Given the wall of private equity (PE) money coming in to Africa, do we have the type of investment deals that equity funds are looking for? Is the same model used in the Europe and North America sustainable in Africa?
According to African Private Equity and Venture Capital Association (AVCA), PE funds invested $8.1 billion (Sh810 billion) in African companies in 2014, the second highest total ever after the $8.3 billion in 2007. The 2014 figure is also an improvement over the $ 4.1 billion in 2013 and $2 billion in 2012.
As more equity funds pour into Africa and more money is raised to fund businesses, there is more scramble for investable deals. But, how many African businesses can pass the requirements associated with equity funds?
Recently, the Abraaj Group, an investor operating in global growth markets, completed its full exit of its investments in UAP Holdings. UAP Holdings is a pan-African insurance holding company with subsidiaries in Kenya, Uganda, Tanzania, Rwanda and South Sudan. Also, Helios Investment partners just completed their sale of stake in Equity Group.
Last year, Leapfrog Investment acquired a majority in Resolution Insurance, which has operations in Kenya and Tanzania. Catalyst principal partners acquired a stake in Mimosa Pharmacy. Emerging Capital Partners invested in the Java chain outlets and Planet Yogurt.
So, what does this tell us about PE funds in Africa? Are they only targeting companies with this type of stronghold and ownership? Are SMEs missing out on the inflow of PE money?
One of the challenges faced by PE funds while sourcing for deals is that majority of businesses in Africa that would pass for some of their investment criteria are family owned.
PE investors require an individual or owner of business to relinquish a percentage of share ownership. This means that decision making will now involve another party, which majority of SMEs have a hard time comprehending.
What many forget is that PE funds normally invest in a lifespan of five to seven years and then exit the business. They could either sell their stake to strategic partner, back to the owner or through an initial public offer. Given that African stock markets are relatively undeveloped much of the exits have been through strategic partners.
So, are SMEs missing out on the PE funding? According to the World Bank, an SME is an enterprise with a maximum of 300 employees, $15 million (Sh 1.5 billion) in annual revenue, and $15 million in assets.
Many PE funds are focused on SME businesses with strong growth prospects. With debt financing proving to be either inaccessible or unaffordable to many, equity funding is an option to consider though one may argue that equity financing would be costly in the long run.
The decision of equity versus debt financing will depend on the business owner and the stage of business and risk appetite.
Chamas have become a common practice in our cities. How many of the investment groups have considered buying partial ownership of companies? Are they willing to take the risk on businesses with promising trajectories? With some of these chamas having large amounts of money they would be able to provide the necessary seed capital to promising companies.
But, don’t forget the saying, “Never invest in a business you can’t understand.” The financial industry has continued to grow and has numerous financial advisors at your disposal. Take advantage and seek professional advice where needed.
There are numerous pros and cons on PE investments. One big advantage is the “governance dividend”. Corporate governance is an important element to private equity investors. It has a direct material influence in companies receiving the funds.
Measures such as the appointment of independent directors, better functioning of the audit and compensation committees and increased board oversight play a role in improved business health.
Why would someone argue that a venture capital (VC) mindset is the kind of model that’s needed in Africa? Venture capitalists usually fund businesses that are in early stages of growth and are looking forward to substantial amounts of investment. Private equity funds usually focus on companies that have existed for at least three years.
Given that majority of Africa’s population is relatively young, with more than half under 25 years, would it be reasonable to state that we need the PE concept on a VC model where businesses would be supported to grow into large substantial companies?
But, one would argue that the risk born by a company without a history is so high that a PE fund would dare not consider. It could be the reason we have witnessed an increase in business incubators in Africa. Incubators support startups and companies in the initial stage of development through collaborative programmes.
By providing workspace, seed funding, mentoring and training, these programmes help entrepreneurs solve some of the problems associated with startups. On the other hand we have accelerators, which are the second stage of the programme. These focus on assistance on operations and more funding for businesses.
As we continue seeing more influx of equity funds and not forgetting the pension funds, we expect more deals in the continent. The direct impact on business growth would result to accelerated job creation and improved economy.
The author is the co-founder at Anchorage Limited, A management and financial advisory firm