As the Nepali PE/VC industry is still developing, it is necessary to understand the characteristics and functions of PE/VC firms from around the world.
The origins of the Private Equity (PE) and Venture Capital (VC) market can be traced back to a $70,000 investment made by Georges Doriot, often referred to as the “father of venture capitalism”, in Digital Equipment Corporation in 1946. Since then, the PE/VC industry has proliferated globally, managing $13.1 trillion worth of assets as of 2023.
As the Nepali PE/VC industry is still developing, it is necessary to understand the characteristics and functions of PE/VC firms from around the world. Adopting the right strategies from leading markets will help facilitate sustainable growth in the Nepali alternative investment market. This article showcases the characteristics of PE/VC ecosystems in key markets such as the US, Europe (UK and mainland Europe), and Asia (Singapore and India) to identify the necessary changes needed to correct deficiencies of the Nepali market.
United States
Before World War II, the private investment landscape in the US was dominated by personal investments made by wealthy families. After the war, companies began to invest in private businesses to support returning soldiers and, more broadly, the economy. A few decades later, the US private market took off with the Leveraged Buyout (LBO) boom of the 1980s, marked by billion-dollar deals. One of the largest acquisitions at the time was KKR’s $25 billion buyout of RJR Nabisco in 1989. By then, the US market had established itself as an industry leader which remains the case even today.
The 2000s brought unprecedented growth in global PE markets, facilitated by the US government’s loosening of credit standards as well as the introduction of complex financial instruments. Private equity firms set historic records with more than 650 US companies purchased for over $370 billion within the decade. Although the age of mega buyout ended due to the 2008-2009 financial crisis, the private equity market continues to be a significant asset class, amounting to almost 6.5% of the US GDP as of 2022.
The US PE/VC firms have distinct characteristics. First, they are notorious for using leverage in acquisitions and buyouts. The availability of credit and the Federal Reserve’s proficiency in creating and implementing monetary and fiscal policy has facilitated frequent use of debt financing thereby allowing US PE firms to grow into industry giants. These firms typically target innovation-driven tech companies, most of which can be found around Silicon Valley and all types of deals occur, from mega acquisitions, LBOs, growth capital investments, venture capital investments and angel investments.
Company organisational structures are generally vertical, composed of limited partners (LPs), general partners (GPs), upper-level executives, and mid/low-level analysts. The US PE/VCs also provide a range of support functions such as legal, investor relations, marketing and compliance services. Fund structures follow the Limited Partnership models, with closed-end funds that typically have lifespans of 10 years. Compensation and profit-sharing models are calculated using the “Two and Twenty” rule, often with a hurdle rate of 6-10%, while allowing co-investment opportunities for GPs and senior-level fund managers. Catchup computations also occur on a deal-by-deal basis, which is a characteristic unique to the US PE/VCs. Unlike Nepal, public listings in the US make up a negligible portion of exits, both by deal value and count, as 97% of deals are either sponsor-to-sponsor or third-party exits. The Securities and Exchange Commission (SEC) is the primary regulatory board, having implemented key policies such as the Dodd-Frank Act, which enhanced reporting and compliance standards post-financial crisis while creating policies to cultivate the private equity and broader financial market.
United Kingdom
The PE/VC market in the UK followed a similar trajectory to the US, with institutions like the Finance Corporation for Industry (FCI) and the Industrial and Commercial Finance Corporation (ICFC) created to provide capital for revitalising key industry sectors post-World War II. Like the US, the 1980s was a significant period for PE/VCs in the UK due to implementation of deregulation and privatisation policies by the Thatcher government. The 2000s brought an era of mega deals pre- and post-financial crisis, with the UK PE/VC market continuing to grow, becoming the largest PE/VC market in Europe.
The market prefers to invest in industries such as financial services, healthcare and technology, using a mix of buyouts and growth capital investments. Unlike the US, the UK tends to focus on mid-market companies with deal values generally ranging from £10 million to £300 million. Funds in the UK are generally structured similarly to the US, using a limited partnership model with firms having a vertical organisational structure. There is also a significant number of boutique investment firms - smaller firms making niche investments - which often adopt a more horizontal structure similar to many startups.
Compensation models follow the usual 2% AMC with a 20% carry, with profit-sharing opportunities provided to executives and senior fund managers, like in the US. Acquisitions constituted more than 80% of the exits from UK PE/VC deals. All of this activity is governed by the Financial Conduct Authority (FCA) which implements registration as well as reporting/compliance-related regulations.
Continental Europe
Continental Europe also had its post-war institutions such as the Deposits and Consignments Fund (CDC) of France and the Credit Institute for Reconstruction (KfW) of Germany. The 1980s saw the establishment of the European Private Equity and Venture Capital Association (EVCA) which is the world’s largest association of private capital investors today. Institutional investors began increasing their investments in European private equity companies in the 1990s, and the EU single market initiative further supplemented transnational investment. More recently, despite the financial crisis, the European PE/VC market recovered significantly due to effective policy implementation and financial regulation. Due to the multinational composition of the EU, PE/VC markets vary across the continent, influenced by differences in economic maturity and regulation. A common factor, however, is their growth equity focus, investing mainly in SMEs across all sectors of the economy. European investors have a modern ESG approach to investing while also conducting traditional low-leverage transactions.
European firms generally adopt limited partnership models with vertical organisational structures. However, due to the EU’s multinational dynamic, sector- and region-specific departments are often created. Another popular fund structure in Europe is the Société d'Investissement à Capital Variable (SICAV) model which are open-ended funds similar to ETFs or mutual funds. “Two and Twenty” is the norm in Europe as well, with similar compensation/profit-sharing models for fund managers, including ESG-related performance bonuses. The primary regulatory figure is the European Commission which implements the Alternative Investment Fund Managers Directive (AIFMD). The AIFMD imposes regulations on transparency, compliance, and reporting, as well as capital and leverage limits.
Singapore
Singapore is widely regarded as a financial hub of the world. Their PE/VC culture is especially advanced due to favourable business conditions created by the Singapore government over the last half-century. The Economic Development Board (EDB) of Singapore, a key facilitator of their rapid and stable growth, initiated programs like the Technopreneurship Investment Fund to promote entrepreneurship and innovation in a rapidly growing market. By the 2010s, hundreds of domestic and international financial institutions had established regional offices in Singapore. Firms generally use standard Limited Partnership models, though special fund structures like the Variable Capital Companies (VCC) model also exist. The VCC model allows investment funds to hold multiple sub-funds within the same entity and enables the issuance and redemption of shares without shareholder approval, providing tax incentives and flexibility. Singaporean firms follow similar compensation models to the US, with an emphasis on responsible operation due to the government’s effective oversight. Similar to most developed markets, PE exits are carried out through trade sales and secondary sales rather than through public listings. The main regulatory figures are the Monetary Authority of Singapore (MAS) and the EDB, both playing significant roles in developing Singapore as a financial hub through effective policy implementation and business regulation.
Unlike the US, the UK tends to focus on mid-market companies with deal values generally ranging from £10 million to £300 million.
India
India is another important market for the Nepali PE/VC ecosystem. PE/VC culture in India began with seed funds provided by ICICI and IFCI for tech-sector firms. The 1990s saw growth due to an increase in foreign PE/VC participation in the Indian market. Throughout the 2010s, the PE market continued to grow, with deal activity skyrocketing to almost $39 billion in 2023, compared to $8.4 billion in 2010. The Indian PE market focuses on technology, consumer retail and the industrial sector. With its vibrant startup ecosystem, India is making significant progress in tech sectors like space tech and fintech, being the third largest fintech market globally. Certain characteristics make the Indian market distinct, such as the lower use of leverage due to higher interest rates and a developing banking sector. Additionally, the prevalence of family-owned businesses makes outright buyouts relatively uncommon.
Similar to global practices, Indian PE/VC firms also follow Limited Partnership models. Exit strategies typically involve secondary sales, with some IPOs on the National Stock Exchange or the Bombay Stock Exchange. The primary regulatory figure for alternative investment funds is the Securities and Exchange Board of India (SEBI) which creates and implements regulations regarding FDIs, tax compliance, fund size and ownership structures. Policies like the Foreign Venture Capital Investors Regulation of 2000 have facilitated the expansion of the PE/VC ecosystem in India.
Nepal
The Nepali PE/VC ecosystem was almost non-existent until recently. Some of the first firms, such as Team Ventures, One to Watch, True North Associates, BO2 and Dolma Impact Fund, appeared in the mid-2010s. Over the years, the market has shown significant growth with the emergence of numerous firms and funds. According to the Nepal Private Equity Association (NPEA), $66 million worth of investments were made as of 2022. Additionally, 12 domestic institutional PE/VC fund managers have been granted Specialised Investment Fund (SIF) licences by the Securities Board of Nepal (Sebon), highlighting the growing popularity of the Nepali PE/VC industry. Key players in the market include private equity firms, investment companies, high-net-worth individuals, insurance companies, merchant banks, offshore funds, banks, specialised investment funds and funds blacked by development finance institutions (DFIs). These firms often focus on sectors such as renewable energy, technology, tourism, agriculture, healthcare and real estate which constitute the majority of investments.
Due to the lack of clearly defined regulations, organisational structures vary from firm to firm in Nepal. The Nepali ecosystem also exhibits a general absence of leverage-backed deals, largely due to the underdeveloped financial sector's reluctance to support debt-financed investments. Initially, companies in Nepal often relied on bank loans for financing, given the dominance of banks in the market. However, as their debt levels increase, they may find themselves ineligible for further bank loans or seek to rebalance their debt-to-equity ratios. Consequently, many turn to private equity (PE) and venture capital (VC) firms, offering permanent equity in exchange for funding. Following investment, PE/VC firms typically aim to exit through IPOs, as the emerging PE/VC market in Nepal limits opportunities for secondary sales.
The requirement for a fund manager to have paid-up capital of at least $143,884 and the need for funds to be close-ended can be restrictive.
Offshore funds, like Dolma, have adopted Limited Liability Partnership (LLP) models, which is the global norm, with clearly defined roles as Limited Partners (LPs) and General Partners (GPs). However, due to the rudimentary nature of Nepali partnership laws, establishing an LLP as an onshore firm is quite difficult. However, clear taxation and regulatory policies have yet to be created which has often been a deterrent to potential foreign investors. Compensation and profit-sharing models also vary across Nepali companies. Certain offshore funds have adopted the commonly used “Two and Twenty” rule, charging a 2% management fee and 20% carried interest beyond a specified hurdle rate. Other profit-sharing structures vary on a company-by-company basis. While most PE/VC firms without SIF licences are regulated by the Office of the Company Registrar, those with SIF licences are governed by SEBON. However, clearly defined regulations are still needed.
Progress and Necessary Reforms
Having understood the characteristics of PE/VC markets globally, it is clear that effective policy creation and implementation is a prerequisite to growth. As done by the Government of Singapore, it is possible to facilitate sustainable growth in younger and developing markets without sacrificing the interests of investors. Some progress has been made by the government and other relevant governing bodies, including the removal of regressive policies such as blacklisting private equity (PE) firms, taxation on changes in capital structure as well as the implementation of the recently introduced SIF Regulations. Furthermore, the private sector has demonstrated significant resilience in dealing with political, economic and financial turmoil, as evidenced by its recovery from major catastrophes such as the 2015 earthquakes, the Indian blockade and the COVID-19 pandemic. However, the government’s cultural lag in identifying the PE/VC market as a key asset class as well as providing clear regulatory frameworks in which PE/VCs can operate has been a significant hindrance.
One of the most necessary policy changes required is to implement clear tax benefits to Alternative Investment Funds. For example, India allows pass-through taxation for Category 1 (startups and early-stage ventures) and Category 2 (unlisted private companies) funds. This also applies to Category 3 (all other types) funds; however, it depends on the nature of the fund. Nepali alternative investment funds either do not have tax benefits (with some companies being subject to double taxation) or there is an incoherence between multiple government bodies (mainly SEBON and MoF) regarding tax laws. This also happened with mutual funds in Nepal. Even though the first mutual fund was created in 2012, clear tax exemption regulations were only established as recently as 2021. Although a precedent has been set indicating that the government will likely eventually allow alternative investment funds to be tax-exempt, the uncertainty in setting regulations causes significant concern for fund managers and investors alike. Therefore, implementing this change not only provides immense benefits to domestic PE/VC stakeholders but also facilitates growth in the PE/VC ecosystem by attracting global institutional investors.
Another policy change would be to allow for blanket approval of FDIs. As of now, foreign funds cannot be allocated without pre-defining which projects will be receiving funding. This long bureaucratic process is not only a deterrent to foreign investors but is also inefficient as key market opportunities may be missed because of this requirement. Allowing foreign funding to receive blanket foreign approval, once the reliability of the parties has been established by the necessary government bodies, will not only enable a more efficient deployment of funds but will also attract more foreign funding through PE/VC firms, who would otherwise refrain from, investing in Nepal due to a lack of market knowledge.
Furthermore, certain regulatory provisions for Special Investment Funds (SIFs) need to be reconsidered, as they negatively impact PE/VC firms, and companies, and deter foreign investors. For example, the requirement for a fund manager to have paid-up capital of at least $143,884 and the need for funds to be close-ended can be restrictive. Additionally, the capital requirement of at least $1.15 million, mandatory holding of at least 2% of the fund size by the fund manager, and the sponsor's commitment of at least 10% of the fund size can be prohibitive for smaller or newer funds. Limiting the number of unit holders to 200 and requiring a minimum unit purchase of $38,461 further restricts access.
Focusing on nurturing the PE/VC culture in Nepal in ways not limited to those previously mentioned will contribute to the much-needed revitalisation of the national economy. First, PEs (even those currently in the Nepali market) have access to global networks, and tapping into these networks is essential for enabling Nepal to participate in global markets. Second, PE/VCs are one of the primary supporters of small and medium enterprises (SMEs), not only in Nepal but globally. As of 2016, SMEs contributed to 22% of Nepal’s GDP, making it essential for financial institutions to tap into this immensely important and rapidly growing market. Lastly, Nepal boasts an abundance of natural resources, necessitating the protection of these assets through sustainable operations.
PE/VCs are increasingly inclined to invest in ESG initiatives, particularly as many banks remain hesitant to divest from traditional investments. While establishing ESG norms in a developing market presents challenges, it lays the groundwork for future ESG-oriented operations. PE/VCs play a pivotal role in identifying financially and environmentally sustainable companies, driving the much-needed transition towards ESG-oriented enterprises in Nepal.
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.)
