When we talked to infrastructure developers 10 years back on what their biggest challenges were, it invariably included “getting people”. That was one of the drivers for setting up a skill training company within Manipal Global Education together with City & Guilds of the UK, the world’s leading skill certification organisation (full disclosure: I still remain associated with this company). The government also focussed a lot on skill training and set up NSDC, which in turn helped spawn a host of other skilling companies, and NSDA. But most of these companies haven’t grown the way they were expected to and the government must be way behind its skilling targets.

Various explanations have been given for this. In this blog I want to outline one reason – the fact that we are a welfare state has made kids less hungry to work hard for a job. Let me explain, before you start slamming me.

I am involved with India’s first dedicated student loan provider for vocational training courses, Springboard Finance, which is helping pilot a programme on student loans for vocational training. Mihir Sheth, the promoter, told me that some kids quit their jobs within a few weeks because of reasons like “my boss shouted at me”, “I had to be out in the sun too long”, “I wanted to be closer to home”, “ the food is not good”, “I don’t like the clothes they make me wear”, etc. And these young adults would prefer to be unemployed than to struggle at the job they have.

So on one side we have employers looking for employees and on the other hand we have youth who chose to be unemployed or underemployed. Why would these youth prefer to be unemployed and not take up whatever job they can get? Admittedly this is not the reaction of most students, but it is representative of a proportion that is still statistically significant.

I can think of two reasons for this – (1) these kids have the safety net of staying at home with their parents or relatives and so their basic needs are taken care of. In some parts of the world they are unlikely to have this privilege and would therefore take up whatever jobs they can get. (2) Because of this safety net, they are happy surviving on whatever little they get from their family or from schemes like NREGA’s Mahatma Gandhi National Rural Employment Scheme, a corruption-riddled employment scheme that the Congress hopes will help them win the next election. It is a well-intentioned programme where, like in all well-intentioned programmes, the challenges lie in its implementation. When I was in Manipur and Nagaland earlier this year the biggest employer seemed to be NREGA-created programmes. These schemes often dull the drive of the youth and also severely impact job migration (which has it positives and its negatives).

A friend of mine, Praveen Chakravarty, who has worked a lot on skilling issues, explained to me that these unemployment insurance schemes have also effectively raised the minimum wage level in the country, which is a positive step. But the higher compensation was meant to be balanced by higher accountability and performance levels. Unfortunately the latter part has been forgotten and as with most government programmes, outputs are ignored. This is why minimum wages have risen without any increase in performance level.

So unless we find ways of tweaking these safety nets we will continue to see a shortage of labour which will impact projects and businesses across the country.

An alternative to tweaking these safety nets is to make the youth understand the importance of hard work by changing their attitude. A few organisations look at this aspect when doing skill training. I was recently discussing this issue with Simon Winter and Punit Gupta of TechnoServe, an organisation I am involved with that empowers people in developing economies build businesses that break the cycle of poverty. They have a large programme with The MasterCard Foundation to train rural youth in East Africa to be entrepreneurs. A part of the STRYDE Program is mentorship and counselling to change behaviour patterns among the youth to work hard at a career. This has to become an essential part of skill training in India.

I recently spoke at a PE Conference after a long time. I started off by describing the power sector in 2003, when we started IDFC PE. The outlook looked very bleak. Many global players had started developing power plants in India during the previous decade and after struggling with archaic regulations for years, most of them had given up.  The customers were mainly bankrupt electricity boards. Tariffs were low and did not make economic sense for the distribution companies. Political interference was high. The demand supply gap was large. Banks had significant exposures to the power industry. Fuel was an issue, with some plants using expensive fuel and gas was expected to be the savior. And, despite the passing of the new Electricity Act 2003, no sane investor would invest in the power sector.

Fast Forward to 2013. Many power plants developed in the previous decade are struggling because of fuel supply and environment issues. The customers are still mainly bankrupt electricity boards. Tariffs are ridiculously low. Political interference is high. Demand is way higher than supply. Banks are overexposed to the power sector. Fuel is an issue with the absence of gas from the KG basin and issues on domestic and imported coal. And, despite the moves by the Finance Ministry to instill financial discipline in the sector, no sane investor is looking to invest in the power sector. Amazing how things look the same, albeit at a much larger scale today.

But we did invest in power way back in 2003 – our first investment was in GMR Power, despite the power sector being the biggest disappointment over the previous 5 years. They had two plants that used expensive fuel – HSD and naphtha – and were developing a new plant fueled by natural gas (our diligence report highlighted the risk that the gas may not be available). And to top it off, no one on the team had invested in a power business before. We must have been smoking something very interesting to have done that deal! One of my professors at Chicago Booth, Steve Kaplan, wrote a case study on this deal. I was present in his class when he taught the case was the first time and the students highlighted the lack of power investing experience in the team as a huge risk in the deal. I agreed with them and said that if we had experience in the power sector we most probably would not have done that deal.

That deal ended up being our best deal ever.  Of course, by the time we had exited some time in 2007 the deal had had changed significantly. Our share holding had flipped into the parent company and we had an IPO of a diversified infrastructure company involved in airports, power and roads.  The IPO was priced attractively. We believed in the developer, we were creative in the way we structured the deal and we had no experience investing in power.

I believe that we have moved full circle and the time is back to do deals in infrastructure – backing passionate developers (if they still exist) who want to build world-class infrastructure.

Luis Miranda spent the last decade investing in India’s infrastructure. He started IDFC Private Equity in 2002 when there was hardly any risk capital available for India’s infrastructure because people didn’t believe that you could make money by investing in India’s infrastructure. IDFC Private Equity identified interesting opportunities and created innovative structures that helped infrastructure become the hottest investment opportunity in India a few years later. Luis has invested in and has been on the boards of companies like GMR Infrastructure, Gujarat Pipavav Port, Gujarat State Petronet, L&T Infrastructure and Manipal Global Education. He was involved in the highly successful IPOs of some of these companies, which created significant wealth for various stakeholders. Looking back, he is proud to be associated with great infrastructure projects like Terminal 3 at Delhi International Airport and APM Terminals Pipavav, which showcase India’s ability to build world-class infrastructure despite the constraints we face. 

A few months back I attended a discussion on education in India. The panelists were Ninad Karpe of Aptech and Jetu Lalvani of Kaizen Private Equity. I was happily sitting in the back of the room minding my own business when Rontu Basu of Quest Partners, who was monitoring the discussion, asked me for my comments. And I sounded very negative on the education sector when I spoke. Later that night as I was heading home by train I asked myself why I had become so negative on the education sector. The answer was actually very simple.

In the past I looked at the education sector from an investor’s perspective. The gaps and opportunities in the sector in India are so large that one has to be an idiot to lose money as an investor in the sector. There are only 3 reasons to lose money in Indian education – pay too high an entry price, execute poorly or get stuck in regulatory crossfire. The fact that engineering colleges are closing down in UP and business schools in Gujarat and Maharashtra are doing the same highlight the fact that there are many idiots playing in this sector (and I have had my fair share of idiotic non-education deals). Hence my friends on the investment side are correct to believe in the great education opportunity in India.

But these days I spend a lot of time looking at policy issues in the education sector, across all aspects – K-12, college and vocational. And the situation is deplorable. There is a lot of talk by the government, especially by the previous HRD Minister, but no serious significant attempts are being made to improve the quality of outcomes. It is frustrating to see how the powers-that-be are only taking small steps to fix the problem. All we see is some tinkering on the sidelines. The RTE has been a disaster when it comes to implementation. I was in Manipur recently and visited a remote village where the only private school in the village was shut down last month because it wasn’t recognised. The government school is like something from the future … a ‘virtual’ school – it allegedly has paid staff but no school building and students. Hence 40 kids have no school to go to from February 2013. Yes, the private school in this village was pathetic, but isn’t the RTE supposed to offer education to all and not cut down access to education? And I am sure that this will be repeated across the country.

This is why I am pessimistic about the education sector today. Hopefully the new ministers will do something different.

On a separate note, I just spent a week in Australia looking at the hotel industry there. One of the very pleasant surprises on this trip was the ease of checking into Qantas domestic flights – the entire process has been automated, including dropping off checked-in bags, and it is extremely efficient. It is also interesting that no one asks for any form of ID and one can carry bottles of alcohol on board in your hand baggage. It will be a sad day when terrorists destroy this Aussie travel experience.

But that’s not the reason for talking about my Australia trip. In Brisbane I drove through a super tunnel that went under a part of the city, cutting down travel time considerably. When driving in from the airport I asked a colleague about the performance of the developer, BrisCon, which is a part of Macquarie Group. A few hours later he told me that BrisCon had called in administrators because they owed AUD 3.5 billion to banks. This was big news in Australia.  This Airport Link toll road in Brisbane had been operating for just 6 months. It is a truly world-class piece of infrastructure, but traffic is only 50,000 cars a day compared to the projected 135,000 cars a day. This once again highlights the risks of developing large infrastructure projects across the world.

In India the risk is even higher because of regulatory uncertainty.  History is full of examples of great infrastructure projects that were financial disasters for the initial developers. In 2009 Fitch published an interesting report that talked about the financial problems developers of projects like the Panama Canal, the Eurotunnel and Boston’s Big Dig.  As governments across the world run out of cash and rely on the private sector to build marquee infrastructure projects through a PPP model, it will be a disaster if the private sector stops developing large projects. It is imperative that frameworks get established to ensure that these PPPs continue to get funded and developed.

A couple of weeks back Tamal Bandyopadhyay released his first book, ‘A Bank for the Buck’. It is the story about HDFC Bank, India’s most valuable bank. I am proud to have been associated with HDFC Bank, being part of  Aditya Puri’s ‘dirty dozen’ that started it in 1995. Our daughter, Mihika, is thrilled since Chapter 4 is titled ‘There’s a Baby on the Trading Floor!’ and it talks about how we had to baby-proof the dealing room since she would spend Saturdays with me at office.

I had forgotten some of the stories that Tamal has narrated, but one that I never forgot was to do with the pricing of our IPO. The IPO was to be at par and most of us ‘smart’ bankers felt we should have a small premium. Deepak Parekh, the Chairman of HDFC, told us, “Leave some money on the table. Investors will reward you in the future for doing so.” We thought he was being too conservative, but Deepak had the last laugh, since the stock has done exceedingly well with a CAGR of 39% for the past 17 years. Maybe, as I learnt from the book, Deepak was worried that he would see a repeat of the near-disastrous HDFC IPO. This was possibly the only capital markets lesson I learnt during my sales and trading career.

At IDFC Private Equity we have taken 4 of our portfolio companies public. And at all of these 4 IPOs we battled, with varying degrees of intensity, with the promoters, management teams and the bankers on the pricing of the IPO. And our constant position was “Price the IPO attractively. Leave money for promoters / sponsors and get the promoters excited (the fact that the execution team would then spend their time dragging down the price could be the topic for another blog!). It happened every time. And promoters have always told us (not at the time of the IPO, but many months later) that this conservative approach actually helped their share price in the long term. A little hit in dilution upfront of 1% could pay handsome dividends over time on the balance 90%. And this is something that promoters just don’t get. Once a stock is hammered after an IPO it becomes very difficult to recover.

A disturbing scenario has consistently been taking place when promoters and PE investors, together, with the bankers, drive the IPO price up when selling the dream. The juice is totally sucked out of the company by pricing the IPO ridiculously high. Some of the existing investors may exit at that stage than barely 6 months back. Retail investors get dumped with this junk.

I have mentioned in an earlier blog about how companies get destroyed when PE investors come in at a high valuation – if it’s a straight equity deal, the PE investor makes the promoter’s and management’s  life miserable and if it is a convertible the promoter runs the risk of being significantly diluted if the company under performs.

Thanks to all of you who have commented on my earlier blogs. One of the comments was that bad investments kill a sector. In the same manner, poorly performing IPOs also kill the IPO market. So remember Deepak Parekh’s simple message 17 years back – “Leave some money on the table.”

(I look forward to having an online discussion on these issues – so please continue to write in with your comments.  I spent over a decade in the private equity industry and enjoyed the excitement of working with great colleagues and partnering exceptionally brilliant entrepreneurs to build India’s infrastructure. We had a great ride, but sometimes we got it wrong! I am now experimenting to see how we can transfer the lessons I learnt, and did not learn, in the for-profit world to the incredibly  passionate and brilliant social entrepreneurs I now hang out with; the aim is to build sustainable organisations without destroying the soul of their NGOs)

I recently spent two days at TiE Con Delhi, where I participated in a fireside chat with Rob Gertner, Deputy Dean at Chicago Booth (where I studied many moons back). The discussion was on the increasing impact of social entrepreneurship on economies, society and the role education can play in accelerating it. On Day 2 Rob moderated a panel discussion with 3 alumni from the University of Chicago who have founded social enterprises – Sandeep Ahuja of Operation ASHA, Sachi Shenoy of Upaya Social Ventures and Chris Turillo, of Medha. In this blog I will talk about some of the takeaways from these two sessions.

The main challenges facing social enterprises relate to financial capital and human capital. Capital markets don’t work well for social enterprises because it is difficult to measure social impact in the short term. There hasn’t been much academic work done so far in the area of striking a balance between social impact and profitability and a lot more work is needed to be done on the role of incentives in social enterprises. So we are still in early days when analysing the success of social enterprises and till then much of the reports will be anecdotal. Many business schools across the world are building out their capability in analysing social enterprises, prompted by the interest seen from students. Rob is the faculty coordinator for the Chicago Booth Social Enterprise Initiative and is the faculty advisor for the Social New Venture Challenge.

Operation ASHA has done a phenomenal job driving down the cost of TB treatment. Their cost is 5% of what competitors incur. They did this by ‘decluttering’ the process. 80% of their work force doesn’t have a high school certificate – and this may look scary in a medical area. But they work closely with the DOTS initiative of the World Health Organisation and the Government. The Directly Observed Therapy Short (DOTS) Course requires each TB patient to swallow each dose in the presence of a certified healthcare worker. Operation ASHA took steps that in hindsight look simple – they took the treatment to the patients, made their 200-odd centres low-cost, efficient and accessible by training non-medical workers and they used finger-printing technology to track the delivery of the medicine. And these centres are now being used by other organisations to distribute supplies and aid to the slums. Their success metrics are fantastic, reflecting how efficiency, technology and process re-engineering using common sense can build scale, lower costs and have significant impact. Their numbers have been vetted by MIT’s Poverty Action Lab.

Medha aims to work with existing education systems – in their case it is government-aided colleges in Lucknow. They prepare kids to find jobs after college by teaching them sector-agnostic skills. They recently won a 2012 Echoing Green Fellowship in New York. And Upaya works with tiny enterprises in North India to create employment opportunities for the poor. Their first investment has already created 300 jobs in the dairy-related space, with household incomes doubling  and expenditure on food quadrupling in 6 months.

What are the lessons learnt from these social entrepreneurs? One, capital raising is tough. Most organisations that I am involved with raise a significant amount of their funding from overseas. Domestic funders are growing but it is still early days and foreign funding will continue to be critical for this sector. Two, social impact has to be measured properly, and this is expensive. This cost has to be treated as an investment since it will help raise subsequent funding for future projects. Most of the funding to assess impact has been raised overseas and it is hard to get domestic funding for impact assessment. Three, financial incentives work in the social sector also. In the case of Operation ASHA they spend $ 4 to add a patient (where $ 3 goes to the care worker who identifies the patient) versus the WHO standard of $ 450 per patient. Four, technology is critical for enhancing productivity and lowering delivery costs.

These lessons, except for impact assessment, could be the same as those learnt by for-profit entrepreneurs. This highlights the fact that in order to succeed, social entrepreneurs need to focus on sound business practices, just like for-profit entrepreneurs. Success measurement does get muddied because success in the social space is not just measured by IRR and the measurement of social impact can be expensive and debatable today. As this sector grows, we will see more academic research in this area.

(I look forward to having an online discussion on these issues – so please continue to write in with your comments. I spent over a decade in the private equity industry and enjoyed the excitement of working with great colleagues and partnering exceptionally brilliant entrepreneurs to build India’s infrastructure. We had a great ride, but sometimes we got it wrong! I am now experimenting to see how we can transfer the lessons I learnt, and did not learn, in the for-profit world to the incredibly passionate and brilliant social entrepreneurs I now hang out with; the aim is to build sustainable organisations without destroying the soul of their NGOs)

One of the challenges the local VC and PE industry faces is that the interest of overseas fund investors (i.e. Limited Partner / LP) to invest in India is very low. This is because of a host of factors:  some of them being alleged poor returns, a depreciating rupee and the shutdown of the government in terms of decision making and passing relevant growth-focussed legislation. So the past couple of years have been bad, making me realise that I did not miss much by staying out of the industry during this period. But things are turning around and my friends seem to be busy closing new deals and exiting old ones, even though the IPO market is long dead and there is gloom and doom all around (notwithstanding India winning 6 medals in the Olympics and the Chicago Booth’s Raghuram Rajan moving to India as Chief Economic Advisor … you can see how badly I am clutching onto straws).

This time I will look at the allegation that Indian VC and PE has underperformed because this is an area where fund managers have some control over. Maybe it has underperformed. But the data is suspect. Most performance reports are based on data collected by media organisations or industry consultants. There is no transparency on how these agencies get the data or analyse it. A few months back I was on a jury to decide on the top performing funds in India and we quickly realised that the data we were given was full of errors and incomplete. So we had to throw it out and look at proxies, based on our anecdotal experience – not an ideal situation and packed with biases. And friends continue to complain that the data does not reflect the true performance of the industry’s performance which they, obviously, believe is actually doing better than what the data shows.

The problem lies with the industry. We need to take charge of the data. And this is not a problem with the Indian industry only.  I used to be on the boards of two industry organisations – India Private Equity and Venture Capital Association (IVCA) and the Emerging Markets Private Equity Association (EMPEA) – and there was opposition at both to compile authentic industry data. I believe that this was because members felt that they would look bad when compared with others, especially since everyone claims to be performing in the top quartile. The problem is that LPs will continue to benchmark fund performances against the industry and they will use faulty data – data that the local players have no control over. On one hand, the industry data may be overstated because poor performers will not voluntarily submit data to these data collectors. On the other hand the industry data may be understated or not analysed properly because the data collectors are comparing apples with oranges (something we noticed when we were trying to analyse the data on that jury).

I used to argue that the IVCA should take the lead in publishing industry performance data in aggregate data because it (a) adds more credibility to the data, (b) it gives the industry some control on how the data is reported (I am not talking about doctoring the data!) and (c) it enhances the role of the IVCA. But this was always voted down and today no one is interested in doing this. Take a look at USA’s National Venture Capital Association (NVCA) website – it carries a host of statistics and research and NVCA partners with various organisations to publish performance data. Why can’t the IVCA do the same? If you Google ‘IVCA’ you first get a message “This site may harm your computer” and there is not much performance data on the website.

Of course there will be challenges initially. When NASSCOM started collecting data years back, a few members were notorious for giving fake data … but that got corrected over time because of peer pressure, etc. All that IVCA has to do is to partner with a reputed organisation (domestic or overseas) who will ensure confidentiality of data and proper analysis. Only then can we say that the data is accurate and stop whining about LPs making decisions based on inaccurate data. LPs, like fund managers, need industry data; and LPs will continue to rely on proxies until the real McCoy shows up.

The VC and PE industry loves to talk about why portfolio companies need proper governance and better transparency. Isn’t it time that we ourselves walk the talk and be more transparent about the performance of our industry. I believe that this transparency will in fact help the industry raise more capital and IVCA has to take the lead.

(I look forward to having an online discussion on these issues – so please continue to write in with your comments (the guys at Forbes still need to be fully convinced).  I spent over a decade in the private equity industry and enjoyed the excitement of working with great colleagues and partnering exceptionally brilliant entrepreneurs to build India’s infrastructure. We had a great ride, but sometimes we got it wrong! I am now experimenting to see how we can transfer the lessons I learnt, and did not learn, in the for-profit world to the incredibly  passionate and brilliant social entrepreneurs I now hang out with; the aim is to build sustainable organisations without destroying the soul of their NGOs.)

First of all, thank you for your comments on my first blog, where I suggested that PE investors and entrepreneurs should visit their local market to learn how to close out deals. The guys at Forbes India actually called to remind me that the next blog was due! Thanks.

A few weeks back I was at a seminar organised by Monitor, the international consulting group. Ashish Karamchandani and his team have been looking for a long time at market based solutions for the bottom of the pyramid. He had a colleague down from South Africa to share their experiences in Africa. One of her success stories was in vocational education. That got me interested because a lot of people had tried to build large vocational training businesses in India, and other than NIIT and its clones, no one has really succeeded. So I asked her for data on the size of the larger players (after all, I studied at the University of Chicago). I forget the exact numbers, but the larger players trained about 3,000 students only. She quickly added that the industry size was well over a million students.

And therein lies the problem – a large market with huge growth opportunity but operated by small, fragmented players. After her session we talked more about this and her view tied in with what was brewing in whatever is left of my brain – in some industries building scale may be tough or not possible at all.

Take the vocational training industry in India. The need to make millions of young Indians employable has been talked about ad nauseum. At Manipal (full disclosure: I still remain connected to the Group) we started building a business in it way before it became fashionable and before others jumped into the fray. The National Skills Development Corporation has funded many players to build large training companies. But the skilling industry has slipped further back in being able to tap this demographic dividend with a lot of rhetoric, bleeding balance sheets and pathetic enrolment in skilling programmes. At the same time small mom-and-pop training shops continue to do well. Maybe the government should just fund students and not schools.

Hence, my proposition that building scale may not be possible in all industries. This has implications on PE investors who are looking at build-up or consolidation opportunities in sectors with huge growth prospects – in some of these cases it may not be possible to build scale. Investors need to spend time analysing whether anyone anywhere has built a scalable model and understand why or why not scale has been built. Don’t just look at a graph that shows infinite growth. Don’t believe consultant reports. Talk to industry ‘experts’. And finally, sit down with a host of conflicting data and decide whether (a) the entrepreneur has the vision to execute the plan, (b) whether a team can be built to execute this growth, (c) whether there is a plan to support this growth with a superior technology platform and process flows and (d) is there enough money in the bank to support this plan (provide for the unexpected when treading a new path). The BPO industry is another example of a human-intensive industry that jumped across borders, accents, education levels and poor infrastructure; early players like GE and Spectramind led the way.

Sometimes it may not be easy to build scale as an operator, but one can build scale as a specialised financier or as a standardised content provider or as a franchiser (though this hasn’t worked well so far if one looks, for example, at the hair and beauty care industry; maybe it is still early days). And of course, one has to look at how technology can be used to build alternate delivery channels that will help build scale. Traditional operating models may not work if one wants to be a dominant player in a fragmented market.

I am not saying that building scale is impossible – all I am saying is that it is not easy. The Aravind Eyecare System is one example of a success story (read their fascinating story in the recently released book “Infinite Vision”, written by Pavithra Mehta and Suchitra Shenoy). But Aravind is an exception and it requires superior vision (no pun intended) to execute scale.  So what is needed to make such businesses scalable? Let’s look at why NIIT succeeded? Three quick reasons – (a) it facilitated getting a job that was aspirational – every fourth Indian wanted to be in the IT sector; (b) it was priced appropriately when related to future expected income and (c) it developed a curriculum that could be delivered through a large network, including franchisees.

My initial thoughts on the challenges to building scale related to the social sector – mainly health and education. But a few days back I was chatting with a friend on this challenge of scalability. Nimit Tanna, of the Trust Group, said that this applied to India’s retail industry also. We have nearly 10 million neighbourhood mom-and-pop food and grocery stores in India and only a few large format stores.  Maybe India will skip a generation in the retail industry and move straight from these kirana stores to online stores, side-stepping the large format stores. India did the same in the telecom sector, where we leapfrogged a generation of technology. Maybe the large format stores will not be able to build scale due to land acquisition and pricing issues, customer transportation/access issues, supply chain/logistic issues and petty politics.

All this means that private equity investors and entrepreneurs have to spend more time figuring out how to build scale and not just get seduced by the huge opportunity that a sector throws up. This is one reason why so many businesses have fallen way behind schedule. One needs to create new paths (like Aravind Eyecare System and Spectramind did), and not just follow the herd. Building scale requires vision, focus on processes and impeccable execution.

P.S I look forward to having an online discussion on these issues – so please continue to write in with your comments (the guys at Forbes India still need to be fully convinced).  I spent over a decade in the private equity industry and enjoyed the excitement of working with great colleagues and partnering exceptionally brilliant entrepreneurs to build India’s infrastructure. We had a great ride, but sometimes we got it wrong! I am now experimenting to see how we can transfer the lessons I learnt, and did not learn, in the for-profit world to the incredibly passionate and brilliant social entrepreneurs I now hang out with; the aim is to build sustainable organisations without destroying the soul of their NGOs.

A common complaint of PE investors is that valuations are a challenge. An old friend and experienced PE investor, Rajesh Khanna, once commented that valuations will always be a challenge; in his career he never did a deal where they believe they got a “cheap” price. This is why I have picked valuation mismatches as my first blog topic. And I am talking only about minority or majority investment deals where the entrepreneur continues to run the business; buy-out deals involve different deal dynamics.

I remember the post-midnight negotiations on our first infrastructure investment way back in 2003. The only comfort we got from that painful experience was that if this is the way they negotiated with us, we can be sure that they will work as hard when negotiating deals with other counterparties and our money is, therefore, safe with them. Let’s face it—if you came out of a discussion saying, “We got a sweet deal!” you should be worried because either (a) your new entrepreneur-partner is a poor negotiator, or (b) your new entrepreneur-partner has no interest in honouring your shareholder agreement. Investors want to invest in companies who can subsequently look after their interest by negotiating hard with others.

So much for trashing PE investors. But entrepreneurs are also to blame. Inebriated by the wealth creation that took place a few years back and excited by overenthusiastic investment bankers they believe that their companies are worth a lot more than what others think. As a result, they don’t want to sell “cheap” and wait like a crouching tiger for a sucker investor to walk in. And in many cases one walks in through the door. Hence deals take long to complete, if at all.

I think investors and entrepreneurs need to take a break and visit their neighbourhood market. Watch how women bargain with the vendor. And I am being deliberately sexist—my wife says I am useless at bargaining. The fruit seller knows that the woman wants to buy the apples and she knows that he has to get rid of his stock before it gets spoilt. They also have an idea of where the market price is. So the fun begins. A deal finally gets closed and both sides walk away happy with the outcome (at the same time grumbling loudly about the unfair price). And she will be back next week to buy from the same guy and the same process will be repeated. Our son learnt the same lesson recently on a school trip to Beijing—a simple lesson in price discovery after being thrown out of a few shops where their first bid was 10 percent of the offer price (they got so excited with their bargaining skills that they finally even tried to negotiate price at a KFC outlet and were told emphatically to “Get out!”).

So why do highly-educated PE investors find it so difficult to close deals? Is it because predator entrepreneurs know that there will always be a new victim waiting to get ensnared? Don’t entrepreneurs also know that high valuations lead to unnecessary pressure on meeting ridiculously exaggerated targets? I have recently been involved in discussions where investors are legally able to seize control of a company because targets have not been met.

It doesn’t make sense for investors to get a “cheap” deal or for entrepreneurs to con investors into paying too high a price. If this happens there is no true partnership and as the comedian Russell Peters said, “Somebody gonna get a hurt real bad”. India is a high-growth economy, irrespective of what foreign investors say and what the government does or does not do. And in a high growth economy it is even more difficult to predict future prices, volumes, competition, etc. So, if there is a serious valuation mismatch one has to look at structures to bridge the gap–if the entrepreneur wants too high a valuation, a structure can be worked out where if targets are not met, the investor’s shareholding in the company ratchets up.

Alternatively, and this is a framework that I prefer, the entrepreneur can agree on a lower valuation and earn out a higher shareholding based on meeting pre-set targets. The reason why I prefer this option is that it causes less stress on the company to meet tough targets (sometimes caused by external factors, like the 2008 global financial crisis). I have seen enough companies in recent times whose souls have been destroyed because the entrepreneurs are cutting corners to meet the high targets they set themselves up for when they closed their PE round at a high valuation. Entrepreneurs fail to realise that they can destroy their company or their relationship with an investor if they push for too high a valuation. If properly structured, they will end up with the same or higher shareholding if they meet their targets. And this is where investment bankers need to nudge both sides to close a “fair” deal. No one will grudge the other side if they both believe they have a “fair” deal.

So it is time that investors and entrepreneurs visited their neighbourhood market to learn the fine art of price discovery and closure.

Luis Miranda
I look forward to having an online discussion on these issues – so please write in with your comments (it would also help me convince the folks at Forbes India that someone is actually interested in what I write!) I spent over a decade in the private equity industry and enjoyed the excitement of working with great colleagues and partnering exceptionally brilliant entrepreneurs to build India’s infrastructure. We had a great ride, but sometimes we got it wrong! I am now experimenting to see how we can transfer the lessons I learnt, and did not learn, in the for-profit world to the incredibly  passionate and brilliant social entrepreneurs I now hang out with; the aim is to build sustainable organisations without destroying the soul of their NGOs.