Private equity surge accompanied by increase in discreet inquiries

Private equity surge accompanied by increase in discreet inquiries

Mumbai: In 2007, when private equity (PE) inflows into India were hitting a high, a PE company looking to invest in a private firm called in Gurgaon-based Alea International Consulting Pvt. Ltd, which provides corporate intelligence services.

As it turned out, the promoter of the company had a chequered past, which meant that the PE firm may not have been able to smoothly exit the company through an initial public offer (IPO) later, as the Indian law does not permit any person with a criminal record to be the managing director of a listed firm.

That deal came close to falling through after that fact came to light, recalls Deepak Bhawnani, chief executive officer of Alea International, and was salvaged by lawyers with a replacement being found for the role.

Three years later, as the Indian PE universe has expanded, the demand for such services is growing fast, and promoters are often at the receiving end of such discreet investigations that go under the bland rubric of “due diligence".

While there is no industry data available on such background checks, Sumchit Anand, director, Protiviti Consulting Pvt. Ltd, which conducts such inquiries into Indian companies, estimates there has been a 10-15% increase this year.

Consulting companies that specialize in conducting corporate intelligence services or reputation diligence on promoters of firms that PE firms are looking at have seen a spike in such business.

“There is an increased awareness and higher acknowledgement of our services (among PE players) now than before," says Richard Dailly, managing director of US-based Kroll Inc.’s India operations, adding that most of its clients now are Indian PE firms instead of foreign ones, as the case was earlier.

Kroll’s services include, among other things, private investigation, background screening, business and market intelligence, and forensic accounting.

The trend is directly linked to the rise in the number of PE firms, PE interest in small and medium enterprises that often have low corporate governance standards, family-owned businesses opening up to PE funding, and emergence of first-time fund managers.

And given the money involved—PE investments in the first half of calendar 2010 were $4.57 billion (Rs21,113 crore), more than three times the $1.5 billion in the same period in 2009, according to research firm Venture Intelligence—it is not hard to see why PE funds would want background checks on who they are going to be doing business with.

“Our work virtually doubles every year," said Deepankar Sanwalka, head of forensics at KPMG India Pvt. Ltd, noting that the company has handled at least 400 such requests in the past three to four years.

However, such investigations often have to rely considerably on the consulting firm’s own networks as the PE space is still evolving. “Not a lot of information is available publicly," says Dailly.

The global liquidity crunch and subsequent economic slowdown, however, revealed fault lines in a number of firms.

“A lot of these checks happened when recession hit because a lot of skeletons came out of the closet, which triggered forensic (investigations)," said Sumchit Anand, director, Protiviti Consulting Pvt. Ltd, which has conducted close to 100 such checks in the past two years.

As family-owned businesses open up to the idea of PE funding, they too are coming under the scanner.

“The need (for such scrutiny) is more when it comes to family-owned businesses," concedes Dailly, because such companies may have different businesses, where one could be sustaining the other and such transactions may not necessarily show up in a financial audit.

Also, if there is internal conflict brewing, the business could be divided in the future.

As intrusive as they may sound, such investigations play a critical part in investment decisions, with Muneesh Chawla, managing director of Mumbai-based PE firm Blue River Capital India Advisory Services Pvt. Ltd, saying they have become an integral part of the so-called due diligence.

“In many cases, the findings of such reports have been deal breakers," he said.

All four companies that Mint spoke with declined to divulge any client names—PE firms that have asked for such investigations—due to stringent confidentiality agreements.

Not all sectors face the same level of scrutiny though. Infrastructure and real estate top the PE firms’ list for such intelligence inputs, said Vikram Utamsingh, executive director and head (private equity) at KPMG, primarily because promoters in these sectors are often influential persons with political connections.

While such connections don’t deter PE investors, they are concerned about such relations hampering their investment in the future.

A KPMG report on corporate intelligence released in February elaborates on this. A promoter aligned to a single politician or party could be undermined if there’s a shift in the fortunes of the ally, leading to business disruptions.

Another contributing factor to the demand for such services has to do with fund managers striking out on their own, said Bhawnani of Alea.

“Many first-time fund managers were a part of foreign funds which have a wide network and offices in different countries." When they start their own funds, they have limited or no access to such networks, he said. “So they need a third party to conduct the diligence for them."

However, first-time fund managers themselves come under scrutiny by limited partners (Lps), the primary investors in a fund. Anand of Protiviti admits they have been approached for such background checks. “Lps realize it’s the people who make the difference. It’s about backing people when it comes to first-time funds," he said.