEEDS

STRATEGIC THINKING

EDGING AHEAD

Sector focus of India-focused and headquartered funds since 2008

Investment strategies of India-headquartered funds

Capital raised by Indiafocused funds compared with targets

% 13

16

11

9

$bn 4%

0.15 0.12

9%

9

-0.03

23 26% 23

$13.6bn

-0.31 -0.75

Total capital

66

-0.39 -0.60

-1.05

61%

30 -2.18 India-headquartered

India-focused

TMT

Venture Capital / Growth Equity

Consumer Goods

Buyout / Corporate Private Equity

Business and Financial Services

Distressed / Turnaround

Industrials

Mezzanine / Debt

2008 2009 2010 2011 2012 2013 2014 2015 2016 YTD

Others Source: PEI Research & Analytics

Source: PEI Research & Analytics

Source: PEI Research & Analytics

CAPITAL BASE

TOP 10

Fundraising by vehicles based in India

Total capital raised by leading Indian fund managers since 2008

$bn

No

16

10

11

10

12

11

7

7

1.79

1.00

2.89

1.54

1.53

1.61

1.21

2.07

2008

2009

2010

2011

2012

2013

2014

2015

1.35

ChrysCapital

1.33

Kedaara Capital

1.02

Kotak Mahindra Group

0.85

CX Partners

0.66

IDFC Alternatives Limited

0.65

Nexus Venture Partners

0.62

Tata Capital

0.54

ICICI Venture

0.51

India Value Fund Advisors

0.44

1 0.53 2016 YTD

Kalaari Capital

Total capital raised ($bn)

$bn

Number of funds closed Source: PEI Research & Analytics

m ay 2016

Source: PEI Research & Analytics

t he india s pecial 2 0 1 6

19

CAPITAL WATCH

Funds in market Some of the key India-based vehicles currently raising capital FUND NAME FUND MANAGER TARGET SIZE VINTAGE FUND STRATEGY ($M) Environmental Sustainable Infrastructure Fund

IL&FS Investment Managers Ltd

1000.00

2014

Venture Capital / Growth Equity

Japanese Venture Fund

Gujarat Venture Finance Limited (GVFL)

1000.00

2014

Venture Capital / Growth Equity Mezzanine / Debt

Piramal India Resurgent Funds

Piramal Enterprises

889.26

2016

Next Orbit Ventures II

Next Orbit Ventures

750.00

2015

Venture Capital / Growth Equity

ChrysCapital VII

ChrysCapital

600.00

2015

Venture Capital / Growth Equity

Multiples Private Equity Fund II

Multiples Alternate Asset Management (Multiples Private Equity)

600.00

2015

Buyout / Corporate Private Equity

Kotak Special Situation Credit Opportunity Fund

Kotak Mahindra Group

570.61

2013

Mezzanine / Debt

India Advantage Fund Series 4 (IAF Series 4)

ICICI Venture

500.00

2014

Buyout / Corporate Private Equity

Zodius Capital II

Zodius Capital

500.00

2015

Buyout / Corporate Private Equity

CX Partners Fund II

CX Partners

400.00

2013

Venture Capital / Growth Equity

Evolvence India Fund II

Evolvence India

400.00

2014

Fund of Funds / Co-Investment

EW Special Opportunities Fund II (ESOF II)

Edelweiss Capital

400.00

2015

Mezzanine / Debt

IDFC Private Equity Fund IV

IDFC Alternatives Limited

400.00

2015

Venture Capital / Growth Equity

Nexus India Capital V

Nexus Venture Partners

400.00

2015

Venture Capital / Growth Equity

Aavishkaar India-focused fund

Aavishkaar

300.00

2014

Venture Capital / Growth Equity

Fairwinds II

Fairwinds Asset Managers

300.00

2014

Buyout / Corporate Private Equity Venture Capital / Growth Equity

Kotak India Private Equity Fund III

Kotak Mahindra Group

300.00

2015

Samara Capital Partners Fund II

Samara Capital

300.00

2013

Venture Capital / Growth Equity

Sealink Capital I

Sealink Capital

250.00

2014

Venture Capital / Growth Equity Buyout / Corporate Private Equity

Amicus Capital

Amicus Capital

200.00

2014

IvyCap Ventures Trust Fund II

IvyCap Ventures Advisors Private Limited

200.00

2015

Venture Capital / Growth Equity

Paragon Partners I

Paragon Partners

200.00

2015

Venture Capital / Growth Equity

Ventureast India Fund

VenturEast

200.00

2015

Venture Capital / Growth Equity

ICICI Prudential Alternative Debt Fund

ICICI Prudential Asset Management Company

168.00

2014

Mezzanine / Debt Venture Capital / Growth Equity

Asian Healthcare Fund II

Asian Healthcare Fund

150.00

2015

Orios Venture Partners Fund II

Orios Venture Partners

150.00

2015

Venture Capital / Growth Equity

IIFL Seed Ventures Fund I

IIFL Holdings

148.21

2015

Venture Capital / Growth Equity Venture Capital / Growth Equity

Kaizen pan-Asian fund

Kaizen Private Equity

120.00

2014

Lok Capital III

Lok Capital

100.00

2014

Venture Capital / Growth Equity

Sabre Partners Fund IV

Sabre Partners India

100.00

2014

Venture Capital / Growth Equity

Skateboat Venture Capital Fund

Skateboat Venture Capital

100.00

2016

Venture Capital / Growth Equity

Stakeboat Capital Fund I

Stakeboat Capital

100.00

2016

Venture Capital / Growth Equity Venture Capital / Growth Equity

Varhad Female Entrepreneurs Fund

Varhad Group

100.00

2013

Vikram Pandit - JM Financial Distressed Fund

JM Financial

100.00

2013

Distressed / Turnaround

Carpediem Capital Partners Fund I

Carpediem Capital

81.52

2014

Buyout / Corporate Private Equity Venture Capital / Growth Equity

Aavishkaar Frontier Fund

Aavishkaar

75.00

2015

Kalaari Capital Partners Opportunity Fund

Kalaari Capital

75.00

2015

Venture Capital / Growth Equity

Zodius Technology Fund II

Zodius Capital

75.00

2014

Venture Capital / Growth Equity

Avendus Special Situations Fund III

Avendus Capital

74.10

2013

Venture Capital / Growth Equity

Canbank Venture Capital Fund VI

Canbank Venture Capital Fund Ltd.

74.10

2014

Venture Capital / Growth Equity Venture Capital / Growth Equity

DICCI SME Fund

Varhad Group

74.10

2013

RVCF III

Rajasthan Asset Management Company

74.10

2014

Venture Capital / Growth Equity

Value Multiplier Fund

Gujarat Venture Finance Limited (GVFL)

74.10

2014

Venture Capital / Growth Equity Venture Capital / Growth Equity

Omnivore Capital 2 India

Omnivore Capital

70.00

2015

Blume Ventures Fund II

Blume Ventures

60.00

2014

Venture Capital / Growth Equity

Oorja Capital Partners

Oorja Capital

60.00

2015

Venture Capital / Growth Equity

Trifecta Capital Partners Venture Debt Fund

Trifecta Capital Partners

59.28

2015

Mezzanine / Debt

Kyron Fund I

Kyron

53.00

2014

Venture Capital / Growth Equity

Contrarian Opportunities Fund I

Contrarian Capital India Partners

50.00

2013

Venture Capital / Growth Equity

Fulcrum Venture India Fund III

Fulcrum Venture India

50.00

2015

Venture Capital / Growth Equity

20

private equity international

may 201 6

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