Home > Opinion > Columns > Opinion | A lot can happen over a private equity-coffee blend

V .G. Siddhartha has many firsts to his credit and that list now includes the manner of his mysterious disappearance and the equally mystifying letter he has purportedly left behind. Boardrooms and corner offices have been buzzing ever since the news of his disappearance and discovery of his body. While the circumstances and nature of his untimely demise will be intensely debated in the coming months, these conversations will find it difficult to sidestep related issues about regulatory red lines, the tightening embrace between business and politics, or the nature of certain foreign investments. Many questions have already been raised about the linkages between Indian businesses, the tax regime and the political ecosystem, but perhaps it is also time to introspect on the friends of businesses: Private equity (PE) firms.

The manner of Siddhartha’s death has forced many issues out in the open and these must be answered or resolved comprehensively. At stake is India’s reputation as a business destination and its promise of unwavering adherence to the rule of law. Siddhartha’s last letter, apparently written two days before he walked out of home for the last time, captures his despair: “I fought for a long time but today I gave up as I could not take any more pressure from one of the private equity partners forcing me to buy back shares, a transaction I had partially completed six months ago by borrowing a large sum of money from a friend. Tremendous pressure from other lenders lead to me succumbing to the situation. There was a lot of harassment from the previous DG income tax in the form of attaching our shares on two separate occasions to block our Mindtree deal and then taking position of our Coffee Day shares although the revised returns have been filed by us. This was very unfair and has led to a serious liquidity crunch."

The elephant in the room is the tax persecution to which Siddhartha has alluded, but which remains unproven so far. The income tax authorities issued a press release on Tuesday, the day the letter was disclosed to the public, defending their actions and accusing Siddhartha of tax evasion, which he, sadly, is in no position to counter. This is the tragedy’s unfortunate aspect: Both have accused each other without providing any proof and it is now up to readers to draw their own conclusions from this tragic turn of events.

The questions will continue to linger. For one, why did the income tax action unfold just before the elections, especially in light of Siddhartha’s known links with the Karnataka Congress? Or, what is Siddhartha hiding when he claims in his letter, “My team, auditors and senior management are totally unaware of all my transactions. The law should hold me and only me accountable, as I have withheld this information from everybody, including my family"? The board, acting under an interim chairman, has promised to probe all past transactions.

The clincher, one that has the financial services industry speculating, is a reference to a “private equity partner". While little is known about this, larger questions have arisen about the conduct of PE players and whether the current regulatory framework is adequate to govern their actions.

PE has been a saviour for the capital-starved Indian corporate sector. Consulting firm Bain and Company’s India Private Equity Report 2019 reported that PE investments in the country during 2018 touched $26.3 billion from 793 deals. The report also estimated the India-focused “dry powder" at $11.1 billion, an indication of the capital available for high-quality deals.

Here is where things get slippery. With so much capital chasing so few “good" assets, intensifying competition between PE firms for deals is leading to all kinds of distortions and forcing professionals to explore regulatory cracks. For one, there are already doubts about the provenance of investors in these funds, especially since very few PE firms actually deploy funds raised in domestic markets. In addition, competitive pressures are forcing many PE firms to design structured products for their clients, which could include a credit component. This gives rise to two problems. One, PE firms—as well as mutual funds (MFs)—have become default credit dispensers, after commercial banks and non-banking financial companies turned risk-averse, without necessarily having the requisite credit appraisal expertise or risk mitigation frameworks. But second, and more important, credit markets are regulated by the Reserve Bank of India and PE firms are answerable mostly to the Securities and Exchanges Board of India, which doesn’t have any credit capabilities. Consequently, a large segment of the financial services industry involved in dispensing credit is now operating in a grey regulatory zone. This has profound implications for contagion risks in an interconnected market; it is well known how some PE firms and MFs have already made a number of rash credit calls in the recent past, which have contributed, perhaps partially, to the credit market freeze.

There has been some discussion about the role of MFs lending money to entrepreneurs against the security of their shares in either the holding company or the operating firm, but there is complete regulatory radio silence about the ground rules needed—perhaps similar to those applicable to banks and NBFCs—for PEs or MFs to qualify as credit vendors. Hopefully, Siddhartha’s death will now spur some regulatory action.

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