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Surya Tutoring:
Evaluating a Growth Equity Deal in
India
SUBRATA BASAK
Financial Management-II
Executive Summary:
In 2010 Surya Tutoring was a fast-growing tutoring academy for high
school students aspiring to get admission to the prestigious Indian
Institute of Technology (IIT). Surya's CEO, R. K. Sharma, wanted to expand
its reach beyond Kota (a city of 1 million people in the northern state of
Rajasthan), which had become the centre of the IIT prep school industry
and home to tens of thousands of students studying for the rigorous IIT
entrance exam. Sharma knew there was vast untapped potential in the
teeming Indian metropolises of Mumbai, Chennai, Delhi, and Bangalore, as
well as in foreign markets such as Dubai and Australia. Sharma had
received term sheets from two private equity firms willing to finance
Surya's expansion. By the end of the month he needed to decide which to
accept: the offer from big bulge bracket fund Blackgem, or the one from
ZenCap, a small Indian firm based in Mumbai with which he had become
intimately familiar during the past year.
Background:
Engineering education is highly regarded in India. India produces about
700000 Engineering graduates annually and growing rapidly. Many
parents wanted their children to study engineering IIT, one of the best
schools in the nation and also well known internationally. Indian parents
would make major sacrifices to ensure an outstanding education for their
children. More than 500,000 students sat for the IIT entrance exam every
year to compete for 10,000 seats. Future demand for IIT enrolment
(therefore tutoring services) looked to remain strong because available
seats in engineering and other disciplines at the top schools had not
grown as fast as the population and the literacy rate, making entrance to
undergraduate schools much more competitive.
Surya Tutoring is one of Indias leading test-prep schools with more than
22,000 studying annually to prepare for IIT entrance exam. About 1600 /
1700 Surya students secure admission in IITs with 10000 open seats.
Suryas value proposition was based on its high success rate- every year
its students claimed more than 15 % of the open seats at IIT. Key to this
success was recruiting and retaining good faculty who were also IIT grads.
But it faced at least 2 risks in maintaining its advantage: first, increased
competition could make it more difficult to place as many Surya students
at IIT, and second, expanding Surya would decrease the percentage of its
students who gained entrance even if the academys overall placement
numbers stayed constant. Surya had a strong record of success in its first
eleven years, which had established its name and credibility. It generated
enough cash not only to sustain itself but also to continue to grow at its
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Financial Management-II
Problems Identification:
Though there was a slow but sure shift occurring in the education tutoring
sector and the demand for the same was steadily growing all across the
nation & demand potential could not be tapped by being restricted to Kota
and hence expansion was required. Many tutoring institutes had already
started offering their services in metros by opening branches.
In order to expand Surya Tutoring, Mr R K Sharma needed investments and had
received investment proposals from two private equity firms in this regard.
1.) Blackgem: A big bulge bracket fund with international reputation
2.) Zencap: A small indian firm based in Mumbai.
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Financial Management-II
Compare the two term sheets and discuss the differences in details.
Which offer should Sharma accept?
Did the deal structure provide appropriate incentives and
governance?
This valuation of Rs. 481 crores is in line with the valuation from two
private equity firms.
Offer Comparison:
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Financial Management-II
Items
Valuation
Investment
Offered
Zencap
Blackgem
Rs.150
crore
shareholding.
for
25%
Other
Pre-financing
No. of
shares
%
15,00,000 100
15,00,000 100
Post-financing
(pre-warrants)
No. of
shares
%
13,36,955 82.0
1,63,043 10.0
Post-financing
(post-warrants)
No. of
shares
%
13,36,955 78.4
1,63,043 9.6
1,30,434 8.0
16,30,432 100
2,04,545 12.0
17,04,543 100
Pre-financing
No. of shares
%
15,00,000 100
15,00,000 100
Post-financing
No. of shares
%
15,00,000 75.0
5,00,000 25.0
20,00,000 100
Financial Management-II
Recommendations:
Though the offers made by both the firms are lucrative considering NPV of
Surya Tutorials, but the conditions mentioned in the Term Sheet of both
the Investors is deterring factor. On one hand we have Zencap, an Indian
Firm having expertise in dealing with smaller Indian firms & also had prior
experience related to education sector and had good connections with
numerous small and mid-level businesses in India. On the other hand we
have Blackgem, a significantly bigger PE Investment firm compared to
Zencap having international repute. It can help the Company cater to its
international aspirations Dubai etc. Moreover it is offering very high
investment amount compared to Zencap.
The Founder Mr. Sharma, appears to be capable of running the company,
but a strong CFO was needed to manage growth and improve company
record-keeping. The company had a total of 280 professors, 70 of whom
were graduates of IIT. Sharma had not shared much equity with the rest of
the team. He is willing to create a separate shareholder pool of equity to
be given to faculty and senior management ZenCaps term sheet provided
for offering equity to faculty; Blackgem did not.
Hence keeping Mr. Sharmas wish to expand in Indian as well as
international markets and apprehensions to excessive dilution of his stake
in the company and willingness to expand in the Indian markets first, we
suggest to with Zencap offer. Though Blackgems investment offer is
more so is its stringency in controlling the company like 2 Directors on
board, any further (apart from pre-selected 4) will be with joint consent of
Blackgem & promoters and Drag-along clause are big detterent.
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