Short-lived Promise

Sanjeev Narula, Lilliput’s founder and promoter, who was accused of dodging the company’s financial accounts, has blamed the PE firms for trying to halt the company’s anticipated public offering of ` 850 crore, which would have funded expansion and cut debt. It now stands at over ` 500 crore and in the process of getting hold of majority stake in the company. At present, Narula owns a 55 per cent stake in the company with the PE investors holding the rest. In the wake of this development, the nominees of the two PE investors, Matthew Levin and Scott Gilbertson, and the four independent directors have resigned. The external auditor, S R Batliboi, has resigned too. The eight-member board also included Narula and the company’s CFO, Arun Jain.

Now that the company is looking at resolving the issue through an out-of-court settlement, hence citing court proceedings, the company has refused to speak to the media. Lilliput’s initial public offering (IPO) has been deferred for an indefinite period, which seems hardly surprising considering the circumstances that the company is embroiled in. Now, all that Lilliput can do is have their financial accounts audited by an independent auditor and try to get new investors on board to buy the existing investors’ stake. 

Such is the complexity of the case that all the respective parties have declined to entertain queries from the media.

Where did it go wrong?

The strain in relations was born out of the fact that a typical PE transaction is undertaken in India with investors trying to get closely involved in the operations, while such intrusion is not keenly welcomed by the promoters. Bain Capital and TPG had bought a large minority stake in Lilliput Kidswear last year for around $ 86 million. It was partly a secondary transaction with previous PE investor, Everstone Capital. This high-profile deal was brokered by the advisory major Ernst & Young, raising the hopes of many apparel retailers who were also seeking such capital infusion for their business establishments.

Lilliput Kidswear hit the headlines this month as its private equity investors took the unusual step of not approving the annual accounts of the company in a board meeting held recently. The situation reached its peak when meetings scheduled to take place somewhere around September did not transpire, primarily due to the absence of independent directors, who later resigned from the board. There were noises coming from all corners, which made the investors believe that all is not well within the company.

“Too many investors for a brand do not make a rosy picture from the outset. Investors are putting in their fundings into the brand, hence it is obvious for them to be authoritative with regards to how the brand is functioning operationally as well as financially," says Harminder Sahni, Founder & Managing Director, Wazir Advisors. “In such cases, a definite miscommunication plays an integral role, forming the crux of such disputes occurring at regular intervals," Sahni adds.

The moment the news came out, Lilliput filed a case against the PE investors in Delhi High Court on October 3, seeking an ad-interim relief to stop them from hampering the operations of the company or harming the image of the firm. The court restrained the PE firms directly or indirectly from acting to the contrary and forbid the investors from giving unpleasant publicity to Lilliput. It also restrained the two PE firms from selling their stakes in the company before offering them to Narula.

New beginnings

The promoters of kidswear company Lilliput Kidswear Ltd are now on the lookout for new investors in order to get the brand moving in the right direction. The company has been accused of not maintaining proper accounts by the investors, while the promoters have blamed the PE firms for looking to take over the control of the firm and in process, are looking to derail the public issue, which acts in their benefit.

“As far as I can recall, there was an IPO listing, which was supposed to happen sometime ago. Instead, a majority of the boardroom executives resigned from their respective positions," says Purnendu Kumar, Associate Vice President, Technopak.

Withstanding tough times, Lilliput Kidswear Ltd has been offering discounts as high as one-third of price in all its stores to hasten cash-inflow to meet the day-to-day expenses after banks froze all sanctioned loan disbursements on investor complaints. In the mean time, Narula had asked the court to restrain the two investors from exiting the company.

Bain Capital and TPG, replying with regards to Lilliput’s petition, have sought immediate investigation of the company’s financial statements. According to media reports, the two PE firms, in their reply to the Delhi High Court, have asked for a forensic examination of Lilliput’s accounts and also sought to appoint an independent auditor to investigate the finances of the firm. The situation at Lilliput has made banks more cautious and they have decided not to release the loan amount, leaving the company with no other option but to generate more footfalls and sales by offering discounts.

Raise the parameters for investigation

According to experts, the due diligence process is expected to become more rigorous, which will impact deals in the short-term. This could also affect the investors’ interest in retail, particularly apparel companies. “Prevention is possible and the only way I see this becoming a reality is much better due-diligence. Independent auditors are just there to help the parties in relation to the due diligence and as they act as a neutral in such scenarios, favoritism can certainly be counted out, which is exactly what SS Kothari & Co. will bring on to the table," Kumar adds.

Mahesh Murthy, Founder, Pinstorm, and Managing Director, Seedfund, opines, “The Lilliput case is a wake-up call for investors to truly investigate the ‘soft’ side of due diligence and not just go by the hard numbers because there is little credibility in the audited accounts of a company. I would urge PE funds to get a sense of real revenues and real profits from other sources than the financial statements."

Strong corporate governance is the primary requirement for any PE fund investor, which calls for transparent documentation, well-structured decision making units and reporting systems. PE fund players look for highly motivated management team, with ambitions set high and having proper strategy to achieve the goals. To achieve financial gains, the management team needs to work very hard. 

Unfortunately, in India, authoritative principles have been poor in privately held companies, allowing culprit fraudsters to escape.

What’s in store?

The need of the hour is to get new investors on board. The promoters are also looking to reconstitute the entire board.

The key problem facing Lilliput is to manage its relationship with the financial institutions. The company has sanctioned a debt limit of around ` 200 crore from its bankers, but the lenders have apparently frozen the arrangement in view of the developments, which is completely natural. The Delhi High Court has appointed SS Kothari Mehra and Co. as the auditor to probe the company’s books, who will be assisted by the investors. The silver lining to this development is Bain Capital and TPG giving consent to raise ` 500 crore through private placement. The bankers, Avendus and Grant Thorton, will do the much desired equity infusion for regular business operations.