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‘Permanent’ capital: Vital differentiating factor for business
By Taponeel Mukherjee
Global trends in money management and business efficiency are a useful guide to build and scale Indian businesses, especially to increase the efficiency of capital usage.
One trend that has been in focus throughout the asset management industry, especially the private equity world, has been that of “permanent capital”. This is broadly defined as access to funds for long periods, instead of the usual seven to ten-year fund horizon that has been the norm in the private equity industry. Permanent capital funds focus less on exiting investments in a defined period – and the emphasis is more on generating potential long-run investment returns.
Investors have generated permanent capital through a variety of strategies. Some large investors such as the likes of Blackstone, Apollo & KKR have utilised Initial Public Offerings (IPOs) to generate capital they can then invest strategically. Apollo has also generated permanent capital through investing and managing assets for a retirement solution focused annuity business called “Athene”, which, through its annuity business, generates significant cash that Apollo has utilised to generate returns.
Access to a constant pool of capital has helped boost returns for both the capital provider and capital allocator.
The essential point to learn is that a higher degree of permanent capital allows businesses to access opportunities for longer time-periods, ride out periods of high market volatility and, most importantly, acquire assets at attractive valuations when rivals are unable to do so due to unfavourable market conditions or internal distress.
The lessons and advantages from permanent capital apply as much to companies as they do to asset managers. The vital question businesses must ask is whether they are building sources of permanent capital or, even better, are they improving the stability of cash flows available to the business – especially with a view on the next market downturn.
For a company or conglomerate, “permanency” of capital can be obtained through access to businesses that provide stable incoming cashflows. For instance, a firm focused on high-risk-return projects in the biosciences field must continuously evaluate whether it has a portfolio of royalty-generating patents that provide it with mission-critical capital inflows.
As mentioned earlier, in market downturns, stable cash flows can help shield businesses from the adverse funding conditions and assist a company in acquiring valuable assets across the industry. Most importantly, the steady incoming cash flows that provide the permanency of capital can assist a firm in continuing to pursue the high-risk-return projects that may yield significant investment returns in the future.
In a world where factors such as specialisation, patents and vertical integration can provide competitive advantages to firms, so can greater access to permanent capital. To frame the argument differently, firms that can have greater permanency to their capital or can unlock sources of permanent capital will have distinct advantages over their rivals.
For companies to succeed through permanent capital vehicles (PCVs), whether through private company platforms or structures such as Real Estate Investment Trusts (REITs), the aim must be long-term value-creation and not just short-term capital raising.
Creating market credibility through both efficient capital usage and managing investor relationships is vital. For businesses that are exceptional operators, PCVs are the avenue to partner with patient capital providers to generate value for all.
For investors looking towards emerging markets such as India, PCVs are essential, especially in the context of relatively lesser secondary market liquidity, longer investment horizons for value generation and smaller size of debt capital markets. The utilisation of PCVs to hold on to investments longer for value creation could be a vital factor. However, it will be crucial that PCVs, when utilised by investors or companies to raise and manage capital, avoid the issues that have been prevalent in some cases.
The focus must be on long-term value creation and not on capital “extraction”. Therefore, the PCVs must be structured to incentivise the operators to maximise long-term value and not focus on merely creating large investment vehicles to generate high fees.
As the capital markets and businesses in India evolve, winners and losers in highly competitive markets will get determined by a variety of factors, including sources of funds. Both the quality and quantity of funding available will be one of the fundamental factors that determine long-term winners. Permanency of capital offers some essential insights into improving one’s competitiveness.
(The views expressed are personal. Taponeel Mukherjee heads Development Tracks, an infrastructure advisory firm.)