Financial Management-II

Case Analysis

Surya Tutoring:

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Evaluating a Growth Equity Deal in India

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SUBRATA BASAK

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 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.

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Background:

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Engineering education is highly regarded in India. India produces about 700000 Engineering

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graduates annually and growing rapidly. Many parents wanted their children to study
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engineering IIT, one of the best schools in the nation and also well known internationally.
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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
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for 10,000 seats. Future demand for IIT enrolment (therefore tutoring services) looked to
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remain strong because available seats in engineering and other disciplines at the top schools
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had not grown as fast as the population and the literacy rate, making entrance to
undergraduate schools much more competitive.
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Surya Tutoring is one of India’s leading test-prep schools with more than 22,000 studying
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annually to prepare for IIT entrance exam. About 1600 / 1700 Surya students secure
admission in IITs with 10000 open seats. Surya’s 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
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this success was recruiting and retaining good faculty who were also IIT grads. But it faced at
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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 academy’s overall placement
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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 current pace. To achieve higher growth, however, it would
need more money for capital investments that would enable it to open centers and schools
across the country and beyond. It received to financing offers, one from ZenCap and the
other Blackgem. ZenCap, in addition to cash, offered connection that would help expand the
business, one idea was partnering with technology companies (connected to ZenCap) to
conduct remote classes using video conferencing facilities around India. On the other hand,

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 Financial Management-II

being connected with an international firm Blackgem, could be an advantage, to Surya with
regards to its plans to open international centers such as Sri Lanka, Dubai.

Private Equity market in India

Private Equity in India was clustered into three geographic centers- Mumbai, New Delhi and
Bangalore & was divided into three main groups of firms:

Big bulge bracket firms: These were mainly based in the United States or Europe & generally
hired Indians who had grown up in the United States or Europe but wanted to work in India.
Some firm in this category included Apax Partners, Blackgem, KPMB, etc.

Large Indian corporate conglomerates: These corporate private equity players such as
Reliance and Tata invested across the board in various industries and technologies in India.

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Independent Indian firms: These firms were smaller in both fund size as well as partners

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and generally invested in much smaller transactions than the big bulge bracket firms. Firms

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such as Tano, Avigo and Zencap came under this category.

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Problems Identification:
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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
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not be tapped by being restricted to Kota and hence expansion was required. Many tutoring
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institutes had already started offering their services in metros by opening branches.
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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.
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1.) Blackgem: A big bulge bracket fund with international reputation

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2.) Zencap: A small indian firm based in Mumbai.

Following questions need to be answered in this case study.

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 How much money did Surya need?

Compare the two term sheets and discuss the differences in details.
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
 Which offer should Sharma accept?
 Did the deal structure provide appropriate incentives and governance?
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Analysis & Solution:

Proposed investment is smaller than typical for private equity firms. Both proposals were for
minority deals that left the founder with majority share in the company. The company
generates enough cash flow to sustain its growth at the current pace, but to achieve higher
growth it needed to deploy more money in the form of capital for opening centers and
schools across the country, or seek technology to enable lower-cost solutions.

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 Financial Management-II

Firstly, we determine which one we should choose based on the fair value of Surya Tutoring.
First we need do the valuation of the firm based on Free Cash Flow method. For that we
need to have discount rate, future growth rate etc. Some of the parameters to calculate
discounted cash flow are given and some of the parameters we have assumed. The
calculations are given below.

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This valuation of Rs. 481 crores is in line with the valuation from two private equity firms.
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Offer Comparison:

Items Zencap Blackgem

Valuation Rs.440 crore post money @12 Rs.600 crore post-money @ 16 times PAT
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times PAT for Audited FY 2010. for Audited FY 2010

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Investment Rs.44 crores maximum accounting Rs.150 crore for 25% shareholding.
Offered for 12% shareholding.
Type of Stock CCPS Series A preferred stock.
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Director on The investors will have a right to
Board nominate one director on the
Board of the Company.
Other At the time of closing the Brand of
“Surya” presently held by the
Promoter personally will be
transferred to the company for a
consideration of Re.1.
The holders of Series A preferred stock
will be entitled to elect two directors. Any
additional director will be elected by the
holders of preferred stock and common
stock voting together.
The Preferred stocks may be converted at
any time at the option of the holder, into
common stock shares.

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 Financial Management-II

Share structure of the company as offered by Zencap:

Post-financing Post-financing
Zencap Pre-financing (pre-warrants) (post-warrants)
Security No. of shares % No. of shares % No. of shares %
Common Founder 15,00,000 100 13,36,955 82.0 13,36,955 78.4
Family 1,63,043 10.0 1,63,043 9.6
Series-A Preferred(Zencap) 1,30,434 8.0 2,04,545 12.0
Total 15,00,000 100 16,30,432 100 17,04,543 100

Share structure of the company as offered by Blackgem:

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Blackgem Pre-financing Post-financing

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Security No. of shares % No. of shares %

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Common-Founder 15,00,000 100 15,00,000 75.0

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Series-A Preferred(Blackgem) 5,00,000 25.0

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Total rs e 15,00,000 100 20,00,000 100
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Secondly, we have to consider other advantages and disadvantages from both private equity
firms. Surya Tutoring gains competitive advantage from ZenCap as ZenCap understands local
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market and business culture more than BlackGem. This allows ZenCap to target the right
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customers and create better assumptions on business analysis, which enables it to make an
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expansion more easily. However, ZenCap values the firm lower than Blackgem and provides
less capital. For an analysis of BlackGem, as it is an international company with relatively
larger size, it lacks of local market knowledge. Furthermore, Blackgem has acquired a
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majority stake, while Sharma is not interested in giving up the control of his firm. However,
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beside from an offering of more capital, the main advantage of Blackgem is that it has more
experiences and connection worldwide, which will offer a great opportunity for Surya
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Tutoring to expand abroad.

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Recommendations:
Though the offers made by both the firms are lucrative considering NPV of Surya Tutorials,
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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.

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 Financial Management-II

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 ZenCap’s term sheet provided for offering
equity to faculty; Blackgem did not.

Hence keeping Mr. Sharma’s 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 Blackgem’s investment
offer is more so is it’s 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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