It seems as though everyone is investing in India. During the past few years, every type of investment in the country — including private equity and venture capital — has exploded. Last year, net foreign institutional investment inflows topped $17 billion. In contrast, just four years ago, in 2004-05, total FDI (foreign direct investment) in India stood at $3.75 billion.

At first, investment tended to focus on the technology sector; today’s investments are in everything from real estate to infrastructure. In a keynote speech at this year’s Wharton India Economic Forum, Vinod Dham, managing director of the NEA-IndoUS Ventures and former vice president/general manager of the Microprocessor Products group at Intel, noted that online services, business process outsourcing and mobile value-added services were the top three investment areas in 2007. While the bulk of the investments are still in the IT and IT-enabled services sector, health care is beginning to pick up, Dham noted, and opportunities are often regional: Bengaluru (formerly Bangalore) for IT, Hyderabad for life sciences, Mumbai for mobile/media, Chennai for manufacturing, and Delhi for business process and knowledge process outsourcing.

So how are companies getting into these opportunities, and how are the deals changing over time? A panel discussion at the conference, moderated by Bain & Company private equity practice head Sri Rajan, explored the current environment and gave the audience a taste of what is to come.

The Investment Landscape

Haramb Hajarnavis, senior member, principal investments area at Goldman Sachs, laid out the landscape. “Historically, deals were smaller in size and more growth-oriented,” he noted. “On the exit side, most entrepreneurs opted for an initial public offering. Now that’s all changing — the deal size has gone up to an average of $45 million, and every flavor of investment can be found. You see multinationals, private equity players, hedge funds and sovereign wealth funds. Cross-border M&A is also emerging as a source of opportunity. The sectoral focus has widened. Buyouts have started to happen, and some exits now involve selling to others. ICICI Ventures sold a stake in Infomedia India to TV 18, as an example. We see a lot of trends in India that were in China before.”

Ranjit Pandit, managing director of General Atlantic Partners LLC, noted that the majority of his firm’s overall holdings were between 10% and 35%, so they were already familiar with the kinds of investments they were looking at in the Indian market. “We are minority investors; we identify high-growth sectors so we can generate returns and do it without leverage,” he said. “We’re also getting more comfortable with sectors we’re not familiar with — it just takes more time.”

Zubin Dubash, India Region head for Merrill Lynch Global Private Equity, said that his firm had begun its private equity endeavor on a global level during the 1990s. “The bulk of our investments had been in the U.S. and Europe — control situations, leveraged buyouts, etc. During the last few years, we have been looking to expand our footprint — into Brazil, Australia, Japan, China and, four months ago, India. While we are used to doing control transactions in the rest of the world, we’re seeing very little of that in China or India. We wanted to tailor our own flexible strategy to do minority investments.” Dubash said that the important factor wasn’t whether it was a minority or control type of investment: “The important thing is, are you really a partner with the promoter? Many promoters choose private equity deals based on value. But private equity players can bring lots of different things to the table — access to customers, access to acquisitions or even operational efficiencies.”

Small Stake, Small Voice?

Ensuring some level of influence in a company without a controlling interest isn’t always easy. “Sometimes you get it wrong, sometimes you get it right,” said Pandit. “The key is, before you do the investment, to get comfortable with the promoter. You have to align the objectives on both sides, which is hard when you have a powerful promoter or when many branches of a family — with different viewpoints — are involved with the business. Getting behind some of these facets is very important.” The most successful experiences have been situations where people have come from nothing and are interested in building enterprises, said Pandit. “Looking back in time, think of Infosys as an example — there were a few professional managers who left another enterprise and who had the technology and the right governance model in place.”

Hajarnavis agreed that it was a challenge. “We do try for larger transactions; we’re not in a rush to deploy hundreds of millions of dollars of capital over a certain number of months. We don’t have a specific timeline — it’s a long-term business. We lived through this in China as well, where we started small and over time we evolved to write larger checks. We view this as a once-in-a-lifetime opportunity for the company, so we have to be patient.”

Hajarnavis admitted that there was some pressure from limited partners, who wanted India exposure. “If we didn’t have a presence there, the question would be asked — why are we not there? As with any other sector, we have to localize our product — private equity — for the Indian market. There may not be a lot of leveraged buyout opportunities, but there are lots of other growth capital opportunities over the next few years. We want long-term relationships with these companies. Goldman Sachs also has had the strategy of following its clients — we see where they have gone. Every large client of Goldman has an interest and a presence in India. That creates a reason for us to be there also.”

Governance structures are important, but hard to influence, the panelists noted. “We have very little influence, so you have to do the homework before getting in,” said Pandit. “You see either a structure of command-and-control or where people genuinely are bettering themselves and building institutions. It’s hard to change it once you’re in there.” Issues around hiring, where to take the business, how much risk to take — all of these are important, he noted. “Ultimately the bet you make is on the top management team. You can’t spend lots of time on all these issues if you have a lot of deals.”

What Value Does a Firm Add?

Dubash, who was previously CFO at leading BPO firm WNS Global Services, gave the panel the perspective of the other side, recounting what Warburg Pincus (WNS’ majority shareholder) had brought to the table. “The biggest value addition they brought was a team of people to facilitate a capture, and then they built a world-class team around that. Also, whenever we did an acquisition, we had access to their entire team’s expertise in a particular area. When we wanted to open an office in Romania, we put our neck on the line and took a cut in variable pay, and the firm supported us.”

Pandit added that firms typically could add value in three areas. “One is the management team, of course. Second, alliances can add value — bringing new technology, customers, sourcing and revenue. Third would be the complementarities — other companies in the portfolio that we are aware of. We see things on the horizon that a company may not. And we can provide funding to make things happen.”

“We all strive to be a sounding board for CEOs; we want them to think of us as their business partner,” noted Hajarnavis. “I’d like them to reach out to us. That’s what we’re there for, and when we can add value. If I know what problem the company management is trying to solve, I can put the resources of our company at their disposal.”

Do the Sweet Deals Still Exist?

Even a few years ago, proprietary deals were sometimes possible, noted Rajan. When asked about the current environment, the panelists said it would be tough to find any advantage these days. “In a hot capital market, competition is inevitable,” said Pandit. “The advantage that any private equity firm has is its relationships. We have a track record of supporting companies, so it sometimes allows us to get a leg up, to have the opportunity to look at a deal.”

Hajarnavis noted that Indian entrepreneurs were sophisticated when it comes to understanding the value of their business. “Given the culture of negotiation, they always want to find the best deal,” he said. “It’s our responsibility to explain to them our tangible value-added. We may get privileged access for a short period of time or maybe one extra meeting that helps us come up with the right judgment, but really, there’s no friends-and-family discount out there.”

“We’re new to the market in the PE practice,” added Dubash, “but the relationships I’ve developed for 20 years are good, so deal flow has not been an issue. You do get some privileges, but you at least have to be in the range in terms of pricing.”