How Private Equity Firms Make Money from Small Businesses in India

Introduction

Private equity firms play a powerful role in the growth of small businesses in India. Whether it’s scaling operations or entering new markets, a private equity firm in India offers more than just capital—they bring strategy, experience, and long-term vision. But how do these firms actually make money from small businesses?

In this post, we’ll break down the core ways private equity firms profit from startup investments in India, offer real-world examples, and share a practical guide for understanding their money-making model.

What Is a Private Equity Firm?

A private equity (PE) firm is an investment company that pools funds from wealthy individuals, pension funds, or institutions to invest in privately-owned businesses. These firms typically focus on buying a significant share or full ownership of a business, improving its operations, and selling it later at a higher price.

How Do Private Equity Firms Make Money?

1. Equity Ownership and Exit Strategy

When a private equity firm in India invests in a small business, they typically acquire a majority or significant minority stake. Their goal is to grow the company over 3 to 7 years and then exit the investment through:

Initial Public Offering (IPO)

Selling to another firm

Mergers or acquisitions

Real-World Example:

In 2019, Sequoia Capital India invested in Wakefit, a direct-to-consumer mattress brand. With the funding, Wakefit expanded rapidly, and the firm expects a strong return during exit due to increased brand value and profits.

2. Management Fees and Carried Interest

Private equity firms earn two main types of income:

Management Fee: Usually 2% of the fund’s total assets annually. This helps cover salaries, legal costs, and daily operations.

Carried Interest: Typically 20% of profits earned from a successful investment. This is the firm’s true earning potential.

3. Debt Structuring and Financial Engineering

Many private equity deals involve leveraged buyouts (LBOs) where the firm uses debt to finance a part of the acquisition. The firm then uses the small business’s cash flows to pay off the debt.

This strategy amplifies returns, but also involves risk.

4. Operational Improvements

Private equity firms often bring in new leadership, streamline operations, or introduce better technology.

Startup Example:

Fireside Ventures, a consumer brand-focused PE firm in India, invested in boAt, a popular electronics startup. They supported the brand in optimizing manufacturing and logistics, leading to better margins and higher valuation.

Why Small Businesses Attract Private Equity

Growth Potential: Small businesses can grow faster with capital and expert guidance.

Undervalued Assets: Many businesses are not using their full potential, making them ideal for value creation.

Diverse Sectors: PE firms target sectors like health tech, fintech, D2C brands, and education.

Step-by-Step Guide: How PE Firms Profit from Small Businesses

Identify promising startups – Often in growth-phase or undervalued

Conduct due diligence – Evaluate financials, risks, and potential

Negotiate and invest – Acquire a stake with clear terms

Add value – Improve operations, sales, and management

Track performance – Regular reporting and strategic tweaks

Exit at a higher valuation – Sell stake to generate profit

What Makes a Startup Investment Attractive in India?

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Scalable Model: Ability to serve large markets with limited added cost

Strong Leadership: Founders with a clear vision and adaptability

Clear Monetization Plan: PE firms avoid ventures with unclear revenue streams

Sector Demand: Health, tech, and education are highly favored

Expert Opinions

Rajan Anandan, MD at Peak XV Partners (formerly Sequoia India), says:

“Private equity success in India depends on identifying the right founders, not just the right numbers. Early-stage guidance is often more valuable than capital.”

Key Takeaways

A private equity firm in India makes money by buying stakes in small businesses, helping them grow, and selling their stake at a profit.

Startup investments in India are gaining traction due to a booming digital economy, young entrepreneurs, and rising demand.

Firms use multiple strategies including equity ownership, operational improvement, and financial leverage.

Investors earn both regular management fees and big payouts through carried interest after successful exits.

Final Thoughts

For small businesses, working with a private equity firm is more than just receiving funding—it’s about entering a partnership that focuses on long-term growth. For investors, it’s a calculated risk that can bring high returns with the right strategy.

If you're a startup founder or investor exploring opportunities, understanding how startup investments in India function through private equity can unlock both growth and financial rewards.