Bulk strategies for investing in PE markets

The Smart Money.

Hey, there! Welcome to the single pitstop for learning about the attributes and mechanisms concerning the private equity space in India. Today, Leadoff is here to enlighten your minds with different strategies that are currently in use to make investments in private equities.

1. Leveraged BuyOut (LBO).

“We have been associated with the Indian LBO asset class since its effective inception in FY2013–14. We have been underwriting leveraged buyouts for several global, Asian, and home-grown PE funds investing in India and enjoy a very healthy market share in this space. We will continue to grow this practice alongside our corporate credit business as we believe this asset class also is poised for significant growth in the coming years” — Piyush Gupta, head of private credit at Investec India.

A leveraged buyout is when one firm buys another utilizing a considerable amount of borrowed money to cover the purchase costs. The assets of the acquiring company and the acquired company are frequently used as collateral for loans.

Example -
Let’s consider that there are two companies. Out of which one is an investment firm (ABC Ltd.) and the other is a logistics company (XYZ Ltd.) Now, ABC Ltd looks at XYZ Ltd as a business that carries the potential to leapfrog its competitors, but it hasn’t been compelling enough. Therefore, it plans to do it by buying out XYZ Ltd.

How will the situation of LBO arise?
Firstly, there should be an agreed purchase price: INR 100 crores. To use leverage in buying out XYZ Ltd., the investment firm ABC Ltd needs to commit INR 10 crores from its locker. Then the remaining INR 90 crores shall be borrowed from a bank.

The loans in leveraged buyout scenario are arranged so that XYZ Ltd. or the company that is being acquired (also known as the target company) assumes the debt. It makes the target company responsible for making all the payments and liable for defaults.

The regulation about Leveraged Buyouts in India.

The leveraged buyout activity in India is regulated by the Reserve Bank of India (RBI).

  • To protect the ownership of Indian companies, the RBI has prohibited the domestic banks from funding such operations/or giving out loans for conducting leveraged buyouts.
  • RBI has allowed the domestic banks to give out loans if an Indian company is conducting leveraged buyout of a foreign company.
  • The Foreign Investment Promotion Board has prohibited the domestic banks from lending out loans to such investors who will use this borrowed money to acquire shares of an Indian company.
  • The Alternative Investment Funds Regulation has also prohibited alternative funds from procuring loans from any domestic financial institution that they might use to directly or indirectly engage in a leveraged buyout of an Indian company.
  • Section 67(2) of the Companies Act, 2013 has placed a restriction on Indian public companies, which bars them from financially assisting any person or organization who/which may get indulged in the purchasing or acquiring the Indian companies via a leveraged buyout.

2. Venture Capital

Venture Capital (VC) investment in India more than doubled from its previous quarterly high of $6.7 billion in Q2 2021 to $14.4 billion during Q3 2021, according to a recent report by KPMG.

Venture capital (VC) is a type of private equity and financing provided by investors to startups and small enterprises with the potential for long-term growth.

A venture capital funding process has namely four aspects:

  1. Conceptualizing an Idea -
    It is a process wherein the seeker of funding has to provide the VC firm with a summarized business plan which will consist of descriptive mention of opportunity, the potential of growth in the respective environment, financial mapping, and description of the company’s management.
  2. Starting-up -
    This is a phase that involves a detailed discussion of the proposed plan. It is also an assessment sort of meeting because, based on this discussion, a VC firm thinks of either moving onto due diligence or discarding an idea.
  3. Due Diligence-
    This phase involves a customer-centric approach where the discussion is targeted to answer deliberative questions about the business strategy, customer queries, and management interviews.
  4. Exiting the company’s ecosystem — There are four options of an exit strategy:
  • Promoter Buyback
  • IPO
  • Mergers and acquisitions
  • Strategic sale of Investment

Regulation -
Venture Capital in India is governed by the SEBI[8] Act, 1992 and SEBI (Venture Capital Fund) Regulations, 1996.

3. Mezzanine Capital

“We are looking to establish an alternate asset class. What’s prevalent nowadays is promoter financing at two times share pledge. So we want to institutionalize the mezzanine market in the country at the holding company and operating company level. This is how it began in the US a few years ago, and it would be a fresh source of capital in addition to banks. Many companies will need this as banks cannot always lend to them because of unsecured lending or capital market limits. In the long run, we can also develop a secondary market space, but it is a long-term game planSanjay Nayyar, KKR

Mezzanine financing is a type of debt-equity financing that allows the lender to convert to an equity stake in the company in the event of default, usually after venture capitalists and other senior leaders have been paid. Mezzanine financing is frequently handled with little due diligence on the lender’s behalf and little or no security on the borrower’s part. On a company’s balance sheet, it is classified as equity.

Why is mezzanine capital preferred?

  1. The funds obtained can be utilized for various purposes, some of which may be forbidden by bank financings, such as financing acquisitions, land purchases, and the creation of intangible assets such as brands.
  2. The repayment terms are usually variable, with a required moratorium and “pay when able” features, especially suitable for projects with erratic cash flow timing.
  3. The standard cost of mezzanine capital is in the 18% to 20% range, with payments made in a combination of periodic coupons, redemption premiums, and warrants/profit sharing.
  4. The USP of mezzanine capital is ‘no or minimal equity dilution.


Since mezzanine capital is a form of subordinated debt, it is regulated by RBI under Tier 2 capital.
As part of subordinated debt under Tier 2 Capital, the bond issuance terms have been defined under Annex 5 of Master circular related to Prudential Norms on Capital Adequacy — Basel 1 Framework.

Following are the norms:

  1. The amount of subordinated debt to be raised is decided by the BOD of the bank.
  2. Bonds with a maturity period of fewer than five years or those bonds that still have one year left to mature should not be considered Tier 2 Capital.
  3. The subordinated debt with a remaining maturity of more than four years and less than five years is issued 20% to the bond’s face value.
  4. The minimum maturity for bonds to be considered part of subordinated debt is five years.
  5. The subordinate debt generally does not have a ‘put’ or ‘step-up’ option.
  6. There is the provision of the ‘call’ option, which can be exercised after maturity, i.e., five years.
  7. These instruments must be fully paid up.
  8. They are unsecured and are subordinated to the claims of other creditors.

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