Case Analysis

Surya Tutoring:
Evaluating a Growth Equity Deal
in India

SUBRATA BASAK
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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 India’s 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.
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 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 academy’s
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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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, 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.

Independent Indian firms: These firms were smaller in both fund size
as well as partners and generally invested in much smaller
transactions than the big bulge bracket firms. Firms such as Tano,
Avigo and Zencap came under this category.

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.

Following questions need to be answered in this case study.

 How much money did Surya need?

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 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?

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.
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.

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

Offer Comparison:

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Items Zencap Blackgem

Valuation Rs.440 crore post money Rs.600 crore post-money @ 16
@12 times PAT for Audited times PAT for Audited FY 2010
FY 2010.
Investment Rs.44 crores maximum Rs.150 crore for 25%
Offered accounting for 12% shareholding.
shareholding.
Type of CCPS Series A preferred stock.
Stock
Director on The investors will have a The holders of Series A preferred
Board right to nominate one stock will be entitled to elect two
director on the Board of the directors. Any additional director
Company. will be elected by the holders of
preferred stock and common
stock voting together.
Other At the time of closing the The Preferred stocks may be
Brand of “Surya” presently converted at any time at the
held by the Promoter option of the holder, into common
personally will be stock shares.
transferred to the company
for a consideration of Re.1.

Share structure of the company as offered by Zencap:

Post-financing Post-financing
Zencap Pre-financing (pre-warrants) (post-warrants)
No. of No. of No. of
Security shares % shares % 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:

Blackgem Pre-financing Post-financing

Security No. of shares % No. of shares %
Common-Founder 15,00,000 100 15,00,000 75.0
Series-A Preferred(Blackgem) 5,00,000 25.0
Total 15,00,000 100 20,00,000 100

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 market and business culture
more than BlackGem. This allows ZenCap to target the right customers

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and create better assumptions on business analysis, which enables it to

make an 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 majority stake,
while Sharma is not interested in giving up the control of his firm.
However, 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 Tutoring to expand abroad.

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 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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