Will the boom in private equity continue in 2020?

Madhur Singhal

Private equity (PE) in India has grown rapidly during the past three years. PE and venture capital (VC) funds invested $12.8 billion in 2016 and the deal value has trebled since then to $36.3 billion in 2019 across asset classes and deal sizes. The growth has been diverse and robust for the longest continuous period.

Deal flow is making a buzz as well. From nearly 450 deals a decade ago, the market now sees close to 900. Not only are funds clinching more deals, cheque sizes are becoming larger, with growth in average deal size at $42 million in 2019 from the earlier $18 million.

Historically, funds flow has been cyclical and typically goes down as economic growth shows signs of a slowdown. The last three years have seen a phenomenal growth in PE and VC fund investments much like what was seen during 2005-07. During the past three years, deal volume has been steady, which indicates continued buoyancy and investor confidence. We do not expect this to abate materially for the reasons listed below.

However, overall funds being put to work might get tempered as the deal size might come off if the economy slows materially in 2020. In the last three years, deal size has grown. Even  $100-million plus deals have grown by 4 percent. While large deals will continue, they might reduce in number and mid-market deals might see some moderation in valuations leading to a somewhat mellowed overall growth.

Scope of alternative investment in India

Despite enough noise around the slowdown in the economic growth rate, the country is relatively stable and growing, albeit at a slower pace. Alternative investments, primarily PE and VC, might be slightly tempered, but not substantially in 2020 for the following reasons, which make it different from the 2008-11 timeframe where the following factors were weak:

• Investor depth: Indian market now has a lot of depth. Currently, more than 1,200 funds operate in India as against less than 500 a decade ago. The market is much more diverse with several family offices, strategic investors, sovereign wealth funds having gone through a deal cycle in India and investing more sharply. Different investors with different risk-return appetite and return expectations enable availability of capital even in relatively weaker times.

• Diverse asset classes: Many new asset classes have appeared e.g. venture debt, funds doing structured deals, Internet-focussed funds, etc. We may see some shift on who is more active than the other, but the presence of multiple asset classes will support the deal flow. Also at the same time, several funds will find value deals, opportunities that are at the right point in the cycle and other quality businesses that are resilient to economic downturns. Consequently, more assets would catch the fancy of investors owing to the tempering valuations in the market.

• Equity vs debt: As the credit availability has tightened, entrepreneurs are becoming even more amenable to equity as they seek partners who have the ability to support their businesses even in tougher times. While stock markets have depth and capital market flows are higher than ever, the Indian capital markets still do not show significant appetite for direct investments or easier listing for smaller companies.

• Maturing of sectors: Several pockets of opportunities are emerging as the economic conditions are changing. For example, as the liquidity in wholesale lending is constrained, companies are capitalising on private equity more aggressively. Some sectors like consumer and retail, Internet-based businesses like FoodTech are not seeing headwinds. In fact, they are benefiting as the economy is formalizing. Technology and the Internet sector is showing examples of profitable growth and are showing potential for large businesses being created from India, like in SaaS (software as a service). This has reduced dependence on Indian economic growth as funds construct their deal pipelines.

• Enough dry powder: Several New India-focussed fund-raisings have taken place recently and consequently, a lot of capital is ready to be put to work. Global funds and large VC investors also now have distinct India allocations and are continuing to scout for early-stage deals. In fact, 31 percent of the funds infusion in 2019 happened in growth-stage startups, growing at 9 percent year-on-year since 2017.

Overall, while observers and economists watch how the India story unfolds in 2020, we believe that alternative investments have found a solid footing in India and will not drop materially. Funds with large portfolios will continue to bet behind the gems in their portfolio and ensure they keep tracking the underlying investment case. And, newer funds will continue to invest in India, given the fundamental attractiveness as the only market that offers growth at scale.

Madhur Singhal is Managing Director, Praxis Global Alliance. Views are personal.