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June 21, 2012

Luis Miranda On Valuations

Former IDFC PE CEO Luis Miranda has started a on the Forbes India web site with a post on (what else?) valuations. And, given the topic, it's no surprise that several PE professionals have chimed in with comments.
It doesn’t make sense for investors to get a “cheap” deal or for entrepreneurs to con investors into paying too high a price. If this happens there is no true partnership and as the comedian Russell Peters said, “Somebody gonna get a hurt real bad”. India is a high-growth economy, irrespective of what foreign investors say and what the government does or does not do. And in a high growth economy it is even more difficult to predict future prices, volumes, competition, etc. So, if there is a serious valuation mismatch one has to look at structures to bridge the gap–if the entrepreneur wants too high a valuation, a structure can be worked out where if targets are not met, the investor’s shareholding in the company ratchets up.

Alternatively, and this is a framework that I prefer, the entrepreneur can agree on a lower valuation and earn out a higher shareholding based on meeting pre-set targets. The reason why I prefer this option is that it causes less stress on the company to meet tough targets (sometimes caused by external factors, like the 2008 global financial crisis). I have seen enough companies in recent times whose souls have been destroyed because the entrepreneurs are cutting corners to meet the high targets they set themselves up for when they closed their PE round at a high valuation. Entrepreneurs fail to realise that they can destroy their company or their relationship with an investor if they push for too high a valuation. If properly structured, they will end up with the same or higher shareholding if they meet their targets. And this is where investment bankers need to nudge both sides to close a “fair” deal. No one will grudge the other side if they both believe they have a “fair” deal.
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