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.
A good example is the pension contributions held by Kenyan fund managers. There is about Sh471 billion—enough to build 17 Thika Super highways, under management by fund managers, according to figures released by the Retirement Benefits Authority (RBA) earlier this year.
Each fund manager is allowed to invest up to five per cent of the cash they manage in unquoted securities— this includes investment in private equity and venture capital. But the RBA report showed most managers allocated a paltry one per cent to invest in unquoted securities.
Then there is the aspect of government regulation which keeps away many of local investors from private equity and venture capital deals.
“The local funds are there but they try to stay away from media because they could become targets for government regulation.
That is why they prefer to close everything out of media circles,” said Johnson Nderi an analyst at Suntra Investment Bank, citing some of local fund managers who set up funds to invest in SMEs.
Government regulation of private equity firms in US and Europe has hit headlines for the better part of this year.
The US government had proposed to double the tax rate from 15 per cent to 30 per cent on profit rewards from buyout deals .
Players in the private equity space say this could also be the case in Kenya if the sector grows.
Currently, most of the companies pay corporation tax of 30 per cent and they don’t get taxed on the profit they make from each buyout or deal.
Taxing them as corporations means they have a good advantage of deducting their overall business costs which reduces the size of the pie government has claim to as tax.
But still another challenge has been that Kenya’s well known private equity or venture capital firms only consider deals of a certain threshold.
Centum and Olympia Capital are two listed private equity firms but they focus on large investments, typically in hundreds of million of shillings, way above the thresholds of many SMEs.