Many LPs with stalled private equity interests in the current slowdown have declared distributions to paid-in (DPI) the only fund assessment metric that matters, eschewing IRR as less revelatory of bottom-line performance. Pratithi Investments, the family office of Infosys co-founder Kris Gopalakrishnan, is not among them.

For Pratithi, ability to generate returns is a function of exit smarts. The boomtime of 2021 was a great time to exit – did the manager in question do so? If the answer is yes, a dearth of distributions during the current malaise may be more forgivable. DPI is still important, but so is pacing.

“As the market goes through cycles, the best managers will be disciplined about exits. Are they holding assets to get the most value out of two or three big winners, or booking some profits with partial exits? We prefer the more conservative approach, and we feel that this is better reflected in IRR than TVPI [total value to paid-in],” said Sheeba D’Mello, head of private capital at Pratithi.

“We do have to be patient through these downcycles. If you insist that people return money at whatever cost, you will get a suboptimal outcome. At the same time, if a fund is in year 10 and hasn’t returned at least 2x, that’s just a sign of poor management.”

Pratithi’s instincts for conservatism and patience appear to be at least partially attributable to an evolution in its approach to private markets. The 10-year-old family office started out investing directly in very early-stage start-ups and funds, leading to a large portfolio where it was difficult to add value and small cheque sizes meant outcomes were not seen as meaningful.

With time, Pratithi recognised it could be a more value-additive investor with a more compact portfolio and more exposure to mature companies. Direct investments are now limited to companies deemed to be growth-stage or late-stage.

Rebalancing act

Early-stage exposure has effectively been outsourced to sister concern Axilor Ventures, a seed investor set up and headed by Gopalakrishnan. Axilor raised about USD 23m for its first fund in 2018 and is targeting USD 100m for Fund II. Pratithi is an anchor LP and works closely with the GP, which operates independently.

“The next few years are likely to see funds differentiating themselves through expertise in a particular sector or strategy, greater operational value-add and partnerships with larger corporate entities,” D’Mello said.

“Traditional business houses are becoming more interested in the start-up space, with more family offices investing in funds or launching their own start-up programmes. The new funds are likely to be a bridge for traditional promoters to work with new-age start-ups.”

D’Mello added that a resurgence of interest in stable, capital efficient business models is another area where collaborations with traditional business houses and family offices can be beneficial for new founders.

Pratithi’s overall portfolio is relatively balanced between direct investments and fund commitments, and this is expected to continue as the two strategies are considered synergistic. Cheques for both direct deals and funds start at around USD 4m-USD 5m but can scale beyond USD 10m.

The target allocation for the portfolio is 80% public and 20% private. Participation in private equity and venture has increased in the past five to six years as the firm has tracked improved market depth in the form of a broader universe of quality founders, repeat entrepreneurs, and active fund managers, both homegrown and foreign.

In the more recent term, this backdrop has been supercharged by a bull run on domestic stock exchanges.

“In last year, public market investors found it difficult to deploy due to the high valuations. Some of them started to be more interested in private markets. Private markets are not uniformly attractive but it’s easier to find a good deal,” D’Mello said.

“Historically, private equity has not done as well as public markets in India, and it’s been very slow to return capital, so I can understand why people might not want to do more. But we are thinking that could change now. IPOs are fuelling more acquisitions, and that could kickstart a new cycle in terms of private equity.”

Key criteria

There are 25 GP relationships currently, including the likes of Chiratae Ventures, 3one4 Capital, Fundamentum, Stride Ventures, Blume Ventures, and Kae Capital. There have been some fund commitment in recent years, but most date back to the early days of the family office.

There is little desire to scale the roster much beyond this level, although additions are not out of the question, especially in priority areas such as healthcare. There is direct exposure to at least three healthcare service providers: Board Health, Sukino and People Tree Hospitals.

Filtering opportunities has become more challenging as the Indian market heats up and more private capital floods in. As Pratithi has maintained its due diligence standards, timeframes for processing the flow have stretched out.

“We spend a lot of time with the entire team, from the partners to the associates and analysts, to understand how well they work together and their long-term prospects,” D’Mello said.

“Are these the same people who will be managing our money 10 years down the line? Is this a good firm culture? Are they promoting people internally and outfitting them with the right skills as they move through their careers?”

The ability to engineer exits in terms of M&A and secondaries is a significant criterion in GP selection. This includes existing connections with potential acquirers and a portfolio that is generally visible to potential acquirers globally. What resources have been plugged into portfolio companies that are clearly not going to develop as IPO candidates?

“If they’ve managed to salvage the worst of their companies to get some value out of it, the fund manager is putting in the effort with the portfolio, rather than just waiting for a multi-bagger exit. We look at some of those finer points in terms of track record,” D’Mello said.

Time will tell

She observed that the Indian LP ecosystem is getting stronger, with family offices, domestic financial institutions and international institutional investors setting up larger offices and investing the time to understand the market and back the best fund managers.

The early LPs are only now beginning to see the performance of their investments from 10 years ago. Their learnings are trickling through the ecosystem, especially in terms of understanding the timelines for distributions and the impact of fees and carry on gross and net returns.

Public markets are on a roll, which makes the private market returns look less attractive. As a result, the next rounds of fundraising will see domestic LPs asking tougher questions, with higher expectations on returns.

“India will stay our main focus because there’s so much more to do here, but we do get opportunities from outside, and we may start to look at those in the next six to seven months,” D’Mello said. “So far, we haven’t had the clarity in regulations to do that, but that’s starting to change. We’re exploring what makes sense, but for now, that’s still mostly India.”