Kenyan PE funds shun small firms despite high returns

Private equity investment in Kenya has hit new heights with recent announcements that Java Coffee House and Virtual City, a mobile technology services provider, turned to foreign firms for cash to fund their expansion plans.

In May, Emerging Capital Partners, an American private equity firm, announced its acquisition of a majority stake in Java Coffee House. The value of the deal was not disclosed. Acumen Fund announced it will be investing Sh130 million in Virtual City.

Pearl Capital said recently that it will give a Sh50 million loan, which can be converted to shares, to Wilmar Flowers, a floriculture firm based in Thika. Pearl Capital raised Sh2.2 billion in September 2011 from US and European investors, which it will invest in 15 to 20 businesses in East Africa.

But this raises a nagging question: Why are local financiers asleep instead of providing expertise and much-needed expansion capital to small and medium sized enterprises?

Lack of knowledge as to how private equity and venture capital industries work has been cited as one of the biggest hurdles in unlocking local sources of capital to fund SMEs.

“This is a relatively new investment avenue in Kenya and not many fund managers understand it,” said a partner at a venture capital firm who requested not to be quoted because he interacts with a number of fund managers.

He added that it is mostly high net worth individuals who are embracing the concept especially as they are being targeted by some of Kenya’s private equity firms like Centum.

How does private equity work?

A private equity firm is formed when partners form a fund where they contribute about two to three per cent of the capital required and then invite other investors who provide remaining capital.

Usually, the investors are often institutional investors in the US or Europe looking for higher returns, trusting their money with the individuals who have formed the fund.

The partners, who run the private equity fund, are paid collectively 1.5 to two per cent of the total worth of the fund annually as a management fee. The partners have the leeway to decide where to invest their funds and they look for a portfolio of companies in which to invest. Africa has been attractive because of the high returns often in double digits.

After several years of investment, the private equity firm can cash out from the companies it has invested in and return the profits to the investors.

The partners in the private equity firm keep 20 per cent of the profits and return 80 per cent to investors, making it a very handsome return for the managers who only put in about two to three per cent of their own cash.

There is cash available to strike private equity deals in Kenya, but the opportunity has not been aggressively pursued by institutional investors.

Most fund managers cite the fact that their hands are tied by their clients —such as companies— for whom they manage pension schemes.