Startup Investments 101: Understanding Private Equity & Public Equity Funding

It is critical that investors, entrepreneurs, and executives understand what the current private equity and public equity ecosystems look like.

Having seen both sides of the coin, I’d like to provide a layman’s explanation of both for everyone’s benefit.

Private Equity 

Private equity investments are shares or stakes in a private company that can range from series seed to series E or pre-IPO. It entails investing in direct private equity stakes or through AIFs.

Private equity has grown in popularity in recent years, attracting millions of dollars for the simple reason of high growth potential. According to a circular issued on September 13, it is expected to grow further, with the Government of India showing support by forming an expert panel to suggest ways to scale up VC/PE investments. 

According to a report by IVCA and consulting firm EY, private equity and venture capital funds will invest $77 Bn in Indian companies in 2021, representing a 62% increase year on year. While the actual number of transactions increased by 37% to 1,266.

Despite these rising numbers, many investors who wanted to take advantage of these opportunities found it extremely difficult to do so. Most private equity investments continued to have traditional significant entry barriers, such as high minimum values, successive financial commitments, and charge fees far in excess of the actual value creation in terms of fixed fees and carry. 

However, the Indian alternatives industry has grown at a rate of more than 30% CAGR over the last five years, making it one of the world’s fastest growing markets for alternative assets. The majority of the gains that are reported in these articles are based primarily on books, which means that they can only be realised upon exit, which could one day be a buyback, acquisition, or IPO. 

According to a report by the IBM Institute for Business Value and Oxford Economics, 90% of Indian startups fail within the first five years. The other 10% either stagnates or succeeds. Is it worth the risk?

Despite this, one cannot deny the potential for value creation… if one is in the right place! However, investors must be able to spot the diamond and be willing to compromise on liquidity and risk, as this type of financing takes several years to realise its full potential.

Public Equity

Public equity refers to shares or ownership in a public company (post-IPO stage), that is, a company listed on a public stock exchange such as the NSE. It entails investing in either direct public equity shares or mutual funds.

Among investors, public equity has become a more popular investment option. Since these companies are more established, it is generally thought to be safer than private equity. Furthermore, public equity can be easily liquidated and is readily available to all.

As a matter of fact, the Indian stock markets have outperformed some of the world’s largest exchanges including Dow Jones FTSE and Nikkei this year.

Domestic investors were so strong in 2022 that they nearly completely offset the money pulled out by foreign investors. According to AMFI, the assets under management (AUM) of the Indian mutual fund industry stood at INR 39.53 Lakh Cr in August 2022, representing an increase of INR 10 Lakh Cr in just 22 months from a total Aum of INR 30 Lakh Cr in November 2020.

Although the markets have performed relatively well, traders have found it difficult to sail this tide due to the presence of high volatility in the markets. Markets have been driven by everything from Federal Reserve rate hike hints to new developments in the Russia-Ukraine conflict. The India VIX, also known in the market as the fear index, is trading around 22, indicating the market’s high volatility.

Overall, it appears to be a safe haven for long-term investors but a burning hell for short-term traders.