The Privileges Of PE Investors

wealthymattersImagine an initial public offering of shares from company,promising an average 15% return after five years of listing if the market returns are not higher. The question that will arise is whether it is an equity issue or a bond issue. By any definition it could be inferred as a sale of fixed income security and not equity.

It is investment into securities with such properties that has been happening for years and masquerading as private equity. Last week the Reserve Bank of India yielded to the long pending demands of the foreign private equity investors that the central bank legitimize put and call options in an equity investment contract. But the industry is still unhappy.

The issue is that such derivative contracts are legal so long as there is no assured return. Private equity investors say that this puts them at a disadvantage. But isn’t every equity investor at the same disadvantage? Is it not risk taking that gives such out sized returns? Equity investments are the riskiest form of investment and one could lose to the last paisa. But there is also an opportunity to earn many times the principal investment. This is one reason why the Securities & Exchange Board of India insists on the disclaimer ‘equity investments are subject to market risk’ on any public communication about an IPO or a mutual fund scheme. If this is the kind of risk that the less financially literate take in equity investment, then private equity investors are indeed a privileged lot with the assurances of  the mandatory return clause.This is a way of guaranteeing risk free high returns.

If an investment contract stipulates that the promoter is buying back at an average return of 20% if the IPO does not materialize, then the conditions are more onerous than that of a local money lender. A better enforcement of an equity holder’s right would be to have a mandatory listing clause or sale of stake to any other investor. The counter is what happens during adverse market conditions?But the entire financial world swears by the market. Are private equity investors keen to sell back to promoters when markets are booming? The practice of PE investments  is ‘heads I win tails you lose’.

One could argue that the promoters are literate enough to understand the consequences of their action. But should not the same understanding be there with the sophisticated private equity investors? When a mutual fund or an illiterate retail investor is  denied the safety net of guaranteed returns on equity returns citing free market principles and dynamics, then why should an evolved community even need such protection?

When private equity investments are rising in publicly-listed companies, clauses providing assured returns infringe on the rights of other equity investors. Recently investors in Redington, a product distributor, were in for a rude shock when they were told one of its subsidiaries had a private equity investor who was promised a fixed return. That changed the entire complexion of the company.

The entire private equity game is probably the most opaque. Very little is disclosed to other shareholders about what the contract is all about. The argument is that when promoters are untrustworthy this kind of protection is a buffer against crooked behaviour. If that is the case, then it should be extended to all equity investors from mutual funds to retail investors. But that would be silly and would take the market back to the stone age.

So as things stand PE investors are a privileged lot.So small wonder that the who’s who of India is getting into the PE business along with the moneybags from abroad.

About Keerthika Singaravel

2 Responses to The Privileges Of PE Investors

  1. Asha Bansal says:

    Hi, very informative article.
    I am a prospective investor and was looking for profitable options to invest. I wanted your views about
    Peer to peer lending and is it a viable option to invest?

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