Challenges faced by Indian SMEs
The major challenges faced by Indian SMEs (Small and Medium Enterprises) due to COVID-19 pandemic are adequate and timely finance, limited access to equity capital along with low-capacity utilization, non-availability of suitable technology and ineffective marketing strategy.
If we look at the last year (2020), we could see that investments dipped significantly and such businesses are struggling to even sustain in the market due to lack of funds, cash liquidity and lesser sales.
The uncertainties in the economic environment and the global pandemic have put a halt on raising funds for SMEs in India, which includes a significant decrease in venture capital investments and private equity.
Even if equity were made available to SMEs the uptake would remain low due to information asymmetry between promoters and investors, non-availability of the robust and agile platform, SMEs’ concerns regarding control and management, smaller investment size tends to increase the cost for equity investors.
Impact of COVID-19 on private equity/M&A for SMEs
Covid-19 has bought many challenges for the private equity and M&A (Mergers & Acquisition) players dealing with SMEs, most of them are experiencing performance deterioration and harder fundraising. Private Equity (PE) funds have come forward in the present crisis backing on past growth in fundraising, valuations and volumes. The pandemic has significantly eroded the value of some investments and brought down the confidence of investors.
There is a pointy fall in deal-making within the short term; the returns over subsequent five to 6 years will depend upon how fund managers react over subsequent six to 18 months. Today, Private Equity (PE) firms have large sums of unused funds that they have raised but not invested. A large part of this money is predicted to be earmarked for emerging markets like India and emerging technologies.
SMEs are generally experiencing negative impacts on revenues, costs, and profitability. Further, SMEs are finding it hard to service debt, and increased risk could lead to increased funding costs, bankruptcies, and NPAs. Overall PE (Private Equity) market volumes in emerging markets are expected to contract over the next two to three years, both in terms of fundraising and levels of activity.
Current deals are deferred, as investors are waiting to ascertain the extent of injury that the COVID-19 pandemic has caused. There could be a V-shaped recovery in deal-making in the third quarter of this financial year and early 2022-23.
It has been estimated that a major fall of 40 to 60% in the private equity firms and venture capital investments will be seen in the year 2021 due to the restrictions imposed by the government amid COVID-19. PE/VC exits in 2021 are also expected to shrink considerably from 2019 levels.
A few of the challenges in deals are
Mismatch of valuation expectations between buyer and seller
Financial markets are significantly disrupted across the world. The pandemic has triggered a disturbance within the equity markets and market volatility has increased. There might be valuation challenges as sellers are reluctant because of mismatch in valuations. This would lead to delay in deal activity in most cases.
Venture debt funds and distress situation funds expected to be more active
There is a liquidity pressure on SME businesses due to COVID-19 related disruption in demand. PE (Private Equity) funds are expected to capitalize on this chance through innovative solutions like venture debt and bridge financing.
Expected change in completing due diligence
The present crisis has highlighted the importance of factoring in multiple scenarios and modeling unpredictable disruption in due diligence. Hence, the scope of due diligence has changed drastically over the past.
The vigilant investors are looking to stabilize their portfolios. On the other hand, the sellers are unwilling to spare their assets as there is a steep drop by valuations. Such a mismatch between the expectations of the customer and therefore the seller will create a hindrance in deal-making. It remains to be seeing how quickly the PE space will get over such market conditions.
Impact on Ongoing Transactions
Any transaction within the end of execution or negotiations is predicted to continue but at a slower pace and few postponed to a later date. The parties to the transaction will now look to amend their contract(s) to deal with the new risks in light of this crisis resulting in changes in various clauses, for instance, indemnity, material adverse change, long stop date, etc.
Innovations and brighter side post Covid-19
As in any time of crisis, opportunities will emerge for the industry to transform its business model and to support companies and economies differently. There are innumerable samples of how big or little firms have stepped up to the challenge by pivoting their normal business models to seek out and deliver low-cost solutions, sometimes in step with the government.
Fund managers are leveraging their strategic and operational know-how to help companies navigate the crisis and the post-crisis readjustments. Unlike banks or other financial intermediaries, PE Funds could contribute to the growth of industries by providing not just capital, but also operational capabilities to firms. FMs (Fund Managers) transfer knowledge and best practices that make businesses more innovative and increase dynamism in the wider market. Evidence shows that when the PE Funds of the industries are active it would grow sooner than others in terms of total production, value-added, total wages, or employment. Investors are identifying companies that started using latest technology to deliver better products, services and expected to assist them in adopting digitization to become more competitive and resilient.
Several megatrends are emerging like shifts in global supply chains toward localization and diversification that have a cross-cutting impact on many sectors, and the opportunities associated with these sectors could result in strategic changes and potential growth. Other megatrends are accelerating towards digital transformation, and focusing on impact-oriented investments.
Hence, amid and post this pandemic certain industry will continue to sustain and grow such as technology, healthcare, e-commerce and pharmaceuticals and due to this reason, private equity firms and venture capitalists are now seeking opportunities to invest in these long-term growth-oriented companies.
Compared to the 2008 global financial crisis, access to capital won't be a drag as PE and strategic investors alone are sitting on almost $5 trillion of dry powder (money), which needs to be deployed in some form.
Dealmakers are all working remotely, helping companies raise funds, initiated the strategic transaction, do M&A transactions, and in some cases, these deals have started and finished during the lockdown. So new benchmarks have been set and the world has adopted newer ways to close deals.
To conclude, Covid-19 shows that, as soon as there is a strong enough stimulus, things can change. This leads to remarkable innovations. Not being allowed to open their doors, for example, restaurants are shifting to delivery mode; schools suddenly do much of the teaching and the testing online. This has created the opportunity for innovations that can last even after the crisis.
About the Author
Shailesh Waghmare is a Business leader with 20 years of experience of impacting organizations through strategic decisions across M&A / equity funding, Financial Services, Consulting Services, MSME advisory, Skill/Education Management, social impact & livelihood and Marketing & Management Consulting. Passionate about contributing to society & organizations and dedicated to the cause of transforming lives &business through solutions and be a change maker. Shailesh could be reached at shailesh.waghmare@apohanconsultants.com