There is no shortage of entrepreneurial ambition and potential in India. Small and mid sized businesses flourish in several parts of the country addressing consumer needs and demands. There are close to 12,000 mid market companies (between INR 150 – 750 crores of revenue) in India, and they are the growth engines of the economy filling crucial need gaps in various industries and geographies and providing local employment. The vast majority of them are family owned and operated businesses and several of them have even competed against large multinationals on the strength of their knowledge of local cultures and networks.
Several of these companies aspire to be larger and more efficient in their operations. However, their growth is restricted by their accessibility to talent, financial capital and mentorship.
Many of the mid market companies require capital for making investments required for scaling up their businesses and propelling future growth. But, while larger companies have the opportunity to access equity or debt financing from public and private markets, including private equity, it is a very different story for mid size companies. Only one in six mid market companies is publicly listed. For many of the others the main source of capital is bank or lender financing and that comes with the burdens of high interest and tedious approvals.
The relative nonchalance of private equity firms towards this sector is linked to capital requirement. The amount of funding that can be absorbed and effectively utilized by mid size companies is not very high. For private equity firms the effort and time conducting due diligence is fairly similar for a Rs. 100 crores deal or a Rs. 1000 crores deal, and with a commitment to deploy sizeable capital in India, there is a much stronger bias towards larger deals. As a result, while there is ‘too much money chasing too few deals’ on the larger end of the spectrum, an aggregate annual funding gap of over Rs. 60,000 crores has emerged for mid market companies.
The disconnect between supply and demand of capital is not unique to India. Recently in the UK, a scheme to encourage small business growth along the lines of Germany’s Mittelstand model was announced by David Cameron. The UK government is painfully cognizant of the fact that many small businesses are unable to grow due to the “inadequate system of business finance” and are falling through the “valley of death” funding gap. Britain estimates that there is an annual funding gap of GBP 1 billion and the government is taking steps towards plugging that gap by guaranteeing bank loans and co-investing. Through a concerted action plan towards funding these companies they are hoping that in time this will lead to the creation of “a British home-grown Microsoft, Google or Tata.”
The German government has carefully orchestrated the Mittelstand model over several decades, resulting in highly efficient and specialized mid-sized companies, which power Germany’s exports and GDP. Over 95% of Mittelstand companies, often referred to as the “hidden champions”, are family owned and together they account for over half of Germany’s economic output and almost two-thirds of its employment. Most of these companies are export oriented and focus deeply on continuous innovation in their products and processes to maintain their competitive advantages.
Recognizing the fact that small and mid size enterprises form the backbone of the economy, the German government has provided enabling conditions for their growth. Mittelstand companies are the beneficiaries of Germany’s highly acclaimed apprenticeship system, which provides them with highly skilled workers through vocational training institutions. And they have various sources of capital ranging from public bonds to private equity. These companies have kept the trust of their investors and proven to be resilient. Even during the recession of 2008-11, which saw unemployment rates across Europe spiraling out of control, the Mittelstand companies increased jobs by 1.6%.
Can the Indian government learn from these countries and do more to address systemic issues faced by mid market companies? It surely can, but in the meantime mid market companies represent a unique opportunity for private equity investors.
The mid-market segment is in need of “smart money” and investors that will go beyond writing the cheque and serve as mentors, advisors and thought partners. With the limited availability of strong managerial talent, there is tremendous scope of value add by providing these companies with best practices in a variety of fields including sales and marketing, financial controls and accounting, supply chain management and organizational and leadership development.
While this segment has been historically neglected and underserved, many of the companies are open to partnering with a private equity company that will help them in shaping the business strategy, guide them and work closely with them to ensure execution and create value. The fact that the investor is also financially vested in their growth and success is the icing on the cake.