BY Team Ventures

Private Equity (PE) firms invest in private companies that are not part of the public stock exchange list. Therefore, it is harder to find new opportunities. Whereas, Venture Capital (VC) firms mostly invest in public startups that show signs of growth. They might look for stealth startups, too, but most opportunities occur within the publicly available area of startups. This article delves into the details of PE/VC due diligence and deal sourcing in Nepal, providing a comprehensive guide for investors. By understanding the landscape, adopting due diligence practices, and implementing effective deal sourcing strategies, investors can tap into the promising opportunities offered by this dynamic market.

PE/VC has gained prominence as investment strategies in Nepal over the past decade. As Nepal's economy continues to grow and diversify, opportunities for investors are emerging. However, to make informed investment decisions, deal sourcing and effective due diligence are crucial.

Deal sourcing, also known as deal origination, refers to finding new companies to invest in. However, the process is different between private equity funds and venture capital. For PE/VC, deal sourcing is the lifeblood of investment strategy. The ability to discover, track, and manage promising opportunities can significantly determine the success of an investment. It is a process that requires considerable time and resources, calling for accurate industry tracking, extensive networking, and in-depth analysis. So, deal sourcing is the proactive pursuit and assessment of investment opportunities that match a firm's criteria, involving strategic networking, data analysis, and relationship cultivation to identify potential targets. 

Whereas, due diligence is a rigorous process used by investors to evaluate the business and legal aspects of a potential investment opportunity. It can be highly unpredictable. In PE/VCs, due diligence is the careful examination of potential investments. Investors looking to invest in Nepal should conduct a comprehensive due diligence process. This involves evaluating the company's operations, market dynamics, management team, and environmental and social practices. Understanding Nepal's infrastructural challenges, market trends, local business culture, and adherence to global environmental, social, and governance (ESG) standards is essential for making informed investment decisions. ESG investing referred to as sustainable investing, responsible investing, impact investing, or socially responsible investing (SRI). It helps identify risks and create plans to reduce them.

PE firms require knowledge of deal sourcing because they are actively seeking new potential opportunities. Deal origination aptitudes are a must for a private equity firm that wants to close more deals than its competitors. For that to happen, sophisticated private equity research must be conducted. Deal sourcing is the backbone of success for private equity and venture capital firms. It is all about finding and grabbing onto promising investment opportunities. This involves a lot of digging and investigation into various companies, checking if they are worth investing in. Due diligence is key here, as it helps to separate the good from the bad, but it can take up a lot of time. With so many players in the field, having a good strategy to stand out is crucial. Building a strong network with other investors, entrepreneurs, and industry folks is one way to keep the flow of potential deals coming.

Private equity investors, venture capitalists, investment bankers, and other firms find investment opportunities through deal sourcing. As deal origination essentially refers to finding new investment opportunities and acquiring companies, the process follows a few crucial stages:

Process of Deal Sourcing:

1. Finding New Leads:

 PE and VC firms actively seek new opportunities through networking, industry events, and data analysis.

 Identifying potential investment targets with high growth potential is the first step in the deal sourcing process.

2. Pitching the Leads:

 After identifying prospects, firms pitch their investment thesis to these companies, showcasing the value they can bring to the table.

 This stage involves presenting the benefits of partnering with the PE or VC firm and how it aligns with the company's goals.

3. Managing Relationships with Investment Intermediaries:

 Cultivating relationships with intermediaries, such as investment bankers, accelerators, and other industry players, is crucial.

 These intermediaries often play a key role in connecting PE and VC firms with potential investment opportunities.

Deal sourcing is the backbone of success for private equity and venture capital firms. It is all about finding and grabbing onto promising investment opportunities.

Venture capitalists utilise deal origination in order to find startups to fund. This process is more important than ever given the sharp competition on the market. Most venture capital firms spend most of their time and resources on deal sourcing as new deals are vital for surviving in this industry. When it comes to sealing the deal, it's all about smart talking and making sure both sides are happy. Negotiation skills play a big role here, ensuring that both parties get a fair share while minimising any risks involved. Once the deal is done, it's not just about getting it on paper; integrating the newly acquired companies into your existing business smoothly is vital. This means making sure everyone gets along and the transition is as smooth as possible, so there's no chaos or confusion.

Strategic Deal Sourcing Practices for Nepali PE/VC Firms

In the context of Nepal, PE/VC firms implement a series of strategic deal sourcing practices to identify and evaluate potential investment opportunities effectively. These practices revolve around key factors such as growth monitoring, liquidity indicators, data analytics, and brand presence.

1. Growth Monitoring

 Monitoring key indicators such as headcount growth, social media presence, and revenue growth aids in identifying potential investment targets in the Nepali market. Tracking movements of key employees and assessing market fragmentation help in evaluating company growth and market leadership potential.

2. Liquidity Indicators

 Identifying liquidity signals, including ageing C-level employees, technological shortcomings, heightened market competition, and industry consolidation, highlights potential investment prospects for PE firms in Nepal.

3. Data Analytics

 Access to startup data enables the discovery and tracking of early-stage startups, offering valuable insights for investors and PE/VC firms operating in Nepal. Leveraging data analytics, particularly firmographic data, facilitates the identification of industry trends, target companies, and the establishment of robust relationships, enhancing the private equity deal flow in Nepal.

4. Brand Presence

 Building a strong brand presence is crucial in the competitive Nepali market, as it increases the credibility of PE firms and their likelihood of securing favourable deals.

Key Areas of Due Diligence

In the world of venture capital investments, due diligence is a crucial process for assessing potential risks and opportunities. It involves a thorough evaluation of various aspects such as financials, legalities, market dynamics, technical capabilities, and societal impact. This process aids VC firms in making informed investment decisions and minimising potential risks. Here, are the key focus areas in the due diligence process within the venture capital landscape, organised according to different types of due diligence:

1. Impact Due Diligence:

Evaluating a company's social and environmental impact, considering the positive and negative implications of its products or services. The process also seeks to understand the company's commitment to responsible business practices and its contribution to societal well-being.

2. Commercial Due Diligence:

Evaluating a company's market position and competitive landscape. This includes sizing up market potential, growth, and industry trends. The analysis extends to understanding customer segments, their needs, and the market response to the product or service, ensuring a well-rounded assessment.

3. Financial Due Diligence:

It involves a swift analysis of financial statements, including income, cash flow, and balance sheets. It extends to examining future growth projections and key financial metrics, providing a snapshot of the company's financial health and performance.

4. Legal Due Diligence:

 Identifying legal risks, examining contracts and intellectual property, and ensuring compliance with regulations which safeguards the investment by addressing potential legal issues and ensuring adherence to industry standards.

5. Technical Due Diligence:

 Technical Due diligence reviews technology infrastructure, intellectual property, and product capabilities, assessing scalability and potential risks. For tech-dependent businesses, a focused IT infrastructure evaluation ensures current capability, scalability, and security risk are addressed, with key emphasis on enterprise applications like ERP, SCM, and CRM.

6. Management Due Diligence

It involves engaging with the management team for strategic insights, supplemented by third-party background checks for a comprehensive evaluation of key individuals. This dual approach ensures a thorough understanding of capabilities and reliability.

By conducting comprehensive due diligence across these different areas, VC firms can gain a holistic understanding of the potential risks and opportunities associated with the investment, enabling them to make well-informed decisions.

PE/VC firms implement a series of strategic deal sourcing practices to identify and evaluate potential investment opportunities effectively. These practices revolve around key factors such as growth monitoring, liquidity indicators, data analytics, and brand presence.

Why is VC due diligence important?

Effective VC due diligence is critical for informed decision-making and risk mitigation. It uncovers red flags, assesses scalability, and evaluates management competence, enhancing the likelihood of successful and profitable investments in competitive landscapes.

Challenges of Due Diligence

Private equity due diligence processes present unique challenges distinct from other industries. Some of them include:

1. Limited Information Availability

 Target companies are often not publicly listed. Less information is accessible compared to publicly traded firms with stock exchange filings.

2. Financial Focus of Private Transactions

 Private equity transactions are predominantly financially motivated. The primary objective is investment profit rather than strategic alignment.

3. Industry-Specific Due Diligence

 Due diligence processes in private equity involve industry-specific assessments. The focus is on understanding the sector's dynamics and potential profitability rather than strategic fit.

4. Lack of Market Benchmarks

Unlike public markets, private equity deals often lack market benchmarks. This absence complicates the evaluation process by limiting comparative analyses.

From Deal Sourcing to Due Diligence and Investment Deployment

The PE/VC firms play a pivotal role in fostering innovation and supporting the growth of startups. With increasing market competition, a robust deal flow process and comprehensive due diligence are paramount for making informed investment decisions.

1. Deal Sourcing: PE/VC firms identify potential investment opportunities through networking, industry events, and data analysis, focusing on companies with high growth potential.

2. Deal Screening: Prospective investments undergo thorough evaluations based on key metrics, market dynamics, and growth prospects, allowing the selection of the most promising opportunities for further consideration.

3. Partner Review: Selected companies undergo an in-depth evaluation of their competitive advantages, market positioning, and potential risks. PE/VC firm partners collaborate to ensure strategic alignment with the firm's portfolio objectives.

4. Due Diligence Process: A meticulous analysis of the target company's business operations, financial health, and market potential is conducted. This involves comprehensive research, financial analysis, and legal assessments to gain a holistic understanding of the target's strengths and weaknesses.

5. Investment Committee: The investment committee, comprising experienced partners and industry experts, reviews the findings from the due diligence process. They assess the overall risk-return profile and ensure the investment aligns with the firm's investment strategy and risk appetite.

6. Deployment of Capital: Upon approval, the final step involves the allocation of funds to the selected investment opportunity, marking the formal closure of the deal and the beginning of the partnership between the PE or VC firm and the portfolio company.

The private equity and venture capital (PE/VC) sector in Nepal boasts a diverse landscape with over a dozen institutional investment firms. The government has introduced the Alternative Investment Firm (AIF) Regulations to promote local investment funds, including private equity. Additionally, it may lead to increased listings of real sector companies in areas like healthcare and technology, thus fostering capital market growth in Nepal. AIF invests in innovative companies with disruptive business models, particularly in the technology and tech-enabled sectors. Main focus lies in early-stage growth firms seeking capital and strategic management support. PE/VC firms seek high-growth companies with strong management and competitive advantages across sectors like technology, healthcare, consumer goods, and infrastructure. They source deals through networking, industry events, and proprietary research, while maintaining relationships with intermediaries. 

Here, are the five best PE/VC deals that took place in Nepal between January 2022 and January 2023:

 Team Ventures investment in Wiseyak

 Dolma Impact Fund's investment of approximately $4 million in Foodmandu in January 2022.

 Genese's second round capital investment of $1 million from BO2 in February 2022.

 True North Associates (TNA) signed an MOU to invest Rs 100 million in Sajilo Marmat Sewa in March 2022.

 Aadhyanta, Team Ventures, Tele Ventures, and Global Equity Fund's commitment of Rs 85 million to Skill Sewa in June 2022.

 Upaya's investment closure of Rs 60 million from Nepal Infrastructures Investment Fund Limited (NIIF) in January 2023.

Nepal's PE/VCs are actively investing and recently recorded successful exits, including Godawari International Pvt Ltd, Le Sherpa, Shanti Engineering, Dalle Restaurant, and The Lakeside Retreat. Notably, Team Ventures recently achieved a 2x return within two years from its partial exit from Foodmandu.

To support deal sourcing, NPEA (Nepal Private Equity Association) has developed a Deal Sharing Platform on its website which serves to bridge the gap between investors and companies seeking funding, facilitating targeted deployment of intellectual and human capital by working with resource providers. The platform acts as a portal, facilitating company exposure to stakeholders for raising financial and non-financial capital. It streamlines communication on investment opportunities, aiding investors and stakeholders in identifying potential deals across markets. Here, are the steps of how the platform operates:

 Companies apply online to initiate the process.

 NPEA screens and lists the company for a nominal fee.

 Company profiles and investment memos are accessible to association members through a login portal.

 Members contact NPEA for meetings with preferred companies.

 Non-members can contact NPEA for company details and meetings at a fee.

When it comes to due diligence, these firms usually conduct thorough investigations to assess the financial, legal, and operational aspects of a potential investment. This process often involves reviewing historical financial performance, conducting market analysis, assessing the competitive landscape, scrutinising the legal and regulatory compliance of the target company, and evaluating the capabilities and track record of the management team. Due diligence helps PE/VC firms make informed investment decisions and mitigate potential risks associated with the investment. Third-party experts may be engaged to ensure comprehensive assessments and informed investment decisions of the target company.

In summary, for both PE and VC sectors, a strong deal flow process and rigorous due diligence are key to identifying and seizing profitable investment opportunities. This strategic approach enables firms to make informed decisions, fostering long-term success for both the companies and the investors involved.

In conclusion, Nepal offers a growing landscape for PE and VC investments. However, success in this market hinges on effective due diligence and deal sourcing. Investors should be well-prepared to navigate the complexities of Nepal's market, taking into consideration legal, financial, operational, market, and social aspects during due diligence. Additionally, adopting the right deal sourcing strategies, building local networks, and being vigilant about risks are key to unlocking the investment potential in Nepal. While challenges exist, the potential for lucrative investments in this emerging economy is worth the effort. 

(TEAM Ventures, is an industry-agnostic alternative investment firm with a diverse portfolio spanning the energy, technology, real-estate, manufacturing, financial institutions, agro-infrastructure, and electric-vehicles sectors.)