Should you invest aggressively in PE/VC backed companies?
Updated: Feb 15, 2022
What is common to Laurus Labs, Zomato, Nykaa, PolicyBazaar? They are all backed by VC/PE investors before they came/are coming for an IPO. The prevalence of Private Equity (PE) and Venture Capital (VC) backed companies especially the latter, has risen manifold in the Indian stock markets today. This has both positives and negatives from a retail investor’s perspective.
A PE/VC investor is usually the first institutional investor into the Company and brings in management discipline and better quality of corporate governance. PE/VC investors usually do a detailed financial and legal due diligence before investing, so any regulatory or statutory issues are taken care of early in the Company’s life. They generally take up Board positions so all strategic decisions regarding the Company’s future are well deliberated with a broad-based perspective. Their experience with other players either in similar segment or growth phase enables leveraging of critical learnings.
Some research also suggests that PE/VC backed firms are usually more efficiently run companies than non-funded peers, and so have much better financial and performance ratios.
FIIs look at such companies more favorably - they get comfort from the presence of institutional investors and are willing to give them a premium for their better governance levels.
The PE/VC investor has a limited investment period in a Company given their investment structure. A liquidity event like an IPO is usually the time for them to take profits off from their investment and hence, is usually done when the Company is poised for high performance. This is the typically the phase when the Company has begun its exponential growth journey post the initial phase of building its identity. The high growth trend is expected to continue over the next couple of years before stabilizing as the Company enters a maturity phase. The valuation of the Company at the time of the IPO tends to be rich supported by stellar track record and in the process also maximizing the return for the investors. Therefore, such companies are rarely available cheap and more likely fully priced. They are also accompanied by a well-coordinated media frenzy and hacks that make the investment sound like the best thing to have happened to the retail investor.
The overhang of a limited-life investor holding a significant chunk of shares makes big public-markets’ institutional investors like MFs wary of taking large positions as the liquidation of the PE/VC fund’s stake is likely to cause downward pressure on the share price.
It is therefore our recommendation that irrespective of presence of high-profile PE/VC investors in the firm, you should closely evaluate the Company metrics do a critical assessment of the business potential and get convinced about valuation justification.
Look beyond the hype and then invest.
About the Author
I am a Finance professional with comprehensive Private Equity experience across growth capital and buyout transactions followed by effective engagement with early stage companies charting their entrepreneurial trajectory across a career spanning 20+ yrs.
Currently, I am a consultant at 1Bridge and an advisor to Eko India Financial Services. My previous experience includes working with firms like Sylvant Advisors, Paras Capital, Avigo Captial, Actis and DSP Merrill Lynch.
I have done my MBA in Financial Management from S.P.Jain Institute of Management & Research, Mumbai pursuant to B.A(Hons) Economics from Lady Shri Ram College, New Delhi.