PEs in India – Is it time to reinvent the investment wheel?

14 The entrepreneurial ecosystem in India is flourishing like never before. Innovative ideas, consumer acceptability and diversity in sunrise sectors are boosting growth. Private equity/ venture capital (PE/ VC) players too are battling to seize the chance, support promising ventures to build a robust portfolio and garner high return on investment. But any path to success has its own set of obstacles. The present state of corporate governance in India remains quite challenging. Other issues such as cut throat competition, ever increasing cost of operations, and inability to have clear differentiators in the business can also plague any burgeoning industry. The end result would typically be companies bending the rules, and in extreme cases, breaking the law to paint a rosy picture of their balance sheet. Such scenarios provide immense scope for entrepreneurs and promoters to manipulate financial performance.

Challenges galore
PE/ VC players have a tough task ahead of them. In recent times, there have been several cases of frauds being detected by PEs, these are not isolated and the issue appears quite widespread. For instance, it may be difficult for PEs to realize the actual performance of the prospective investee companies. In many cases, investors have limited options to monitor the performance as they may hold minority positions or may not have access to operational intelligence of the investee company. Their role would be restricted by the promoters/ entrepreneurs as alternate sources of investments which the latter controls. From regulatory perspective, corporate governance standards are still at a nascent stage and in strict sense are only applicable for certain classes/ size of companies. So PEs will have to adopt an alternative proactive approach to identify any red flags concerning their portfolio companies.

Investment boom or bust?
The Indian Government has proclaimed its commitment to the entrepreneurial landscape when it announced allocation of INR 10,000-crore fund to back early stage companies during the Budget. So while PE/ VC players stand at the cusp of an enormous investment opportunity in India, they need to tread carefully if they want to remain profitable in the long run. As a result, it is critical for them to realize that routine due diligence procedures will not create an impact in the current business environment. So if PEs really want to protect their investments, before or after deal, they need to follow stringent processes which are truly independent, comprehensive and designed to monitor and protect investment

Measures to mitigate fraud
With little clarity on the tools to monitor and protect the investment, PEs can often fall in a trap and unwittingly become victims of fraud. This can lead to damages, impacting them at multiple levels – financial, personal liability as well as reputation damage. In light of this, there are still several ways to mitigate risks related to fraud and safeguard the investment. For instance, a forensic review of internal financial data of an investment can identify malpractices. Forensic accountants can also be a key catalyst in providing a comprehensive approach to fraud risk management and help PEs assess their vulnerabilities to mitigate fraud risks.

These experts can also help investors foresee and assess the magnitude of the fraud risk, evaluate effectiveness of exiting counter measures, give training to employees so they adhere to the anti-fraud policy and keep control and checks on it. They are adept to address accounting and compliance issues by auditing records as well as performing fact finding on critical issues. Once the investigation is completed, they can also support by providing expert witness reports in case of any litigation / arbitration proceedings.

India as a business destination continues to offer a myriad of opportunities to global and Indian PE/ VCs. To leverage the advantages that the industry currently offers, it is key for them to keep checks and measures in place for misappropriation of funds, employ experts who can safeguard assets, resolve matters in a confidential and effective way.

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