What are Private Markets?

An average startup needs about US$10,000 worth of capital to get the ball rolling. In Indian rupees, that’s roughly ₹8.3 lakhs on average, a modest fortune required to take an idea and turn it into a full-fledged thriving business.

And this is just the tip of the iceberg. To grow a business from the embryonic startup phase to a full-blown company demands an ever-increasing infusion of capital. It’s the classic “you have to spend money to make money” scenario.

This is where the private markets step in.

While most retail investors shy away from private markets, there is no denying their importance in the companies’ growth trajectory. Private markets grease the wheels of progress for businesses at every twist and turn of their lifecycle.

In the previous chapters, we’ve laid the groundwork on private markets, their functions, and the type of private market funds. Now, let’s understand how private markets contribute to advancing businesses at various stages of their lifecycle.

The private markets enable startups to raise capital from institutional investors and high-net-worth individuals.

Seed and Early-Stage Funding

In their nascency, startups have quite a high risk of failure. According to IBM, 90% of startups close shop within the first five years of their existence.

Now, this could be due to a number of factors. Maybe the product didn’t work, or the founders had a falling out or maybe there were even regulatory issues. One of the reasons for failure, however, is the lack of funding.

Private markets allow early-stage startups to raise funding from angel investors or venture capital firms. The role of the investors is not just restricted to the provision of funds but also valuable expertise.

Venture capital firms form a symbiotic relationship with the businesses they invest in. They offer mentorship, guidance, and access to a network of industry contacts.

One should note, however, that different VCs specialise in different stages of the company’s growth, from angel and pre-seed to seed, series A, B, and beyond.

You see, each stage demands distinct expertise, connections, and resources. Early-stage VCs have the right skills but limited funds, so a successful startup or business often procures funding from three sources: Its initial VC, the initial VC’s new fund, and later-stage VCs with more money. This passing of the VC relationship baton is important, as the company partners with investors who fit its changing needs.

Growth-Stage Support

As startups progress beyond the seed stage, their capital requirements grow significantly. The bigger the size, the greater the expenses. To scale their operations and expand their business, startups need a larger injection of capital.

This is precisely where growth-stage alternative investment funds step in.

These investors specialise in identifying businesses that have the potential to become leaders in their chosen sectors. The infusion of funds is the catalyst that helps them reach the next stage in their growth trajectory.

The capital that private equity funds provide is not just monetary; it’s strategic. It allows the expansion into new markets, the development of new products or services, and investments in research and development.

The sourcing of capital through private markets is definitely instrumental in the growth of a business. But what’s in it for the investors? Why should they participate?

“Private capital markets have been outperforming equities, offering investors opportunities with higher yields and portfolio diversification.” — EY

Imagine being able to invest in Apple or Google when it first launched. Even if you had been able to invest a few thousand when these companies were established, you might have been able to take an early retirement today.

Private Equity

Private equity funds offer the unique opportunity to find high-potential companies before the rest of the market does. These funds specialise in acquiring ownership stakes in private companies and then they take an active role in managing and increasing the value of these investments. They bring a plethora of experience, industry knowledge, and operational expertise to the table.

The objective is clear: transform the company, and make it more competitive, efficient, and ultimately more valuable.

Top Private Equity Investment Trends in India:

• The number of mega-deals declined in size. This indicates that while investors still have faith in the presence of good opportunities in the Indian startup ecosystem, the global market headwinds have left them jittery and unwilling to commit too much.
• There were a lot of early-stage deals in the lending, insurtech, and wealth-tech spaces.
• The energy sector, too, was a popular choice for investors. The number of deals increased from 26 in 2021 to 58 in 2022.

Let’s take a look at the number of private equity investments in India by deal size.

Mezzanine Financing

Private equity is not the only option when it comes to raising funds. Some companies prefer to opt for mezzanine financing instead.

What sets mezzanine financing apart is its hybrid nature. It combines elements of both debt and equity. It functions mainly as a loan. But, it can be converted into equity or it can grant the lender an equity stake if certain conditions are met.

Mezzanine financing is particularly attractive because it offers a high degree of flexibility. It allows the startup to change its capital structure depending on its requirements. For instance, if the company earns good revenue and is able to repay the debt, it will be able to retain the ownership stake.

Aiming for profitable exits

As with investors in the public markets, the ultimate objective of investors in the private markets is also to earn profits on their investments. The difference lies in the fact that while public investors have no control over how the company is performing, private investors do.

This means the private markets allow investors the unique opportunity to invest in a startup and then help the startup grow and realise its potential. After all, if the company grows, the valuation will increase. If the valuation increases, the investor will be able to exit with capital gains.

If you think about it, it’s a win-win situation!

Mergers and Acquisitions

Mergers and acquisitions (M&As) are quite a common exit strategy for private investors.

As the name suggests, the startup in question either gets merged with another startup, or it gets acquired by another company. In the former case, a new company is formed by merging the two startups. In the latter case, however, the startup simply gets absorbed by the acquiring company.

In both cases, however, investors can exit from their investments.

When startups choose to go the M&A route, their latest valuation is calculated by the acquiring company. This means that for any existing investor, the value of their ownership stake can increase. At this stage, the investor can sell their stake to the company at the updated valuation.

Initial Public Offerings

This is the other popular exit strategy for private investors.

Startups who go the IPO route apply to SEBI to get listed on the country’s stock exchanges. This means anybody — retail or institutional investors — can buy and sell the company’s shares after that.

Please note, however, that going public is a transformative event. Once companies decide to list on the stock exchange, they get increased visibility from a greater number of investors. But, they also fall under stricter regulatory scrutiny and additional responsibility to the new shareholders.

The table below shows the fifteen largest exits in the Indian private markets in 2022.

Note: A secondary sale occurs in two primary scenarios:

1. When earlier investors sell their stakes to new investors to new investors in a funding round
2. When a PE/VC fund sells its entire stake in a company to another fund

The secondary sale allows investors to cash out and bring in new owners, often supporting the company’s growth.

Private markets allow startups to access capital on an unparalleled level. They facilitate the growth journey of a company, from the time it was an idea till it gets listed on the stock exchange. Through each stage of development, alternative investments are the facilitator that propels entrepreneurship and innovation.

In the next chapter, we uncover the intricacies of a fund lifecycle and the strategies that shape them. It’s a vital piece of the puzzle, one that connects the broad vision of business growth with the finer execution of sound investment strategies.