The Bombay Stock Exchange: As the Sensex soars, VCs wary

VCs hate it when the stock markets are booming. Why? Valuations go through the roof, promoters turn up their nose, and it gets that much harder for VCs to find deals that will earn them the kind of returns their investors want. And a Sensex at 7,800 seems like the worst time to be a private equity investor. Says Akhil Gupta of Blackstone: "We are evaluating about 10 companies currently, and the investment could happen anytime now or could even take a year. I can't say particularly when because valuation expectations are simply too high."

Why are valuation expectations high? There are several reasons. One, there's more money (read: funds) in the market; therefore, there's stiffer competition among the investors. Two, promoters have a number of ways of raising equity without having to put up with 'meddlesome' private equity investors, majority of whom insist on a board seat. The promoter can launch an IPO, do a short-term private placement, issue foreign currency convertible bonds (FCCBs, which seem to be all the rage now), and even issue global depository receipts (GDRs). Says Donald Peck of Actis: "There's absolutely no shortage of money. The question is, what types of deals (can VCs do) and at what price?"

If some of the India veterans are looking smug in the face of new competition, it's because India isn't an easy market to operate in. Deals are relationship-driven, regulations are complex, some of the terms of co-ownership are unique to the country, and there's premium on quick turnarounds. That immediately puts at a disadvantage funds that don't have a sufficiently long experience of operating in the country or have fund managers who aren't required to get every single decision they make vetted by a superior sitting somewhere else in the world.

One way some of the newer funds are trying to address that problem is by hiring seasoned India managers. Akhil Gupta of Blackstone, Rajeev Gupta and Shankar Narayanan of Carlyle, Vivek Paul of Texas Pacific Group, Anil Ahuja of 3i are all people with extensive knowledge of India and, therefore, have possibly been given greater elbow-room than most fund managers. Fortunately for the smaller funds, they may get to survive in niches, where deal sizes are much smaller (say, between $1 million or Rs 4.4 crore and $20 million or Rs 88 crore). Yet, there's no doubt that it will be tougher hereon to generate the kind of returns that VCs in India have over the last two years. "VCs can't just take the old stand of spraying capital and praying that some of them turn out to be such winners that they cover losses from others," says Sridhar Mitta, Managing Director & CTO of e4e, a Bangalore-based outsourcing company that's trying out an alternative 'holding company' VC model.

Others like Vishal Nivetia, CEO of GW Capital, say that while it's clear that there's more competition and money now than five years ago, the verdict is not out on whether there's too much money. "In France, which is as small as any state of India, there are 75 PE firms, and in India we have only about 20 active funds. There is enough room for everyone, and I feel the market will segment and be more focussed in each segment," says Nivetia. It's hard to disagree with him. India's growing economy may just surprise everyone by sucking in a whole lot more money than what's on offer.