Private Equity Vs Capital Markets: What makes more sense?

Growing and evolving small to medium-sized businesses need regular flows of funds and cash infusion to implement technological upgradation, expansion, or diversification plans. Companies can raise capital through various means. Based on the amount required and the objective, the decision makers finalize the route that should be adopted. Small and mid-sized companies have limited funding options to raise large sums. The routes usually considered are private equity (PE) or an initial public offering (IPO).

Historically, companies in India have always preferred either going public or the IPO route. However, access to funding is now easier, as the presence of PE players (global as well as domestic) in the market has increased, and relatively large sums of private funding are available for investment. This has led to companies increasingly preferring PE funding.

The funding route that a company adopts is decided by its highest management after carefully considering various aspects. The decision makers need to find answers to critical questions such as:

• What are the company’s strategic goals?
• How much funding is required at the current stage?
• How much equity should be diluted?
• Does the company have the resources to meet all regulatory and disclosure requirements?

What is the company’s risk appetite?

Various additional factors also influence the management’s decision in finalizing an option.

Although getting a business listed on stock exchanges increases brand visibility and proves to be a major milestone for its owners, floating an IPO is an expensive, complex process. It includes several regulatory frameworks, and a company must fulfil all the required criteria to be eligible to float an IPO. Compliance to public market regulations involves high expenses. The company is also required to maintain transparency regarding its financial and strategic data to go public. Furthermore, the regulatory charges do not reduce even after the capital has been raised. A player in the stock market is always under scrutiny, as its short-term financial performance has immediate impact on its stock prices. Poor performance in one or two quarters exposes the company to the risk of eroding stock prices.

Through IPOs, companies enter stock markets that are volatile in nature. Macro-economic and global uncertainties can create fluctuations in the stock market, which could negatively impact the company’s stock prices and capital.

Smaller businesses usually adopt the PE route due to the following reasons:

- PE funding allows owners to retain control on the company’s operations. They can continue to remain actively involved in the company’s day-to-day operations and decision making.

- PE players are increasingly opting for long-term investments that are not just financial in nature. To support their agenda of exiting after reaching higher valuations, they consult their own expertise for strategic inputs and directions, thus ensuring the company’s growth and positive financial performance.

- A company’s valuation may drop due to its poor financial performance. However, even if it does, it is not necessarily a knee-jerk reaction.

Resorting to strategic PE thus allows company owners to maintain executive control as well as continue strategizing as per their set business plans. Staying away from stock markets limits a company’s exposure to intense capital market competition and enables it to follow its strategic plans without the constant pressure to perform well financially to maintain its stock prices.

Most small and mid-sized companies struggle to comply with rigorous reporting, governance, and controls that public companies need to follow post IPOs. Therefore, the PE route is gaining popularity among such companies for funding of long- and short-term plans.

The author is Sector Lead (Financial Services), Business Research and Advisory, Aranca