Bangalore: When Thrissur, Kerala-based Manappuram General Finance and Leasing Ltd (Magfil), a small non-banking finance company with high ambitions, planned to raise funds, its biggest concern was getting the right valuation and an investor on board for the long term. To do so, I. Unnikrishnan, Magfil’s managing director, took a decision that companies such as his are increasingly making: Engage a specialist investment bank to findhim a suitor.
“We are an emerging company and it is very difficult for us to sell our story on our own to investors, so we needed a credible intermediary,” says Unnikrishnan. The firm raised Rs70 crore from Sequoia Capital and India Equity Partners, with Chennai-based boutique investment bank Spark Capital Advisors Ltd as adviser.
With venture capital (VC) and private equity (PE) investments in India growing, investment banks are emerging as an important link matching companies seeking funds and firms vying for investment opportunities. Experts say up to 40% of investment opportunities are helped by such intermediaries. “Investment banks are crucial as you need a third party during negotiations,” says K.P. Balaraj, managing director, Sequoia Capital India Advisors Pvt. Ltd.
Investment banks with large operations such as local arms of the US financial houses such as Merrill Lynch and Co. Inc. or the likes of home-grown Motilal Oswal Securities Ltd typically look for large deals—say, above $20 million (Rs86 crore) each. Professional services firms such as Ernst and Young and KPMG International, too, have large corporate finance teams. And, Yes Bank Ltd, IDBI Bank Ltd and ICICI Bank Ltd are among a growing breed of lenders with their own investment arms. But, it is the boutique investment banks and specialists such as Spark Capital or Veda Corporate Advisors Pvt. Ltd that are gaining custom from start-ups and firms with small investment needs. Others active in the PE and VC business include Avendus Capital, Edelweiss Capital Ltd, Cipher Capital Advisors Pvt. Ltd, Mape Advisory Group and o3 Capital Advisors Pvt. Ltd.
An investment bank’s job begins with screening companies, which are then introduced to VC and PE players.
With their own reputation at stake, investment bankers say screening and picking companies is a tough task. “We have a deal strike rate of 80-90%, so it is crucial for us to pick the right companies. Our reputation (before VC and PE firms) depends on the companies we propose,” says C. Venkat Subramanyam, founder and director at Veda. The Chennai investment bank has closed more than 30 deals, totalling more than $500 million, and emphasizes on client referrals.
After screening the company, the investment bank prepares an investor presentation, a profile of the product or service offered, and an all-inclusive information memo (that includes valuation), which would be required to interface with prospects. The firm then identifies five-eight potential investors, who could be interested in the deal. The discussions with an interested investor are pursued until a letter of intent is ready, which outlines the broad terms and structure of a potential deal.
Further negotiations include issues such as valuation, terms of transaction and the deal structure leading to due diligence process and other issues leading up to an agreement and the final deal closure, including exit routes. A deal typically closes in three-six months and the investment banks often stay on as advisers, as the promoter may require more funding in future. Sequoia-backed Magfil, for instance, is now looking at raising a second round of funding.
Fees for the investment bank usually varies between 2% and 4% of the capital raised and is paid by the investee company. With early stage firms, the investment banks often opt for a combination of a fee in cash and equity stake. Most promoters have unrealistic expectations on valuations and are disillusioned with the amount of equity dilution in a VC or PE round. Having an outsider on their board of directors is often a big issue with promoters. K. Ramakrishnan, Spark Capital’s investment banking executive director and head, says he has seen promoters who work hard “with the sole idea of getting back their full stake in the company from investors”.
VC and PE firms see value in not having to spend excessive time with company promoters in deals pitched by investment firms. The involvement, however, is not without drawbacks as the firms can create artificial expectations in terms of valuations. “As the investment firm usually proposes one deal to a number of funds, they can create a valuation bidding (among) funds” ending up with a mismatch, says Srini Vudayagiri, managing director Lightspeed Advisory Services India Pvt. Ltd. Experts say the opportunity and outlook for investment banks will continue to be positive, with more entrepreneurs coming into the ecosystem. “The market is untapped for $2-5 million deals,” says Deepak Srinath, founder director, Viedea Capital Advisors Pvt. Ltd, adding the firm has four deals being readied that could be closed in two months.