Private Equity (PE) funds emerged at the start of the 2010s as a key source of capital for businesses, muscling in on an area previously dominated by debt and capital markets. However, the activity has slowed down in the last few years as many struggle to deliver the high returns they promised their fund contributors.
The Business Daily talked to Chris Maranga, the newly appointed Acumen East Africa regional director for insights on the issues behind the shift in the industry.
Acumen has funds worth nearly Sh50 billion for investment across its global markets. What are the sectors you are targeting in Kenya?
We first have early stage investing or startups venture capital, for which we raise money from philanthropies, then for growth of businesses going to maturity. We look at three sectors, starting with agriculture, especially smallholder farmers. In order to grow that industry, we connect them with markets and value addition.
We also look at education, lately through vocational training. In our research, we found that vocational training has the highest employment to population ratio, at about 79 percent, as opposed to 68 percent from the other university graduates.
Only about one percent of people who graduate in Kenya, and Africa, go into vocational training. So there's a huge gap there, and thus a market.
A third focus area is energy, where we look at productive use of energy and people who have had no access to electricity. So, we look at things like home solar systems, and we have invested in companies like D-light and SunCulture, which provide these services.
We’ve seen a relative slowdown in PE investments compared to a decade ago. What has changed to inform this shift?
It is to do with PE industry itself, and secondly, the macro environment. Many PE funds were raising a lot of money between 2010 and 2012, when there was that boom in PE funds coming up in in this market. Prior to that, there were maybe two or three PE funds. But after 2010, there were more than 50 operating here.
On average, a PE fund has a 10-year cycle—five years for investing and five years for managing your exit— since limited partners want their money back after a decade.
Between 2010 and 2020, we had disruptive elections in 2017-2018, and then Covid-19 from 2019. So many PEs did not deliver the results that they had promised.
The limited partners like development finance institutions (DFIs) have been hesitant about new rounds of fund raises from 2020, and are increasingly investing directly on their own.
PE funds have also become cautious against aggressive investments and throwing money at anything, and that depresses the activity in the industry. On macro level, many of the businesses targeted by PEs in the past decade are the ones being sought by banks for lending, and may not need to deal with a PE fund.
PE funds like Acumen are therefore looking at early stage businesses for opportunities. We call it the missing middle. But the days of big deals are probably behind us, but you will see many small deals being announced.
To give context, what sort of returns were promised back in 2012, and what did the partners get in terms of net returns?
In general, most PE funds were saying they would deliver in the region of 15 percent internal rate of return in US dollars. Many of them did not give a return because there were several write offs for the reasons stated above. Some gave high single digit returns, but a significant number were only able to offer low single digit returns on average. My view is that the average return given by the PE funds in East Africa was probably low single digit.
We are seeing co-investments with DFIs. Is this a consequence of the low returns we saw earlier?
The industry—PE funds, venture capital (VC) and DFIs— have learnt a painful lesson after working in silos. They have now realised that their challenges are interlinked across the value chains, and therefore, that partnerships are essential if the macro systemic and market driven challenges are to be addressed properly.
Club deals or co-investment is one of the ways to mitigate risk, because each of the investors has different experiences, and has a different way of managing that risk. The trend now is that if a DFI decides on a direct investment, they want to go in together with a PE or VC fund that has experience in that sector. We call them sector specialist funds.
How are high interest rates in the west affecting your ability to raise funds?
US Treasury bonds are paying on average seven percent. By the time you add country, industry, currency and difficulty-of-doing-business risk for Kenya, you're probably looking at these investors asking for an equity return in the high teens and in some cases over 20 percent. It is very difficult to get businesses that can provide that kind of return.
This has however led to local funds looking at opportunities that can enhance or protect their returns, such as export oriented companies which generate foreign currency income or which have locked contracts with outside buyers that can guarantee steady forex flows.
DFIs are also giving long term concessionary and even in some cases, local currency financing. That reduces the risk profile of a company, and you can use that to show investors abroad that you have cut risk and therefore they can accept a lower return.
Exits in the PE and VC sector have mainly been to fellow PEs, and hardly through the capital markets. Can you see this changing?
There are three types exits—to a strategic investor, a financial investor such as a fellow PE fund, or through the stock market.
A strategic investor puts a premium on our business because they have a reason for buying it and a plan to grow the business. So that will usually be the first place we look to exit because you can get the best premium there.
For the financial investor, the advantage is that PE funds operate within the same code of governance. So a PE fund finds it easy and convenient to close the deal because of confidence that you have already put in the right governance and structure systems. Execution risk is low, but maybe not the return because you're negotiating with a savvy counterparty.
In the capital markets, the advantage is that you can get a very good valuation, but there is a challenge of regulatory and compliance requirements before being allowed to list.
Success on the capital markets is also driven by factors outside your control, like liquidity, regulatory framework, investor appetite and the state of the economy, unlike deals with a strategic or financial investor. You also have to pay stockbrokers, transaction and legal advisors and registrar, on top of perpetual listing fees.
However, the capital markets might give you the best return, since you get to set the price and let the market take it or not. It should therefore be natural exit place for PE funds, and we are working with the Capital Markets Authority to make it more vibrant and liquid to facilitate such exits.
