Private investment in public equity - PIPE

Private investment in public equity - PIPE

As the name suggests, PIPE involves private equity participants investing in companies whose shares are publicly traded. Thus, private funds are directly infused into the listed company. Generally, the transaction involves private participants (who are a limited group of investors or Institutional investors) and the listed companies which are looking for funds. Thus, the companies allot the shares directly to the investors.

Why should a listed company look for private equity funds ?

All the companies, at what ever stage of life cycle they may be, require funds. The desired end usage may be for repayment of debt, acquisitions, entry into new markets, improving the operations etc., If the market conditions are promising and the market is in bull phase, these companies will for sure go for follow up public offer. However, if the market is in bear phase, then the companies will not be interested in approaching the public for the funds they require. This is because, the market prices of the shares of the companies may be lower than their intrinsic value. If the company approaches public during these times, the company has to under sell the shares at prices which are very much lower than the intrinsic value. The public also may not be interested in buying the share a the price at which the follow up public offer is announced. These factors drive the listed companies to look for PIPE funding.

Why should a private equity investor / institutional investor invest in a public company ?

As said earlier, during the bear phase / gloomy market conditions the valuations of the listed companies will be generally lower than the intrinsic value and the retail investors will not be in mood to buy the shares in these companies. This results in getting a better acquisition price for the private equity investors. The public companies which are looking for funds will be ready to issue shares at the price which will be mutually acceptable to both the parties.

Moreover, the private equity investors will also conduct the due diligence of the companies which are looking for funds. The out come of the due diligence will have great impact on the price at which the private investors want to acquire the stake. Any issues if identified during the due diligence process will further reduce the price at which the stake will be acquired by the private equity investors. Thus, the private investors will get the stake in the public companies at promising values. The private equity players will also have an easy route for exit as the companies are already listed.

Private equity and Venture capital

Venture capital (VC) and private equity (PE) are two terms which often overlap in practice, so the distinction between these goes un-noticed. The purpose of this post is to lay down how both the terms differ.

Private equity is usually about taking an existing company with existing products and existing cash flows (positive or negative depending on the industry, products, strength of management team, prospective markets etc), then restructuring that company to optimize its financial performance.  When private equity works right, it can save poorly performing companies from cash crunch and turn them into profitable enterprises thereby avoiding them from becoming bankrupt.

A Private equity firm wants the companies in its portfolio to continue to grow, so it may add on other synergistic acquisitions and then sell the company to another firm within a few years. Although enormous growth rates are usually desirable, most PE firms are realistic and don’t expect their portfolio companies to grow by quantum leaps. They aren’t seeking exponential growth but rather good, solid geometric growth.

Venture capital is investing in financially viable start up ideas which are backed up by technical brains behind the ideas. This involves funding the persons generating the ideas so as to enable them turn these ideas into realities which generate cash. Venture capitalists invest small amounts of money in dozens of companies. Funding these ideas involves high risk. Also, the funding is required generally at very early stages of product development.

A Venture capital involves betting the start-up which will rapidly bloom into an enormous company (eBay, Microsoft, Sun, Google, and Apple are all examples of venture funded start-ups). The Venture capitalists expect their investments to increase with exponential growth. At the same time, the venture capitalists also run a great risk of failure of the start ups which were earlier funded by them. [As per the historical data, most of the start-ups shut their shops within 5 years from the commencement of business...!].

Apart from the above basic approach differences between PE and VC, the following areas also does matter:

§    PE firms buy companies across all industries, whereas VCs are focused on technology, bio-tech, and clean-tech and simply said emerging areas [New area is the education industry where the investment by VC is growing in India].

§  PE firms mostly buy 100% of a company in an LBO, whereas VCs generally acquire a minority stake – less than 50% [The balance is held by the founders/promoters].

§  PE firms make large investments in various large companies. VC investments are much smaller (since the investments in start-ups generally don’t require huge outlay as the funding is based on the ideas).

§    VC firms use only equity whereas PE firms use a combination of equity and debt.

§  PE firms buy mature companies with products known in the public and which have potential to grow whereas VCs invest mostly in early-stage – sometimes pre-revenue – companies (funding of financially viable ideas which may take considerable time).

REITs (Real Estate Investment Trust) in India - Tax implications

Tax implications on REITs

Why will any investor invests in any venture ? One of the answer is to get a good return. The term GOOD depends on perception. I see 12% net of tax as a good return over a period of 6-9 months, some see this as 8% net of tax for the same tenure. 

Thus any person, while calculating the return on investment will consider the tax impact on the income generated from the return. If TAX element is not calculated / considered properly, the results screw up the happiness of the investors.

Investors in REITs would like some favorable tax treatment so that this remains an attractive route for them to put money as compared to other options present in the market.

Tax treatment of REITs should be made in an efficient manner so that TAX component will not eat into the return generated thereon and if that is the case this will not be any good avenue for the investors to park their money.

Below are few aspects of taxation of REITs which needs to be addressed by the forth coming budget [which will happen sometime after elections results of 2014 are declared].

Dividends

Dividends received by the investor from companies as well as mutual funds are tax free in their hands. 

Now with REITs entering the league as a separate instrument, the question is whether the taxation of the dividend received from this instrument will be liable for the same treatment as of dividends. If this is not the case then the amount received would have to be taxed in the hands of the investor which would put a burden on them. Further, if this amount is o be included as part of income for computing tax based on slab rates, the investors end up paying too much of tax. This is owing to the nature of REITs, most of the primary investors in REITs will he high net worth individuals who are already in higher tax bracket.

Capital gains benefit

There are favorable provisions related to the investments into equities and equity oriented mutual funds when it comes to capital gains earned on these instruments if the gains there on are of long term in nature [holding period being more than 12 months]. 

In case of the REITs there are no clear guidelines on what would actually be considered as the nature of the instrument and how would this be taxed. 

This has importance because if there is a capital gain that is earned at the end of the day when the investor goes to sell the investment and if the impact here is negative then this could dent the overall returns from the investment. 

Securities transaction tax

The nature of the REITs is such that it will be listed on the stock exchanges wherein it will provide investors with an option to actually trade in them and in which case this trading may invite securities transaction tax. 

In the absence of clarity of tax matters on these issues, there is very little chance that an investor is going to be attracted towards a REITs in the form that has been proposed. The entire effort of earning returns in the investment could be negated by the tax position. 

This tax angle will be key before investors invest in them. Unless there is a beneficial way in which this is actually dealt with it could turn sentiment against REITs which could be difficult to correct at a later stage hence the important thing is to get the details right the first time around.

So, let’s keep our fingers crossed and wait for the Finance Minister [New...!] to come up with some provisions in the budget.