Mumbai: Domestic private equity (PEs) funds and their large investors are increasingly teaming up to make so-called co-investments as they battle cash-rich foreign rivals to clinch large deals.

Such co-investments are a win-win for both sides, as the domestic PE (general partner or GP) gets to raise significant sums while the investors (limited partners or LPs) gain from the PE fund’s knowledge and the due diligence process, and get to choose target companies and take direct exposure in them. Such investments also help the LPs source new deals.

When Delhi-based Mankind Pharma Ltd approached its former investor ChrysCapital for a stake sale, the fund was initially hesitant due to its limited fund size. However, backed by its LPs GIC and Canada Pension Plan Investment Board, ChrysCapital made a $350 million offer for 10% stake in Mankind Pharma, emerging as a surprise last-minute winner, trumping global peers Carlyle Group and Advent International. Mankind Pharma is known for its over-the-counter products like Manforce condoms and Prega News.

“For local PE firms, sometimes, the capabilities are there, understanding of the sector is there and ability to work with the company is there but the size of the capital pool becomes a hurdle. So, if an entrepreneur is looking for more money than a PE fund can support, it is automatically out of the deal unless you have an LP who says I will work with you to present a unified face. Consequently, co-investing also allows the entrepreneur to partner with its choice of fund," said Gaurav Ahuja, managing director at ChrysCapital.

Meanwhile, True North, another home-grown PE firm, has teamed up with its global sponsors to bid for a minority stake in general insurer Royal Sundaram General Insurance Co. Ltd for 1,300 crore.

“From our perspective, we would not like to be under pressure to deploy $1.5-2 billion. But, equally, opportunities are increasing and we would like to be in a position to deploy such amounts. Hence, co-investments provide nice flexible capital. Otherwise, we would have to raise a larger fund and be under pressure to deploy," Vishal Nevatia, managing partner at True North said.

For its fifth fund, True North invested close to $1.2 billion, with $700 million coming from the fund and another $500 million from co-investments. For its latest fund, the firm expects to invest around $1.5 billion—$900 million from the fund and rest through co-investments.

Meanwhile, PE firms are emerging as intermediaries for their investors keen on increasing their investments in India. Thus, as Nevatia puts it, co-investment presents a “win-win" situation for both PEs and LPs.

“There is a lot of interest among global investors to invest more in India but they may not have the knowhow to do the whole transaction completely on their own. So, they would rather have a local partner who has been on the ground long enough and can work with the company on an on going basis. It allows the LP to do some diligence on a particular investment while partnering with a fund it already trusts,"said Ahuja of ChrysCapital.

For strategic LPs, co-investment also offers a platform for future acquisitions. “For strategic investors including family offices from industrial houses, investing in a fund is a good way of getting insights, inroads and access to deals which could be a strategic fit for them," said Nupur Garg, regional lead, South Asia, International Finance Corp.

Apart from getting exposure to high-quality companies, what makes a compelling case for doing co-investments is the economics involved. Garg added that for a commercial fund of funds, the aggregate cost of investment can be lowered when since co-investments are done on no-fee no-carry basis.

“Co-investments allow fund managers to execute their strategy with a smaller pool of capital. There is reduced pressure on both capital deployment as well as the amount needed from exits in order to deliver expected returns. It is easier to return a 3x on a $300 million fund than on a $800 million fund," she said.

Also, there is evidence of pressure from LPs to expand co-investments. According to a 2018 survey by Emerging Markets Private Equity Association, just under 60% of survey respondents plan to begin or expand emerging market PE co-investment activities over the next two years, while 41% plan to begin or expand direct investment programmes.

“For GPs, having a large co-investment pool is not necessarily a good thing as it could lead to a sub-optimal effort-reward equation. Usually, one sees co-investment pools of up to 25-30% of the fund size raised." said Vivek Soni, partner and leader, private equity services, EY India.

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