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The Conundrum of Private Equity Funding Landscape

, January 19, 2023, 0 Comments

The funding landscape, especially the Private Equity (PE-VC) money, is concentrated in certain industry segment pockets that is defined by the asset size – asset light, asset medium and asset heavy – as well as by the product segment and business model such as B2B, B2C, B2B2C, D2C, and so on.

While an industry ecosystem has a value chain from basic industries to the peripheral industries where each forward segment in the value chain is dependent on the immediately preceding segment, the funding landscape (PE-VC money) to these industries is quite skewed and the flow of money is not evenly channeled across the segments in the value chain.private-equity-funding-marketexpress-in

Before we dig further in spreading out the anomaly of the funding landscape, let us first take a moment to understand the segment value chains from Basic to the Peripheral structure. Back in our school days, we all would have studied the cell structure of living organisms with the nucleus in the center and the cell membrane at the periphery of the cell. The industry ecosystem, like the cell structure, is the same, but with a defined value chain. Like the cell structure, I call the basic industry as the “Nucleus” and the asset-light enablers as the “Peripheral industry” or the cell membrane within that industry ecosystem.

Basic Industry is the Nucleus and the Asset-Light Enablers are the Peripherals
Any industry ecosystem (be it automotive, healthcare, education, hospitality, travel, financial services, consumer goods, etc.) is recognized by its basic industry segment or the “Nucleus” and the survivability and growth of the industry ecosystem is dependent on the survivability and growth of the basic industry i.e., the Nucleus. While the ancillary industries within the industry ecosystem forms an integral part of the value chain, the “peripheral industries” (asset-light enablers) are used as a tool to make the industry more dynamic, more accessible, boost consumption by inculcating the ease of conducting business transactions and enhancing the speed of business. These peripheral industries are in no way a substitute to the basic industries, but a mere enabler and are totally dependent on the survivability and growth of the basic industries. In fact, from the point of view of the peripheral industries, every segment in the industry value chain is a potential basic industry for the peripherals if they have an enabler to offer for each of these segments. Therefore, for any industry ecosystem, the enterprise enablers (B2B) and the consumer delivery enablers (B2C) of the basic industry (Nucleus) are the peripherals, which are always asset-light as opposed to the basic industries that are asset-heavy.

So What’s The Conundrum That We Are Trying To Explain?
Every segment in the industry value chain, periodically, needs the lifeline with adequate flow of blood i.e., funds to not only manage their existing operations, but also to fund the growth and capture higher market share. However, when it comes to funding (especially the PE-VC money), that’s not the case. While the asset-light peripheral industries are getting huge funding tractions, the basic industries (Nucleus) are the ones getting ignored, and, at times, they are cash starved – and hence The Conundrum. This incongruity in the funding landscape can be further explained by simplifying and getting to the roots of the problem in what I call “watering the plant theory”.

Watering The Plant Theory
An industry ecosystem is like a plant with roots, trunk/stem and branches. The roots are the main source to provide nourishments – water and nutrients – that passes through the trunk/stem to the branches. Now if the watering (to be read funding) of the plant happens only at the branches (because the branch bears the leaves/flowers/fruits) while ignoring the roots that may get very little to no water, the plant sooner or later would perish. When that happens, the branches too, as a cascading effect, would perish even though they received a significant share of water.

That precisely is the conundrum in the funding landscape where bulk of the money is chasing the peripherals while ignoring the very roots (basic industry) that forms the very basis of the industry ecosystem, thereby, at times leaving them short of funds to even continue with their existing operations. Unless the funding approach is holistic, the anomaly in the landscape will continue.

Take for example, if the airlines/hotels are not well-funded and because of which they had to scale down their capex/operations, it will, in turn, badly impact the online aggregators (OTAs) that may have received significant funding and perhaps at a very high valuation. Similarly, a Health-tech would badly suffer (despite heavy funding) if the hospitals and its ancillaries are not well-funded, or a Pure-tech (B2B) would suffer despite funding if the industry they cater to are not well-oiled in terms of funds.

This leads to the problem of creating “asset bubbles” in certain pockets, which sometimes becomes an uncontrollable issue for the investors and asset managers leading to writing-down of their investments.

The Conundrum Creates Asset Bubbles with Unjustifiable Underlying Fundamentals
When bulk of the money chases very few businesses because of them being in the periphery, it creates a bubble in certain pockets of the industry ecosystem. These asset bubbles are formed because the asking valuation begins to rise significantly as a result of huge fund availability in those pockets. The underlying fundamentals to these spiraling valuations may most certainly be not justified, leading to an inevitable end of asset markdowns (in other words, booking of losses). Without naming, one can recall that some of these peripheral businesses got publicly listed on Indian bourses through IPOs in the recent past, and the way the market reacted to the asset price vis-à-vis the business fundamentals post-listing, thereby leading to significant scaling down of their underlying asset prices.

So In Essence To Conclude…
We fully understand that the PE-VC money is sector focused, theme-based, business model based, and the fact that it’s investors’ right, at the end of the day, where they wish to invest. However, we feel that such defined funding channels at some point become counterproductive for reasons explained throughout in this article, and instead the investing approach should be holistic and should be focused, purely, on good business fundamentals. While watering the plant, one should ensure that the roots get adequate water supply because only then the peripheral branches would eventually blossom.

The opinions expressed in this article are the author’s own and do not reflect the view of MarketExpress – India’s first Global Analysis & Sharing Platform or the organization(s) that the author represents in his personal capacity.