Parabellum Investments: Beware the private equity trap
For the latest generation of Australian business owners, recession has been little more than economic theory they will have read or heard about. In all likelihood, many will not know what it feels like to be in a shrinking economy. And it could get worse because of the long-term ramifications of Covid-19. Consumer confidence is waning – and this will have a detrimental impact on many businesses.
A loss of revenue creates a multitude of problems such as finding new sources of capital and servicing existing debt. As head of a privately-owned investment firm, specialising in the mid-market, I regularly speak to the management teams of such companies. Right now, not only in Australia but around the world, many are feeling the heat and looking for new sources of funding to weather the economic storms ahead.
Equity investment, if available, is the best option for many because it will improve treasury and working capital. It sounds glib but not all forms of equity investment are equal. One particular example is an instrument portrayed as equity but behaving as a mixture of debt and equity – preference shares.
Preference shares, used by many private equity firms for funding, rank ahead of ordinary equity in the sense that the first money that will be paid out of a sale will go to the preference shares holder, ahead of the ordinary equity holders.
The ranking of distributions upon a sale is not a concern if things have gone well and there are sufficient funds for debt providers to get their money back and all equity holders to make a return. However, in cases where returns are less than 1x investment (excluding any interest), it is always the debt providers who are paid out first and the balance of proceeds then split among the equity holders.
In addition, preference shares also attract an interest rate, which the company is often required to service on a regular basis, typically monthly. This means it is debt, which could well be in addition to any bank debt – and priority of debt servicing will usually always go to the bank first.
Debt is a valuable instrument when used judiciously and when everyone understands the rules of the game. In good times, when trading is buoyant, many businesses may cope perfectly well with the cost of servicing their debt, including that carried in the preference shares. But in tougher trading environments – like now – many businesses will struggle to generate free cash flow given profits are siphoned off by onerous debt obligations.
Other than the obvious, the practical implications of this is that the company can be deprived of sufficient working capital, particularly in cases when it is intending to reinvest. What results is an unhealthy environment where management feels trapped and views their effort as simply serving obligations to the bank and the private equity firm.
The debt and financial structuring of an investment in the business can, without proper scrutiny and controls, leave management in a worse state than before – not making enough money to re-invest in the business and unable to raise more, or sell. At Parabellum, we do not – and never will – inject equity in the form of preference shares, preferring to invest in businesses where we believe our operational experience will help the management team turn a company around or take it to the next level, allowing profits from the company to be reinvested and deliver growth.
We are all living through difficult times and I understand one does not always have the benefit of being selective with new funding – but it is always worth a closer look. We are a new class of investors that have genuine operational knowledge and the mettle to use our own funds rather than those raised from third parties by bankers and private equity houses. In our own experience, this can make a huge difference in the performance of a company.
Rami Cassis is CEO and founder of international investment firm Parabellum Investments, which backs mid-sized companies looking to grow in global markets.
Timeline: India takes unicorn leap with six in five days
We chart an historic week in India’s tech industry, where in just five days, between 5-9 April 2021, the country achieved six new unicorns, bringing India’s total to 10 in 2021 to date, an immense unicorn leap from just seven in 2020 and six in 2019.
April 5: Meesho
India’s first social commerce unicorn, Meesho raised US$300m from SoftBank, Facebook and Shunwei Capital, giving the Bangalore-based startup a US$2.1bn valuation, a threefold jump from its previous funding round in 2019. Founded in 2015 by two IIT-Delhi graduates, Meesho connects producers and resellers, helping small businesses sell through social media. It has 45m customers and has enabled 13m entrepreneurs to start their online businesses with no investment.
April 6: CRED
Founded just over two years ago, Bangalore-based credit card repayment app CRED raised US$215m from Falcon Edge Capital and Coatue, nearly trebling its valuation to US$2.2bn from its January US$80m round. Allowing customers to pay off their credit card debt while earning CRED coins which they cash in for rewards, CRED has grown rapidly during COVID-19, doubling its customer base to nearly 6 million in a year.
April 7: API Holdings / Groww
The first epharmacy startup to gain unicorn status, PharmEasy (API Holdings), which has digitised 60,000 brick and mortar pharmacies and 400 doctors across India, raised US$350m in a round led by Prosus Ventures. Founded by four former Flipkart employees as a way of making investing simple, investment platform Groww became India’s second-youngest fintech unicorn, raising US$83m in Series D funding led by Tiger Global, quadrupling its previous round in September.
April 8: ShareChat
New Delhi-grown social media startup ShareChat, founded in 2016 by Mohalla Tech raised US$502m from Lightspeed Ventures, Tiger Global, Twitter and Snap taking its raised total over six rounds to US$766m and pushing its valuation to US$2.1bn. The funding will be used to grow its user base and short video platform Moj, which launched in 2020 following TikTok’s ban in India. The regional language startup claims 280m users.
April 9: Gupshup
AI-led conversational message startup joined the unicorn club after raising US$100m from Tiger Global giving it a ten-fold valuation of US$1.4bn. The smart messaging platform, which has seen accelerated growth during the pandemic, was founded in Bangalore in 2005 by serial entrepreneur Beerud Sheth, whose online freelancing platform Elance is now listed. Gupshup’s API enables 100,000+ businesses to build messaging and conversation experiences across 30+ communication channels.