Private Equity Investment Process

This post is intended to be a primer on how a typical investment pitch happens in a private equity firm.

  1. Sourcing of proposals:

PE funds are flooded with proposals, both direct and through their investment teams. Given their lean structure, they prefer proposals that are vetted by their team members, or are received through their network of professionals. Even amongst people from their contacts, funds have their preferences — essentially those with whom they have had good experiences in the past, or they are otherwise comfortable with the professionalism of the introducing party or its key director/partner.

2. Initial contact / Flier

Out of the several hundred fund and other PE investors, experienced investment teams can identify the handful parties that are most likely to be interested in a specific proposal. They may sound out a partner or director in the fund to check on their interest, based on broad information about the proposal. There are several reasons why a fund may not be interested, even in a good proposal from an industry they have an interest in. For example, they may already have made an investment in a competitor of the prospect, and would like to avoid a situation of conflict of interest. Else, 
they may not have room in their current tranche of funds. can identify the handful that are most likely to be interested in a specific proposal. They 
may sound out a partner or director in the fund to check on their interest, based on broad information about the proposal.

The flier, which may be just one or two pages, has the bare details of the proposal — the issuer, the business and nature of proposed transaction.

3. Non-Disclosure Agreement (NDA)

If the fund finds the proposal interesting, it will seek further information. This could be in the form of a brief presentation or telecon. Thereafter, subject to interest, NDA is signed between the fund / investment team and the investment bank / issuing company. This binds the people receiving any information to use it only for the purposes of the transaction and not share it 
with anyone else.

4. Information Memorandum

After the NDA is signed, the Information Memorandum is shared. This is an important source of information for the fund to review the investment. The following are typically contained in the Information Memorandum.
- Highlights 
- Executive Summary
- Promoter background
- Industry background, regulatory environment, market structure and competitors
- Key drivers of success in the business and the overall value chain
- Company background, its management team and clients
- Business model of the company 
- Strengths, Weaknesses, Opportunities and Threats (SWOT) analysis of the company vis-à-vis the chosen business model
- Capital expenditure plan and proposed means of financing
- Revenue model and strengths / uncertainties associated with each stream of revenue
- Cost and Margin structure
- Historical financials
- Projected financials for about 5 years, or longer for long gestation projects
- Patents or any intangible assets owned by the company
- Key successes of the company
- Litigation or tax issues associated with the company or its promoters
- Proposed transaction, including purpose of mobilisation, size of mobilisation, proposed dilution and the valuation.
- Justification for valuation
- Risks associated with the investment
- Likely exit possibilities for the investor
- Time frame, or any other key aspect not covered above

5. Management Presentation

Based on comfort with the memorandum, the fund will call for an interaction with the management of the company. If the proposal has flowed through an intermediary, then this would be the first direct interaction between the fund and the company. The management needs to take the extra effort to ensure that they make the right impression. The team representing the company should include all key functions, especially finance and marketing, besides the CEO. A technology-based business should be represented by the technology-head; people-based businesses should have head of Human Resources as part of the team that meets the fund.

6. Initial Due Diligence

Based on the inputs obtained thus far, the investment team from the PE firm will do its own due diligence, to validate key information.

7. Preliminary Investment Note

After all the requisite clarifications are obtained, the investment team will put together a preliminary investment note for the consideration of the fund management / investment committee. It will include all the points mentioned above under the para on Information Memorandum, but in a briefer form. The note will also highlight the initial due diligence done and the findings and comments of the investment team on the attractiveness of the proposed investment. This is the stage at which approvals are sought for making non-binding commitments to the company.

8. Non-binding Letter of Intent

If internally approved, the investment team will send a non-binding letter of intent to the company. The purpose is to disclose in writing, the likely form in 
which a deal is possible with the fund.

9. Final Investment Memorandum

The investment team will put together this memorandum for obtaining internal approval for he investment. It will cover all aspects covered in the Preliminary Information Note, any new findings during the due diligence and their implications on transaction structure and valuation or the proposed investment. The Final Investment Memorandum will also list various steps 
hat will need to be taken after the approval for closing the deal. The Final Investment Memorandum will be discussed in a meeting of the directors / partners. Finally, approval may be given for the investment and conditions in which the investment will be made. Authority will also be given to designated officials for signing the term sheet, becoming nominee directors on the board or joining the management committee of the company etc.

10. Signing the term sheet

The term sheet has all the details indicated earlier in the Non-binding Letter of Intent. However, it is now binding on the fund. The term sheet will also mention a time frame for which the fund shall remain committed and situations when the fund can withdraw from the deal.

11. Closure of the deal

After the term sheet is signed, and before the fund releases the money to the company, various other processes need to be completed, such as:
- Drafting and execution of subscription agreement outlining the respective parties’ rights and obligations
- Making relevant changes in memorandum and articles of association and other agreements with various parties, as may have been decided
- Permission of Cabinet Committee on Economic Affairs, SEBI, RBI, Ministry of Finance, relevant Ministry for that industry, state government, local authorities etc.
- Obtaining any no-objection certificates that may have been highlighted as part of the legal due diligence
- If the transaction structure provides for any escrow arrangements or other guarantees, then effecting the same
- If the deal is subject to any changes in the financial structure of the company including fresh borrowings, then obtaining firm commitments for the same and concluding the relevant documentation

Once all the requirements are fulfilled, the fund will make the payment to the company or the owners, as the case may be and secure ownership of the shares or other assets purchased.

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