New Delhi-based Lilliput Kidswear Ltd, which moved court in early October to prevent private equity (PE) firms Bain Capital Llc and TPG Growthfrom exiting the company because of an alleged corporate governance failure, is now seeking an out-of-court settlement with the investors.

The two investors had accused Lilliput’s founder Sanjeev Narula of fudging the company’s financial accounts. Narula, in turn, had said the PE firms were trying to halt the company’s planned Rs850-crore public offering and get hold of a majority stake.

“We are looking at resolving the issue through an out-of-court settlement," said an executive at the kidswear maker and retailer. “Nothing has been discussed with the investors so far," said the executive, who did not want to be named, citing court proceedings, which bar the company from speaking with the media.

Lilliput’s initial public offering (IPO) has been deferred for an unspecified period, said the official. “It’s really out of question right now."

The executive said Lilliput is open to having its financial accounts audited by an independent auditor and will try to get new investors on board to buy the existing investors’ stake. “We will get another audit done and then approach new investors," he said.

Bain refused to comment on the issue, in response to a mail sent by Mint, seeking its views on the prospects of an out-of-court settlement. A TPG spokesperson said the company cannot “comment on this because the matter is sub-judice".

Last year, Bain and TPG competed fiercely, drove up valuations, and bought stakes in Lilliput Kidswear through an auction before joining forces against the promoter, as corporate governance became an increasingly significant issue for PE investors.

ICICI Venture Funds Management Co. Ltd, an investor in discount retailer Subhiksha Trading Services Ltd, in court filings against Subhiksha in 2009, alleged lapses in corporate governance by the management, besides concerns over its financial health and liabilities. ICICI Venture had to write off a part of its investment in Subhiksha.

In July, three PE investors—Multiple Alternate Asset Management, Mount Kellett Capital Partners and Wolfensohn Capital Partners—and US-based financial firm Customers Bancorp Inc., which had proposed to invest Rs290 crore in Dhanlaxmi Bank Ltd, called off the deal at the last moment even though they did not cite any particular issue with the bank.

In a stock exchange filing, Dhanlaxmi Bank said Customers Bancorp “will not be able to participate in this preferential allotment and subscribe to the equity shares due to certain regulatory reasons applicable in the jurisdiction of its incorporation."

Following this, the PE investors “expressed their reservations in subscribing to the preferential issue".

Last week, Dhanlaxmi’s banned employees union alleged irregularities in the way the bank managed its books of accounts but the lender denied such allegations.

“An increasing number of investors will now begin to get worried about the issue of corporate governance," said Deepesh Garg, managing director at O3 Capital Global Advisory Pvt. Ltd, an investment bank. “At times, particularly when a company is chased by many investors, certain aspects are overlooked in a hurry to close the deal."

Pressure to close a deal has an impact on due diligence as well.

“Governance standards are poor in privately held companies and a fraud is something difficult to unearth," said the head of the PE practice of one of the top four global audit and consulting firms. “You are pressurised to do due diligence in four weeks." He requested anonymity, citing the sensitive nature of the issue.

As due diligence process is expected to become more intensive, experts said the short-term impact of this will be on the time taken to close deals. This could also affect the investors’ interest in retail, particularly apparel companies, experts said.

“Barring companies in specialized retail, broadband retail is not a sweet spot for investors any more. With issues of corporate governance cropping up, deals will be impacted, along with a further tightening of agreements.," said C. Venkat Subramanyam, founder and director, Veda Corporate Advisors Pvt. Ltd, a Chennai-based investment bank.

In the long term, if returns from the Indian market don’t meet the expectation of investors or limited partners, the allocation towards Indian PE will be affected.

“This is a sensitive issue, but over the past 10 years close to 5,000 companies have been funded by PE and VC (venture capital) firms. So such issues are bound to come up," said Srinivas Chidambaram, managing director at PE fund Jacob Ballas Capital India Pvt. Ltd. “Fund managers will become more cautious" while limited partners who invest in PE funds are “sitting up and taking notice of these issues".