While alternative ways of finance such as angel investment come in the idea stage and venture capital for early stage of startups with higher risks, PE firms support the growth phase when the company has earned certain amount of revenue.

--BY NIKEETA GAUTAM

Unlike in advanced and emerging economies, entrepreneurs in Nepal do not have facilities of alternative financing to start or expand their businesses. While wealthy entrepreneurs have various sources of financing, new and struggling entrepreneurs find it very difficult for a collateral free way of financing to take their businesses to the next level. 

"Not all companies are able to get into IPOs or have access to the capital market. So, Private Equity (PE) can be effective way of alternative financing for the entrepreneurs here," views Ajay Shrestha, Chairman and Managing Director of investment and holding company iCapital and partner of private equity and venture capital firm True North Associates. 

Aspects of Private Equity 
"In the investment ecosystem, angel investors, venture capital, and private equity are asset classes providing support at the various stages of business, before taking the companies to public for participation through IPOs and listing arrangements," says Bidhyabaridhi Sigdel, Investment Director at Dolma Impact Fund, the first Nepal-based international private equity and impact fund. 

While alternative ways of finance such as angel investment come in the idea stage and venture capital for early stage of startups with higher risks, PE firms support the growth phase when the company has earned certain amount of revenue. Such firms not only provide assistance in terms of capital but also provide strategic insight and upskill them with best practices to gain profitable growth in exchange of its equity.   

In PE funding, there are two kinds of partnerships - general partners and limited partners. General partners are the private equity firms and limited partners are the investors that invest the capital. The limited partners can be high net worth individuals and institutions such as Citizen Investment Trust Nepal, Nepal Telecom, IFC (International Finance Corporation) and World Bank in case of Nepal.   

"The delineation of the PE fund and the management is important from the governance aspect. Generally, the fund would have limited life and it has to exit or transfer the assets under management to limited partnerships (LPs) at the end of the life. The fund managers pick up appropriate companies for investment and the deal is structured with the desirable instrument for investment and returns," informs Sigdel. 

"PE firms have to raise funds locally or internationally to be able to create a corpus to invest in the companies that qualify or meet their risk appetite.  Once they have the funds, mostly the funds are close -ended, they find a pipeline of companies also called deal sourcing and after a rigorous due-diligence process invest in the companies," informs Siddhant Raj Pandey, Chairman and CEO of Business Oxygen, an SME Fund managed by the White Lotus Centre (WLC). "PE funding does not take collateral and is based on the future cash flow of the company," he adds.

PE firms usually invest on late stage startups. According to iCapital’s Shrestha, startups that have started to market prototypes of their products, gained trust of customers, have proven their business model and maintained a good track record are the companies worth investing for private equity firms.  The PE firms basically evaluate the needed investment of such startups, their value and the percentage of equity they are willing to give.

The fee structure consists of management and performance charges. The firms charge annual management fee of around two percent of the invested capital. The performance fee is 20 percent of the profit from the investment. "In terms of return, either the founder themselves buyback the shares or the investors acquire the company. Most of the PE firms exit through IPOs," informs Shrestha.  Pandey says that the investment period is mostly 4-7 years in a company depending on the mandate of the PE.  At exit, they sell the shares and withdraw their investment with a capital gain. 

Benefits
"PE plays an integral role in developing the businesses by injecting much needed capital in investments that the companies would otherwise find difficult to raise. The investments can be either seed money or growth capital.  In Nepal, banks and finance companies (BFIs) are the primary source of capital, but not all have the capacity to access that capital due to lack of collateral or investment appetite of the BFIs.  This gap is filled by PEs," mentions Pandey. 
 
As per Shrestha, though PE firms demand 100 per cent ownership which is taken as one of the limitations in this way of financing by many entrepreneurs, having experienced professionals in the business, have chances to result in major improvement. He says that it is an effective way of financing especially for the tech startups as BFIs usually don't take risk on the basis of the idea of innovative people who have the zeal to become tech entrepreneurs and to those with fewer financing options. 

Besides this, the PE investment also helps small businesses to tie-up with big businesses, which helps them to gain visibility in the market.

Dolma Impact Fund investment director Sigdel says that the entrepreneurs entering into partnership with these entities can focus on the core business and take it to the next level of excellence because, besides financial participation, these partners come with the objective of ensuring growth, operational efficiency and transparency in governance to the company. 

Trend in Nepal
PE financing is a new term for Nepal where entrepreneurship is still in a nascent stage. "Besides investment companies created as Special Purpose Vehicles (SPVs) for collective investment, there are a few PE funds in the country. The industry is new, but we can see a number of players at different stages to support the investment ecosystem in Nepal," mentions Sigdel. 

However, there are only a few firms that have come up specifically as PE funds. “There are around hundred investment companies registered in the Company Registrar office. However, it is difficult to identify if they are working as private equity firms. With the formulation of proper regulations, the data can be structured," shares Deepesh K. Vaidya, Managing Director and Founder of Kriti Capital and Investment. 

Private equity investment started getting recognition after the entry of three PE funds with international capital including Business Oxygen promoted by IFC and WLC Ventures, Dolma Fund with its investors from Europe and One to Watch, a Dutch company. Similarly, companies such as iCapital and True North Associates are notable names in PE funding in the country. 

"PE funds started over one and half decade ago in an informal way in Nepal.  In 2001, an effective private equity model was adopted by Nepali investors while buying the shares of a French company that had 50 percent of the shares in the Nepal Indosuez Bank," Shrestha shares.  As the French investors wanted to sell their shares to one individual, the investors in Nepal formed a joint fund and selected a leader to buy the shares. Afterwards, they distributed it among the shareholders and changed the bank’s name to Nepal Investment Bank.  

"Though it has been five years since PE fund started formally, it is observing a good growth in the last two years. The credit goes to international capital based PE funds that started engaging in policy levels and also began promoting themselves in media which helped the PE financing to gain momentum," says Shrestha.  

In Nepal, PE funds are basically being received by some high growth sectors including renewable energy, pharmaceuticals, healthcare, hospitality, IT, agro-processing and restaurants. Some PE firms like Business Oxygen are sector-agnostic while, funds like Himalayan Infrastructure focus on construction, One to Watch on impact social entrepreneurship and impact investment and True North Associates invests on disruptive and technological business.  Attic Bar, Kidzy Pre-school, the popular food delivery website Foodmandu are some few examples that have benefitted through the PE investments. Meanwhile, Buddha Airlines and Nimbus Group are also said to have used the PE investment model for their growth in the past.  

Need of Legal Framework 
PE mainly needs investment opportunity. The more it gets opportunity, the more it can strive.  Now, it has limitations from formation to investment area because of lack of regulations. Legally, PE firms have not been recognised as institutions and due to this, it is definitely facing lots of problems. 

Currently, there are issues in entry, operation and exit as a private equity fund. "PE is not regulated in Nepal, so the general corporate regulations prevail for the operation and investment of such funds. For any PE investor, there have been issues with the valuation of the company, as the company law restricts the issue of shares at premium for any company who has not made profit or declared dividends for three years," informs Sigdel, adding, "The securities board regulation relating to issue of shares at premium is limited to the net worth of the company and locked in period of three years proves a challenge for any company which has limited life. There have been Nepal Rastra Bank (NRB) directives relating to blacklisting and single obligor limits which restrict the PE funds in leveraging the company." 

Sigdel mentions that for the international funds willing to invest in Nepal, with all the above mentioned hurdles, the investment has to have approval from the Department of Industries for the FDI and also from NRB to bring in the funds in the country and for the repatriation of dividends at exit. The methodology for the valuation at exit for international investors is also one major hurdle. 

"PE has just started to gain momentum in Nepal.  At present, we do not have the requirements or regime to regulate PE.  However, this fiscal year, the budget has mentioned PE for the first time and the draft of FITTA also has clearly mentioned PE as a part of alternative form of investment. Along with it, the Securities Board of Nepal (SEBON) is also mooting regulations in this area," says Pandey.  

Pandey has been advocating for a special regulatory regime for PE investments.  “In Nepal, all investments, at present, are regulated by Banks and Financial Institutions Act (BAFIA) or Company Act.  PE is governed by the Companies Act, which is inadequate and confusing,” he says.  According to him, issues such as valuation of shares, taxation issues and exit options are not addressed by present regulations, which make it difficult to operate a PE along the lines of international practices. 

A report published by Kriti Capital and Investment highlights structural issues in PF financing as FDIs and investments from non-resident Nepalis are being prioritised over domestic investments. The research also explains about blacklisting of investment firms, which is a hindrance to PE investments in Nepal. According to it, as per NRB's approach of blacklisting, if an investee company with 15 percent of its stakes controlled by PE investor, defaults from any commercial loan, the PE investor is subject to blacklisting and is forced to withdraw all the existing investments. 

"We would like to see a special alternative investment regulation that would govern PE alongside other forms of investments that will enable PE in its truest form," emphasizes Pandey . 

Global Scenario
The modern PE industry started with the formation of American Research and Development Corporation (ARDC) in 1946.  Prior to that, there were some similar types of US governmental institutions that were created to address the needs of businesses after two World Wars and the Great Depression. Till 1970s, there were small volumes of PE firms, elementary firm organisations with limited awareness about PE industry. 

"As per the US-based data and intelligence company Preqin, the global private equity assets under management is USD 2.4 trillion, which means it is one of the biggest assets class," informs Sigdel.  The Blackstone Group, Kohlberg Kravis Roberts, Apollo Global Management, CVC Capital Partners, Oaktree Capital Management, The Carlyle Group, Axcel, IK Investment Partners, Business Growth Fund are some of the largest PE firms in the world. Big ventures including Facebook, Google, and Amazon have received huge growth after receiving PE investments in their growth stages. 

United States 
PE industry ran largely unregulated for many decades until 2010 when the Dodd-Frank Wall Street Reform and Consumer Protection Act came into effect as the federal law. The Act was drafted to address the problems that contributed to the financial meltdown of 2008. 

The Act requires all PE firms with more than USD 150 million in assets to register with the Securities and Exchange Commission (SEC), the US agency to regulate securities and capital market, in the category of “Investment Advisers.” The SEC in 2012 created a special unit to oversee the PE industry. 

India 
 A recent report states India as the most attractive market in terms of attracting PE investments in Asia-Pacific followed by China. 

Sigdel says that in India, total assets under management are close to USD 60 billion. "In 2016, 53 percent of total FDI investment in the country was through private equity. In India, PE firms are well established with a significant track record of good returns to their investors," he adds.  

Challenges in Nepal
Vaidya observes that the investors in Nepal have a short horizon in terms of return. "Value creation in PE takes time. It is only after about five years, the profit will turn out three-four times more. However, the Nepali investors keep a small horizon of 6-7 months with an expectation of huge growth in the short period," he says.  

Besides this, investors in Nepal are wealthy individuals rather than institutions. "The individual investors keep their eye on profit, whereas private equity firms understand that to gain the profit, there should be the growth of the company. Internalising this, they themselves engage in the activities for growth of the company," he says. For this, notes a dire need of proper regulation addressing PE in order to bring proper private equity funds for systematic PE investments. 

 He views that investors should understand that economy has to run with a normal growth.  "If we see the growth of stock market in the last ten years, it has gone up by 18 per cent per annum. So, Nepali investors should understand the concept of reaping investment and invest with long-term prospect in their mind." Another challenge Vaidya points out is the lack of experience in Nepalis regarding PE financing. "Nepal has no history in private equity and there is no big market for it to bring well -experienced professionals. So, we have to groom the homegrown human resources to do well in this sector," he says. 

Besides this, the companies willing to take PE investments are very few in our country. "In Nepal, most businessmen hold their family business. Due to this, they don’t like the engagement of the PE firms in the operational aspect of the business which has been running for many years. Companies should be educated in all these aspects which will help them go to the next level of their business," he says.