Small and medium-sized enterprises (SMEs) have begun to attract more attention from private equity (PE) investors looking to bet on what they view as small shops with large potential. Specialized SME funds worth nearly $500 million (Rs2,050 crore) have been raised or announced for the Indian market in the past 12 months, and this money will be deployed over the next three-five years.
SMEs—companies whose average revenues are between Rs50 crore and Rs200 crore per year—are somewhat under-served by PE investors. Most investors active in India play either in the start-up and early-stage space or in the large-cap (market capitalization) segment. Deal sizes in the SME space look similar to most large-cap PE deals done in the Indian market at present—mostly in the $5-15 million range. But the similarity ends there.
SMEs are somewhat unique in terms of their needs. “They require a measure of hand-holding, much like start-ups, but their capital needs are similar to mid-cap companies,” says K. Srinivas, managing partner, BTS India Advisors, which started investing in Indian SMEs in 1997 and has funded 19 companies till date. The Mumbai-based firm has just launched its second India fund, the $80 million BTS India PE Fund, and will invest $3-5 million per company.
Investors such as BTS, Gujarat Venture Finance Ltd (GVFL), Sidbi Ventures, Avigo Capital Partners and Aureos India are some of the firms that now specialize in such companies. The Ahmedabad-based GVFL is raising a Rs100 crore fund that will invest across sectors. Sidbi Ventures, backed by the state-owned Small Industries Development Bank of India, is raising a similar sized fund and already invests out a $111 million SME Growth Fund that was raised last year. Avigo, a New Delhi-based PE investor, has recently started investing out of a $125 million fund in India and the UK-based PE investor Aureos Capital has a $100 million kitty in the market managed by its local arm Aureos India in Mumbai.
The SME space is attractive from a PE point of view, as it is not crowded.Saif DhorajiwalaVice-president of investments, Avigo Capital Partners Saif Dhorajiwala, vice-president of investments at Avigo Capital Partners, says other funds do not always want the smaller deals because they are perceived as requiring the same amount of work (as large deals) for a smaller absolute return. However, since these companies are smaller, the entry barriers for investors are lower. Many of them are family-owned businesses that want to work towards professional management and better corporate governance standards. These are areas in which PE investors can play an active role and thus build value into the company. “The SME space is attractive from a PE point of view as it is not crowded,” says Dhorajiwala. His firm invests $2-7 million in one go in profitable companies with annual revenues of $10-45 million.
SMEs are also viewed as plum PE projects because many of these companies do not yet have strong-enough balance sheets to attract bank loans. Further, even if they do rope in such loans, it may not be the best form of capital to finance their growth needs. “Most SMEs, by virtue of their scale-up requirements, need to sustain growth at 30-40% year-on-year. Equity finance is the best way to do that,” says BTS’ Srinivas.
Yet, not everyone agrees that funds specializing in SMEs offer greater value to the investees. Vibhor Mehra, principal at Asia-focused PE firm SAIF Partners, which manages over $1 billion across Asia, says a fund that markets itself as specializing in SMEs does not necessarily offer better expertise to a company. “All funds try to maximize the contribution to the success of their investee companies,” he says. Usually, the funds that claim to specialize in small and early stage deals, he says, are smaller in size and have a limit on the amount they can invest in a single deal—boundaries that keep them out of larger deals by default.