dhriti bhatta 2014 pe investment in africa [external submission]

2014

Dhriti Bhatta

Fletcher School of Law and Diplomacy

7/31/2014

Rise of Private Equity in Africa

Changing Landscape and Imminent Challenges With Cases from Kenya

Submitted in partial fulfillment of the degree of Master of Arts in Law and Diplomacy at the

Fletcher School of Law and Diplomacy

Advisor: Professor Patrick Schena

Acknowledgements

I would first like to thank my thesis advisor, Prof. Patrick Schena for his invaluable advice and all the spent with me discussing and clarifying my many questions. I also have to thank him for his thought-provoking questions and for helping me look for answers to some of them. I learned a lot about private equity and emerging market investments from our conversations. I would further, like to thank the Institute for Business in the Global Context and Dean Sheehan at the Fletcher School, along with the Institute for Global Leadership at Tufts University, for providing me the opportunity to travel to Kenya and gain key insights on the private equity market there. My visit would not have been fruitful, had it not been for the kindness of every single person I met and talked to while in Nairobi. I would also like to thank my host family (Mr and Mrs Kafle) for their warmth and space. I would especially like to thank representatives of all of the PE funds who agreed to interviews, along with the representative of the East Africa Venture Capital Association, KenInvest, Jetro-Kenya and VP-Floriculture. I would also like to further thank Mr. Lenka Dewa, Ms. Anne Maina, Ms. Hazel Ojany, Ms. Caroline Eboumbou, Ms. Dia Martin, Prof. Peter Nyongo and Mr. George Omondi for their time and engaging conversations. I learnt a lot more about Kenya, the private equity sector, agribusinesses and SME investments from them. I would like to thank my parents for always believing in me and making this soul-searching journey in graduate school possible. I pray that I can do for my children what they have been able to do for me. Finally, I am most thankful to my dear husband for all the support he has provided me during the course this thesis. I am grateful for the delicious warm tea and snacks he would bring me every day to rejuvenate my wandering mind while I pondered this difficult topic.

Table of Contents

1. Introduction .......................................................................................................................................... 1

2. Private Equity Landscape in Africa: Facts and Figures .......................................................................... 4

2.1 Deal Types and Size ......................................................................................................................... 4

2.2 Regional Breakdown ..................................................................................................................... 10

2.3 Sector Breakdown ......................................................................................................................... 15

2.4 Exits .............................................................................................................................................. 19

3. Key Characteristics of African PEs: A Deeper View from Kenya and Beyond ..................................... 25

3.1 Study Methodology ....................................................................................................................... 25

3.2 Fund Structures ............................................................................................................................. 27

3.3 Limited Partners ............................................................................................................................ 32

3.4 Investment Size & Type ................................................................................................................. 33

3.5 Deal Structures, Fees and Post-investment Involvement ............................................................. 34

3.6 Sector Analysis .............................................................................................................................. 35

3.7 Regulations .................................................................................................................................... 38

3.8 Challenges Facing Fund Managers ................................................................................................ 39

4. Key Discussion Points and Policy Issues .............................................................................................. 40

4.1. Effects of Impact and Commercial Investors Investing in the Same Space ................................. 40

4.2 Providing Operational Support to SMEs ....................................................................................... 43

4.3 Attracting Venture Capital in Africa .............................................................................................. 44

4.4 Increasing Government Attention to PEs in Africa ....................................................................... 45

5. Conclusion ........................................................................................................................................... 46

Bibliography ............................................................................................................................................ 49

2014 Dhriti Bhatta Page | 1

Rise of Private Equity in Africa: Changing Landscape and Imminent

Challenges with Cases from Kenya

1. Introduction

Frontier markets include economies that are less developed compared to emerging markets, but

are still investible given their positive growth and improving governance structures. Although

frontier markets have smaller financial sectors and lower liquidity compared to emerging

markets, they can be highly attractive to investors who are in search of high, long-term returns,

and who want to diversify their portfolio with investments that have low correlation with other

markets. Of the 24 frontier markets listed by MSCI, five are African economies, namely,

Nigeria, Kenya, Mauritius, Tunisia and Morocco. With a population of over 1 billion and an

average GDP per capita of over $900, consumer demand in Africa is increasing and the region is

witnessing a boom like never before.1 Furthermore, demand for public utilities like energy and

infrastructure services has also soared in keeping with the needs of growing businesses and

households. This increased demand for goods and services has led to a surge in foreign

investments in the region to close the financing gap that hampers the growth of these key sectors

on the continent.

1 World Bank, “Africa Development Indicators 2012/13,” http://data.worldbank.org/data-catalog/africa-

development-indicators

http://data.worldbank.org/data-catalog/africa-development-indicators

http://data.worldbank.org/data-catalog/africa-development-indicators


Foreign Direct Investment in Sub-Saharan Africa increased by 11% in 2013 and reached over

$35 billion (USD).2 Investors from countries like the United Kingdom, United States and China

were among the top foreign investors, while the regional giant, South Africa, has also become a

crucial player and is leading the path for intra-Africa investments. The three main sectors

receiving FDI included technology, media and telecoms (TMT), retail and consumer products

(RCP) and financial services.3 However, with only a few liquid and developed capital markets in

the region, aggregated portfolio investments to Sub-Saharan Africa have not seen the same kind

of growth and stability as FDI. Portfolio investments have dwindled in the region since the

financial crisis of 2008-09 and have remained negative for most of those years, although some

growth nations like Kenya have seen growing and positive flows. The overall negative trend for

the region seemed to end in 2012 with over $10 billion in portfolio investment. However, the

number again fell to negative $673 million in 2013.4

Despite poor capital market structures and volatile movement of portfolio investments, an asset

class that has recently gained prominence among international investors in Africa is private

equities. Private equity includes investments in private companies that are not publicly traded on

a stock exchange. A new index for African private equities, created by Cambridge Associates in

collaboration with African Venture Capital Association, reveals that African PE funds

outperformed U.S venture capital and are roughly in line with the broader Cambridge Associates

2 IMF World Economic Outlook Database 2014,

https://www.imf.org/external/pubs/ft/weo/2014/01/weodata/index.aspx 3 Ernst & Young, “Executing Growth: 2014 Ernst & Young’s Attractiveness Survey,” 2014.

4 IMF World Economic Outlook Database 2014

https://www.imf.org/external/pubs/ft/weo/2014/01/weodata/index.aspx


emerging markets private equity and venture capital index for the decade ending in 2012. The

index posted an 11.2% annualized return for those 10 years. Furthermore, for the decade ending

in 2008, African private equity outperformed the 10-year emerging market benchmark.5 Given,

such high returns, PE penetration in Sub-Saharan Africa has seen an increasing trend. The ratio

of PE investments to GDP in the region increased from 0.06% in 2010 to 0.09% in 2011.6

Furthermore, the number of fund managers and investors working in the region has been rising in

the last couple of years.

While there has been much attention lately on how private equity deals are evolving in Africa,

there is little analysis on the specifics of deal sizes and distribution, fund operations and deal

structuring, and other issues regarding PE operations in frontier markets of Africa. This report

will try to address some of these gaps by first looking broadly at private equity deals in the

continent, and then by narrowing the analysis to a much smaller sample of firms in Kenya, one

of the fastest growing PE markets in Africa. The report will utilize both secondary and primary

data . Secondary data sources will include facts and figures from reports by mainstream business

consulting firms like E&Y, Deloitte and others. The primary source of data comprises mostly

qualitative information collected by the author over a short trip to Kenya in the winter of 2013.

The first part of the report will provide a comprehensive description of the private equity sector

in Africa, followed in the second part by key characteristics of some of the PE firms in Kenya.

5 AVCA & Cambridge Associates, “New Index For Africa Private Equity Reveals 11% Annualized Return for 10 Years

Ending September 2012”, April 8, 2012, http://www.avca-africa.org/new-index-for-african-private-equity-reveals-11-annualised-return-for-10-years-ending-september-2012/ 6 Avanz Capital, The Private Equity Climate in Africa: Embracing the Lion, 2012.

http://www.avca-africa.org/new-index-for-african-private-equity-reveals-11-annualised-return-for-10-years-ending-september-2012/

http://www.avca-africa.org/new-index-for-african-private-equity-reveals-11-annualised-return-for-10-years-ending-september-2012/


Using this analysis, the report will draw attention to some key issues currently facing the PE

sector in Kenya in the final section, and in some instances, provide recommendations on the way

forward.

2. Private Equity Landscape in Africa: Facts and Figures

2.1 Deal Types and Size

Private equity firms have traditionally segmented their market in three stages—venture capital,

growth financing and acquisition/buyout financing stage. PE firms that invest in the venture

capital stage, more popularly known as venture capitalists and/or angel investors, make seed,

start-up and early business investments. Seed investments are made to help companies develop

product or business ideas and to undertake market research. Start-up investments, on the other

hand, involve investing in companies that already have business plans and are ready to initiate

their operations. Finally, early business investments are made in companies that have initiated

their operations. The growth financing stage of PE investments is quite different than these early

venture capital investments. In this stage, PE firms finance businesses to reach their full capacity,

expand their operations and/or plant capacity, and even assist them in strategic acquisitions by

larger companies. Finally, in the acquisition/buyout financing stages, PE firms provide funds to

acquire other companies or use leverage to buy out investee companies themselves or provide

funds to their internal management to do so.


Although all forms of PE investments are seen in Sub-Saharan Africa, growth financing

dominates the PE market in the region.7 Most PE investments are happening in firms that are

expanding their market share to capture growing consumer demand. Such expansions have taken

the form of value-chain extensions, enlargement of distribution channels and increment in

international/intra-regional trade, among others. As stable economic growth and increased

consumer demand are recent phenomenon in many African countries, PE investors could capture

huge growth potential by investing in well-performing companies that are strapped for resources

needed for business expansion.

7 AVCA, Guide to Private Equity in Africa and 2013/2014 AVCA Member Directory (London, 2014).


Venture capital, on the other hand, has not gained the same kind of prominence in Sub-Saharan

Africa as growth financing, although angel investors are increasing their attention to the space.

While VC is more present in South Africa, the biggest PE market in the region, other regions

have seen fewer instances of such investments. According to KPMG and SAVCA, investments

into seed, start-up and early stage businesses contributed to 9.3% of cumulative unrealized

investments in South Africa in 2012, which amounted to only 16.3% of the number of

investments that year.8 Such figures are difficult to find for the rest of the regions, as the

proportion of venture capital to overall investments is very small. Nevertheless, venture capital

funds for tech-related investments, especially for the telecommunication and payments sectors,

are rising in Africa. There are growing numbers of accelerators and tech-hubs appearing in

countries like Kenya, Nigeria and Ghana, which are increasingly attracting networks of angel

investors. Even in South Africa the telecommunications and software sectors make up over 30%

of venture capital investments.9

Similar to VCs, buy-outs of all kinds have also been limited mostly to deals in South Africa.

Lack of leverage in less-developed financial markets outside of South Africa has deterred LBOs

in those regions. According to Merger Market Groups, “PE buyouts targeting Sub Saharan

countries decreased for the second year in a row, down 18.2% by value during 2013 (US$ 0.9bn)

compared to 2012 (US$1.1bn).” This amount accounts for 3.5% of total Sub-Saharan mergers

8 KPMG and SAVCA, KPMG and SAVCA Private Equity Survey, 2013, 32.

9 Stephan J Lamprecht and Gert Louis Van Der Walt, 2012 SAVCA Venture Solutions VC Survey, 2012, 12.


and acquisitions, a decrease of 5.2% in 2012.10

Buy-outs are decreasing even in the South

African market. They decreased from 36% in 2011 to 31.4% in 2012.11

PE investments can also be segmented according to their investment size, and the size of

companies in which PE firms are investing. Investment size in Sub-Saharan Africa ranges from

as little as 50,000 USD to over 400 million USD. Firms that execute smaller deals, mostly less

than 5-10 million USD, invest in Small and Medium Enterprises (SMEs). Although the

definition of SMEs varies across investors, the parameters used to define them include maximum

revenue or revenue turnover, maximum asset or asset turnover and maximum number of

employees. The benchmark for these three indicators varies across the region and depends on the

size of an economy.

According to AVCA, based on the disclosed financial details of 53 transactions, the aggregate

value of African deals increased from 1.6 billion USD in 2012 to 3.2 billion USD in 2013.12

Furthermore, the number of deals also increased from 77 in 2012 to 98 in 2013. The average deal

size for the region was 60 million USD in 2013. However, excluding two big transactions—IHS

Mauritius Ltd’s 1,035 million USD investment in telecommunications and Delonex’s 600

million USD in oil and gas in Kenya—the average deal size decreases to 30 million USD.

10 Merger Market, Sub-Sahara Africa M&A Trend Report, 2013, 3.

11 KPMG and SAVCA, KPMG and SAVCA Private Equity Survey.

12 E&Y, Private Equity Roundup: Africa, 2014, 13.


Furthermore, as AVCA’s data does not capture many of the smaller transactions taking place all

over the continent, it is expected that the average size is even smaller for the region.13

Furthermore, of the 53 disclosed deals to AVCA, 53% of the deals were below 10 million USD,

whereas 28% were between 10-49 million USD. Only a small proportion of the deals were above

50 million USD—4% between 50-99 million USD, 11% between 100-499 million USD, and the

remaining 4% of the deals were above 500 million USD.14

In a different dataset complied by

EMPEA, which contains fewer financially disclosed deals than the AVCA dataset, deals less

than 25 million USD have consistently captured over 60% of the investment volume from 2009

13 E&Y, Private Equity Roundup: Africa.

14 AVCA, African Private Equity Deal Dashboard 2013, 2013.


to 2013.15

These figures provide good reason to believe that a large percentage of PE investments

in Africa are going to SMEs. However, with the maturing PE market, large commercial investors

are also increasing their presence in the region. There is a high likelihood that larger deals are

only going to increase in Africa, if it continues to see stable economic growth.

However, there are no publicly accessible datasets available to analyze how many of the deals

fall under the VC, growth and buy-out categories, and what size of deals each of these

transactions encompass.

15 EMPEA, Sub-Saharan Africa Data Insight, Sub-Saharan Africa Data Insight (Washington, D.C., 2013).


2.2 Regional Breakdown

As data on private equity deals are not publicly available, most information on such deals is

privately collected through surveys by various firms. Depending on the respondent size, this

information on PE deals could differ vastly across different surveys.

According to an analysis by Ernst and Young (E&Y), PE investors are increasingly venturing

into newer markets in Sub-Saharan Africa, in contrast to their established approach of targeting

only South Africa, the most developed country in the region. By compiling data from EMPEA

for 2008 to 2012 and from AVCA for 2013, this report finds that between the years 2008 and

2010, deals in South Africa received 57% of total PE funding in the region and accounted for

44% in terms of the number of investments. “However, from 2011-13, South Africa just received

20% of the overall PE investment in Sub-Saharan Africa in deal size and 19% in terms of deal

volume.”16

This information shows that PE firms have become more optimistic of the business environment

on the continent and are comfortable exploring other frontier and emerging markets in the region

beyond South Africa. According to the 98 deals collected by AVCA in 2013, West Africa

received the largest number of deals at 33%, followed by East Africa at 26% and Southern



Africa at 19%. Central African, North African and Multi-regional deals captured 9%, 6% and 7%

of the deals respectively.17

Comparison of PE activity in South Africa versus rest of Sub-Saharan Africa

17 AVCA, African Private Equity Deal Dashboard 2013.


However, a separate survey by Deloitte in 2013, contradicts AVCA’s findings. The survey with

reported value of 3.69 billion USD from 46 deals with disclosed financials shows that only 15%

of the deal value was accounted for by West African deals. In contrast, 50% of the deal value

was from continental deals, 13% from Southern African deals, 4% from East African deals and

the remaining 18% were spread between Central African and cross-regional deals. When we look

at the same information using deal volume instead of deal value, we see a slightly different

picture, although the analysis still contradicts AVCA’s findings. The survey recorded a total

number of 84 deals. In this case we find that only 29% of the deals are Continental, and East

Africa leads with 31% of deals. Southern Africa follows with 22% of deals, followed by Central

Africa with 8.5%. Finally, West Africa and other cross-regional deals make up the remaining

9.5% of the deals.18

18 Deloitte, 2014 East Africa Private Equity Confidence Survey: Clarity and Distinction, 2014.


This information tells us that about two dozen deals that are spread across the continent made up

the majority of deals by value in Sub-Saharan Africa in 2013. Furthermore, individual deal sizes

in East Africa were much smaller compared to the rest of the region. Even though the region

received maximum number of deals for the continent, together they accounted for about 4% in

terms of deal value. Moreover, the average deal value in West and Central Africa was much

larger than that of East Africa. Although the numbers of deals these regions received was

considerably less than East Africa, they captured a quite significant proportion in deal value.

Finally, Southern Africa still played a crucial role within the PE market in Africa as it received a

significant number of deals of decent size.

Moreover, another report by Riscura, also a well-respected advisory and consulting firm for PE

investments based in South Africa, contradicts some of the findings from both the AVCA and

Deloitte report, especially the prominence of Southern Africa and the contrast between East and

West Africa. From an undisclosed sample of deals, collected from a number of public data

sources and gathered from their internal database and network, Southern Africa dominates the


PE investment space in terms of number of deals at 61% of all deals recorded. West Africa

follows with 19% of deals, whereas East Africa comes third as opposed to first in the Deloitte

survey.19

There is a strong possibility that the Deloitte report reflects underreporting in West

Africa as compared to East Africa, where more recent PE firms are open to sharing information

about their numerous but smaller deals. As the AVCA report also has more deals from West

Africa, we have a stronger reason to believe this. Moreover, according to Riscura, the proportion

of Pan-African deals is also very low, instead of being second in the Deloitte survey. As the

Riscura report does not mention deal values, it is difficult to make a comparison across data

sources.

There is no conclusive evidence whether there is greater PE activity in recent times in East

Africa versus West Africa, although there is some evidence to believe that the average size of

West African deals is larger than East African deals. Both regions seem to be playing an

important role in bringing investments to regions other than Southern Africa and the well-

established markets of South Africa. East Africa is particularly doing more than other regions in

the continent to integrate and simplify cross-border trading and business. This is definitely

helping the region to attract more foreign investors. One of the reasons Pan-African or

Continental investments seem greater in one report and not as much in another might be that

South African firms or firms headquartered in South Africa are executing deals throughout the

continent. The Riscura report might have categorized such investments as South African,

19 Riscura, Bright Africa: A Guide to Equity Investing on the Continent 2014, 2014.


whereas the Deloitte survey might put them under Continental. Finally, North Africa, although

having the second most developed private equity market in the region after South Africa, is

under-represented in all of the reports.

2.3 Sector Breakdown

Unlike the diversity in regional spread of PEs among different data sources, we see more

consistency in figures related to sectoral spread of investments. An AVCA 2013 survey, with the

maximum number of reported deals among all the different sources (N=98), shows that

consumer-driven sectors such as financial services and agribusiness recorded the most number of

deals in 2013, totaling 34%. The technology sector captured 10% of the deals whereas oil and

gas covered only about 6% of the deals. A more precise breakdown of the deals in the dataset is

shown in the graph below.20

20 AVCA, African Private Equity Deal Dashboard 2013.


Similarly, the Deloitte report (N=84) also showed that the highest proportion, in terms of number

of deals, were in consumer-driven sectors like financial services, manufacturing and

agribusiness. About 15% of them were in the manufacturing and financial services sector each,

whereas the agribusiness sector captured 12% of the deals. Furthermore, the telecommunications

sector captured about 8.3% of deals and extractive industries, which include sectors like oil and

gas and mining, seized about 4% of the market.21

However, the representation of sectors changes once we analyze the spread of the deals

according to deal value. For the Deloitte dataset with disclosed financial details of 3.69 billion

for 46 deals, extractive industries comprised about 58% of the total deal value, followed by

infrastructure at 11%, manufacturing and industries at 10.5%, financial services at about 8% and

telecommunications at 7.5%. This shows us that transactions in sectors like mining and oil/gas

21 Deloitte, 2014 East Africa Private Equity Confidence Survey: Clarity and Distinction.


that have traditionally received large sum of foreign investments in Africa still hold the largest

share of the total PE investments in the region. However, the numbers of deals in these sectors

are not as numerous as compared to deals in consumer-driven sectors. This information,

combined with increasing purchasing power of African consumers, offers us strong reason to

believe that PE growth in Africa will continue to occur in consumer-driven industries. Deals

such as the Abraaj Group and Danone’s combined acquisition of Fan Milk International, West

Africa’s leading manufacturer and distributor of frozen dairy products and juices, in June 2013

provide further evidence of such PE activity. With equity stake of at least 400 million USD22

,

Fan Milk’s acquisition is reportedly the largest PE deal within the “Fast Moving Consumer

Goods” sector in African history.23

22 Ibid.



Further analysis using an EMPEA dataset from 2010 to Q3 of 2013 provides a somewhat similar

picture of the sectors attracting PE investments, compared to the AVCA dataset. Energy and

natural resources, telecommunications, banking and financial services and other consumer

industries received most PE attention in Africa between 2010 and 2013 Q3. An analysis by

E&Y, using data from EMPEA for this period, finds that banking and financial services had the

largest number of transactions over the period, with 40 transactions and an aggregate value of

772 million USD, for all deals that reported financial information. Energy and natural resources

followed with 27 transactions totaling 1.2 billion USD, media and telecommunications had 9 (1.3

billion USD) and consumer industries had 692 million USD worth of transactions. The banking

and financial services led with the most number of deals, followed by the energy and natural

resources between 2010 and Q3 of 2013.24

However, as deal values were not reported for each

deal within each category in the sample, we cannot deduce which among the four sectors had the

highest value of transactions. Furthermore, when we total the deal value in the four sectors for all

the three years, we find that the aggregate amount is just over the value of deals for 2013 alone,

as recorded by other sources like AVCA and Deloitte (3.2 and 3.6 billion USD). As such, we

have good reason to believe that the EMPEA database does not contain information on a number

of deals. Hence, although this data can be used to confirm that the same sectors, as those

highlighted in the AVCA report for 2013, have been generally prominent in Africa in the last

few years, lacking complete information, ranking each of these sectors in terms of transaction

value and volume is difficult.

24 Ibid.


2.4 Exits

Private equity firms invest in companies with the expectation of ending their association once

they have raised the latter’s value and made them attractive for sale, usually in 5 to 7 years. They

expect to exit the businesses at a higher equity value than what they initially paid for, and make

the bulk of their return on investment from these exits. Therefore, exits are of prime importance

to any PE firm and the potential exit opportunities affect their decision about whether or not to

invest in a company. The ease in completing exits also strongly affects a firm’s ability to raise

funds from other investors who invest in their fund (LPs). A figure that is most often used to

analyze PE investors’ gains is EV/EBITDA.25

By comparing the EV/EBITDA amount that the

PE firms pay for a business at origination with the EV/EBITDA value they receive when they

exit the business, we know how much they gain from the investment.

There are a few alternatives that PE firms can use to make exits: Initial Public Offering (IPO),

Trade Sale, Secondary Buy Out, Leveraged Recapitalization. Through an IPO, PE firms list their

portfolio companies on the stock market for the first time, and sell their shares to the public. In

countries with strong capital markets, IPOs are one of the most popular methods of exits, as they

enable PE investors to realize the highest return of investments when the market conditions are

right. However, IPOs are usually expensive, time consuming and are subject to strict regulatory

requirements and are, thus, quite risky.

25 EV, or Enterprise Value, is calculated by: EV = Market Capitalization + Total Debt - Cash


Trade sale is another exit route that is commonly used by PE firms. Through trade sale, private

equity investors sell all of their shares held in their portfolio companies to a third party, which is

usually a company that has strategic interest in buying the portfolio company. Trade sales are

much simpler, quicker and more efficient to execute than IPOs, as negotiations are usually

limited to a single buyer. However, one of the major risks is that the portfolio company, at least

their management, could be resistant to the sale, since the change in control often ends up

replacing the company’s management. “A trade sale might also entail serious business risks as

the buyer is oftentimes a competitor of the company, which will inevitably obtain confidential

business information during the negotiation process.”26

Secondary buyout is another popular exit method that PE firms adopt whereby they sell their

portfolio companies to another PE investor. This method is usually faster than IPOs and trade

sales. One of the main reasons PE firms follow secondary buyout is that they might reach a point

when they are not willing or able to finance the portfolio company anymore, even without it

company being ready for a sale or IPO. “In that case, selling the company to another private

equity firm which sees potential in further developing the company might be a reasonable

solution.”27

Secondary buyouts can also be carried out when management of portfolio companies

want to change their financing source from one PE firm to another.

26 Hungarian Private Equity and Venture Capital Association, “Exit Routes in Private Equity Transactions,”

http://www.hvca.hu/pevc-explained/private-equity/exit-routes-in-private-equity-transactions/ 27

Ibid.

http://www.hvca.hu/pevc-explained/private-equity/exit-routes-in-private-equity-transactions/


Finally, leveraged capitalization is another way through which PE investors extract their capital

from the portfolio company by substituting their equity financing in the company with debt. As

such, PE investors do not sell the company to other shareholders in this process, and instead raise

debt for the company through banks or corporate bonds. After raising the debt, they use this

amount to cash out their equity investment. To do so, the management of the portfolio company

buys the PE firm’s shares using the debt amount. “The most important advantages generally

associated with leveraged recapitalizations are that investors can remain in control whilst still

receiving payment and the possible tax benefits compared to other types of exits.”28

However, a

leveraged recapitalization can overleverage a business, which can eventually lead to financial

difficulties and further hinder operations.

A survey on PE exits in Africa by Ernst and Young and AVCA recorded 118 transactions

between 2007 and 2012. The actual number of exits however, could be expected to be even

higher as a lot of PE firms keep information on sales and purchase private. The current survey

provides a positive picture of the exits market in Africa. The region has mostly seen an

increasing trend in exits since 2010, and 2012 witnessed the most number of exits since the

financial crisis of 2008-2009.29

The average holding period of a PE firm, however, was higher in

Africa than any other region of the world at 5.1 years. Given the nascent PE industry, and a lack

of human capital in the region, it only seems obvious that PE firms would have to engage a little

longer with their portfolio companies before they are ready to take the exit route.

28 Ibid.

29 E&Y and AVCA, Harvesting Growth: How Do Private Equity Investors Create Value?, 2013.


African PE Exits in comparative perspective

Note: Exits data for Latin America & US from 2007-2011, Europe from 2006-2012, and Africa from 2007-2012

In terms of geographical spread, South Africa accounted for about 42% of the exits and the

remaining 58% was spread around other regions in Africa. West Africa had the second highest

proportion of exits at 25%, followed by East Africa, North Africa and Southern Africa

(excluding South Africa) all accounting for 11% each.


Moreover, in terms of sectors, the financial services sector had the highest proportion of exits at

23%, followed by other consumer-driven sectors like industrial goods at 13%, food/beverages

and agriculture at 9% and telecommunications at 8%, among others. As the number of

transactions in the financial services sector has outnumbered most other sectors, it is not

surprising that the highest number of exits is happening in this sector too.

With regards to the methods used to exit PE deals, trade sales dominate in Africa. Trade sales

have consistently accounted for the majority of all exits since 2007 to 2012, with the exception

of 2008 where they captured 41%. Local and regional strategic buyers play the most important

role in trade sales, and the latter have become more prominent since 2010. Most of the regional

buyers originate from South Africa, signifying the increasing importance of South African

businesses for the entire African continent. Multinational companies, on the other hand, only

make up a small proportion of trade sales and their prominence has been decreasing since 2010

due to unstable global macroeconomic conditions. Their share decreased from 31% in 2007-2009


to 15% in 2010-2012. However, when we stratify the trade sales data according to deal sizes, we

find that multinationals have equal presence as local and regional buyers among deals that are

above 50 million USD. Therefore, as larger PE deals enter Africa and the global macroeconomic

environment also becomes more stable, multinationals could be expected to play an important

role in trade sales in the region.30

Exit routes for PE investments in Africa and focus on trade sales

Exit year & population for PEs in Africa

Source: E&Y and AVCA 2013

Categories of buyers in trade sales by enterprise value (in million USD)

Source: E&Y and AVCA 2013

Furthermore, secondary buyouts have increasingly become more popular in Africa. The largest

proportion of secondary buyouts occurred in 2012, at 23% of all deals. As PE firms are

becoming more comfortable about investing in Africa, secondary buyouts can be expected to

increase in the region. However, the proportion of IPOs in the region is considerably low. As

most of the capital markets in the region other than the Johannesburg Stock Exchange are

30 Ibid.


relatively illiquid, PE firms have avoided IPOs. Instead PE houses “more commonly buy and sell

minority positions in listed companies,” and “9% of the exits were via stock sale on the public

market in 2012.”31

Finally, leveraged capitalization has also been rare in the region like IPOs, as

credit markets are still illiquid and nascent in the region.

Finally, with data on equity multiples from 62 transactions, the report by E&Y and AVCA

claims that PE exits have been quite lucrative in Africa and that they have provided higher

returns than the Johannesburg Stock Exchange. The report claims that PE exits gave investors

almost double the returns they would have received at the Johannesburg Stock Exchange. The

highest returns were recorded in East and West Africa, where the markets are least mature and

are growing rapidly. However, a discussion usually missing in the analysis of PE exits is how

they are complicated due to co-investments by a number of PE firms in a portfolio company.

Most PE firms in Africa act as co-investors and have minority stakes in portfolio companies. In

these cases, the coordination required to align the interest of all investors can make exits time

consuming and inefficient.

3. Key Characteristics of African PEs: A Deeper View from Kenya and Beyond

3.1 Study Methodology

Private equity firms across various regions in Africa have evolved to develop some similar

characteristics. East Africa was relatively late to adopt private equity. However, with rising

growth, better governance and increasing regional coordination from the reestablishment of the

31 Ibid.


East African Community, Private equity firms have made headway in the region recently. To

gain a deeper understanding of the operations and characteristics of private equity in Africa, the

author conducted primary research in Kenya, the biggest PE hub in East Africa. With the

generous support of the Institute for Business in the Global Context (IBGC) and the Dean’s

Office at the Fletcher School, along with the Institute for Global Leadership at Tufts University,

the author traveled to Nairobi, Kenya in December 2013 to conduct a qualitative study of some

of the PE firms, along with other actors within that ecosystem. From December 15, 2013 to

January 14, 2014 the author used an unstructured questionnaire to interview representatives of

six PE firms and others at the East Africa Venture Capital Association, Kenya Investment

Authority, JETRO-Kenya, and VP Floriculture.32

The author talked to several other contacts in

Nairobi who had knowledge of and contacts within the PE space in Kenya in order to secure

these interviews. Over a dozen PE firms and other actors in Kenya were approached for

interviews, but only a few firms returned inquiries about their funding structure and operations.

In the first section, the questionnaire generally included questions to capture the broader

characteristics and workings of PE firms in Kenya, along with the business climate in the

country. It then followed with narrower questions related to PE transactions, specifically within

the agribusiness sector. Most of the interviewed personnel were either upper-level management

staff or investment associates in the firms. Given their busy schedule and, thus, limited time it

would not have been possible to get into details of PE investments in all sectors. The author

32 JETRO-Kenya is the business and trading branch for the Government of Japan in Kenya and VP Floriculture is one

of Kenya’s largest agribusinesses.


therefore, strategically chose to focus on the agribusiness sector, which has a growing

importance to the region. As discussed in the analysis of sector distribution of PE investments in

an earlier section, agribusiness has consistently ranked among the top five sectors that are

growing and attracting investments from PE firms in the region.

3.2 Fund Structures

All PE firms interviewed in Nairobi, with the exception of one, were managing at least one if not

more funds. These firms, also more commonly known as fund managers within the PE

ecosystem, raise capital from various investors or Limited Partners (LPs). The fund managers

then invest this capital among a portfolio of high-growth companies that they expect will provide

them the returns they are seeking. They conduct rigorous due diligence to pick the investee

companies after they have raised their target amount of capital. Each LP receives returns that

commensurate to its investment in the funds, the details of which are clearly articulated in

investment contracts and agreements with the fund manager. The fund manager, on the other

hand, receives a management fee for managing the funds. In addition, it could be eligible to

receive carried interest, which it would get only after returning all capital contributed by the LPs,

along with some minimum rate of return (hurdle rate). Carried interest, basically is a share of the

capital gain that fund managers are eligible to claim, after exit is completed from the portfolio

company. This also works as an incentive for them to enhance the performance of these

companies and thus, increase their own and the LPs’ returns.


PRIVATE EQUITY FUND STRUCTURE

However, this simple distinction between fund managers and limited partners might not always

apply to all actors on the ground. One of the five PE firms interviewed was a major multilateral

Development Finance Institution (DFI). It operates as a fund manager in Kenya, but also

operates as a LP in many funds managed by other fund managers.

The only fund manager with a slightly different fund structure was a self-defined impact

investment fund. According to Global Impact Investment Network (GIIN), “impact investments

are investments made into companies, organizations, and funds with the intention to generate a

measurable, beneficial social and environmental impact alongside a financial return.”33

Such

33 Global Impact Investment Network (GIIN) website, http://www.thegiin.org/cgi-

bin/iowa/resources/about/index.html#1


impact investments could be targeted at both emerging and developed markets and might target a

rate of return that ranges from below market rate to market rate. However, as more and more

commercial PEs are adhering to Environment Social and Governance (ESG) standards, it is

increasingly becoming hard to distinguish them, at least in terms of their definition of impact,

from impact investors that invest in deals of similar sizes.

We cannot be certain whether various data sources presented in the section describing the PE

landscape in Africa include information from impact investing funds or not. None of the reports

have a clear definition of what kinds of fund managers they chose to survey. The market for

impact investment is only growing—a survey by GIIN and J.P. Morgan found that a total of 10.6

billion USD was invested in 2013 globally by 125 impact investors, with impact investment

capital of 10 million or more, and they expect their investment value to increase by 10% and

number of deals to increase by 20% in 2014.34

Not only is collaboration between commercial and

impact investors increasing, but these funds in many cases are also similarly structured.

Sometimes, they even have the same investors or they invest in the same portfolio companies.

Hence, it is important now more than ever before to include impact investors in the discussion of

PE investments, both within the SME and even mid-market space. As the maximum deal size of

many self-defined SME investors in East Africa is less than 2 million USD,SME investments

from this point will be defined as deals from about 500,000 USD to less than 2 million USD.

This definition is also consistent with Dalberg’s 2011 report on Impact Investment in West

34 JP Morgan, Spotlight on the Market, 2014.


Africa. However, we can further segregate this investment range by defining deals of around

50,000 to 1 million USD as investments in small enterprises and any deals above them as

investments in medium enterprises.

The impact investment firm in Nairobi that shared information with the author followed a

structure adopted by many impact investment funds. The firm had an investment fund that raised

capital from investors and lenders to invest in portfolio companies. At the same time, it also had

a non-profit division that received grants from donors to provide business advisory services to

the same and other high-impact businesses. As impact investors sometimes have much smaller

total fund sizes compared to other commercial PE firms, their earnings from management fees is

not enough to operate them sustainably. As such they usually have relationships with other grant-

making bodies that can provide them with the available capital required to run their operations

without any financial constraints.

AN EXAMPLE OF IMPACT INVESTMENT FUND STRUCTURE

However, structures of PE and impact investment firms are not only limited to what the author

witnessed among these fund managers in Nairobi. There are many other variations in the way


investors come together. Sometimes to attract commercial investors as LPs, many grant-making

bodies or DFIs act as partial guarantors for commercial investors and in return expect

commercial investors to accept lower returns than other LPs who are willing to take a higher

risk. A report by the U.K. Cabinet along with the Association of Charitable Foundations in UK

defines this model as a “risk-return” model.35

The African Agriculture Capital Fund (AACF),

managed by one of the fund managers interviewed in Kenya, follows this structure. The 25

million USD fund has three foundation investors—Gatsby Foundation, Rockefeller Foundation

and the Bill and Melinda Gates Foundation that take higher risk and subsequently get higher

returns. J.P Morgan, the fourth investor in the fund, on the other hand receives a lower return as

it takes lower risk than these three foundations. Half of J.P Morgan’s investment is guaranteed

by USAID.36

Furthermore, there are also other examples in which some foundations are willing to take higher

risk and also to take lower returns. Defined as a “But-for-funds” model by the same U.K.

government report, foundations are willing to do so to attract commercial investors, who

otherwise would not invested in funds that have quite high risks. Furthermore, another model of

fund management could be the “Catalytic First Loss Capital” model, as defined by the GIIN

network. In this model, one of the investors willingly decides to bear the first losses from risky

35 UK Cabinet Office and Association of Charitable Foundations, Achieving Social Impact at Scale: Case Studies of

Seven Pioneering Co-Mingling Social Investment Funds, 2013. 36

Sapna Shah and Min Pease, Diverse Perspectives, Shared Objective: Collaborating to Form the African Agricultural Capital Fund, 2012.


investments. As in the case of “But-for-funds” model, the actor taking the risk of the first loss

does so to “catalyze” participation of investors who would have otherwise not participated.

3.3 Limited Partners

In conversations with representatives of fund managers, it was pretty clear that DFIs played a

crucial role in enabling the PE environment in Africa. All of them mentioned that they had either

already received funds from DFIs as LPs or they were currently seeking funds from them. In

Kenya, European DFIs such as Norfund and CDC were more frequently mentioned as key

investors by fund managers than OPIC, the US government’s DFI. Furthermore, IFC and AfDB

were among other key multilateral DFIs that the fund managers identified.

One of the fund managers, which operates throughout Africa and had already closed 14 funds by

the time of the interview, divided its investors into three distinct generations. The first generation

of investors from whom the firm raised capital were the DFIs. FMO, the Dutch Development

Bank, trained some of its first management staff/ associates and invested in its first fund in 1994.

Since then the firm has tapped into many other DFIs to expand its capital. The firm described

private individuals and foundations mostly from Europe as its second generation of investors. In

more recent years as the PE market in Africa has gotten more attention, the fund now attracts

investments from its third generation of investors, which include private individuals and pension

funds from Africa and Middle East along with other high-net worth individuals from other parts

of the world. DFIs are still involved with the firm, although in a much lower capacity.

Involvement of such diverse range of LPs in African PE provides us good evidence to believe

that the PE space in Africa has matured to an extent. All of the other interviewed funds also had

DFIs, private investors from Europe and elsewhere and/or some foundations as their LPs.


3.4 Investment Size & Type

The following table shows the investment size and type for the 6 interviewed fund managers:

FM

Code

Investment Value/Deal (USD) Investment Type

1 70,000 – 1.3 million

Equity and/or Debt

2 1-2.5 million

Debt Only

3 5 million and above

(not more than 25% of a company’s capitalization)

Equity and/or Debt

4 2.5 - 10.5 million

Equity and/or Debt

5 100,000-1.3 million

(merged with another PE recently & expects to invest 1-5 million soon)

Equity and/or Debt

6 250,000-2.5 million

Equity and/or Debt

We can see that four of the six managers mainly invest within the SME space. This pattern is

consistent with the Deloitte survey, which found that most of the fund managers investing in East

Africa were investing in deals less than 10 million USD. One particular observation here is that

the impact investment fund is clearly operating in the same SME space as other commercial

investors. Although there has been no large survey on impact investors in East Africa, this

observation is consistent with Dalberg’s findings from a survey of impact investors in West

Africa.37

Furthermore, to hedge their risks, all of the PE firms include a combination of equity and debt

investments in their portfolios. Debt covenants prevent fund managers from losing all of their

37 Dalberg, Impact Investing in West Africa, 2011.


invested capital in case of bankruptcy of portfolio companies. Moreover, the only fund manager

that offered debt alone was the impact investment fund. On further inquiry, the difficulty and

uncertainty of exits was cited as one of the prime reasons for such an arrangement.

3.5 Deal Structures, Fees and Post-investment Involvement

All the representatives interviewed revealed that their firms were mostly co-investing in their

portfolio companies, holding minority stakes. In terms of control, all of them had a member on

the board of the portfolio companies and included covenants in the shareholder contract to have

control over certain management actions. For example, a representative of one of the fund

managers said that they include conditions to retain control over decisions such as the maximum

capital expenditure that the management can incur and the hiring and/or firing of the CEO. This

particular fund manager also required that the company get their approval before acquiring more

debt or equity. Moreover, it included in the shareholder’s contract all legal clauses endorsed by

the Kenyan government for protecting minority shareholder’s rights.

However, when asked about how much operational support they provide the management, firm

representatives revealed that all fund managers had very little involvement in the operations of

their portfolio companies. The representatives said that they had influence over the company’s

larger growth strategies and ensured that the company’s long term strategic vision matched with

theirs. However, the fund managers were not involved in providing these companies any kind of

day-to-day guidance. They mentioned lack of resources, high costs and the difficulty in

coordination with other shareholders in the company as reasons for not getting involved in the

portfolio company’s operations.


Furthermore, all representatives of fund managers mentioned they monitor their equity portfolios

much more closely than debt portfolios. This strategy makes economic sense as fund managers

are able to recover bad debts through various legal means but are not capable to do the same for

equity. One of the fund managers, regarded as one of the biggest DFIs in emerging market

private equity, has associates who make monthly visits to companies in which they have equity

stake. Furthermore, the DFI also helps these companies grow by connecting them to other

members within their value chain. However, the fund manager only supervises debt portfolios

quarterly and is much less involved in the workings of the leveraged companies.

Finally, all of the fund managers put their management fees between 2-3%. However, there was

slight difference in hurdle rates among those who disclosed this information. One of the

managers had a hurdle rate of 10%, whereas another put it at 6%. The former PE fund, which

was led by a young Kenyan investment professional with a few years of PE experience, was

established recently at the time of the interview. It was just in its fund-raising stage and was

targeting European investors to close its first fund. The latter with a lower hurdle rate, however,

was a quite well-known PE firm within the SME investment space in East Africa. The hurdle

rate in the former could be higher because LPs investing in it would be taking higher risk and as

such would expect higher returns.

3.6 Sector Analysis

All of the fund managers interviewed in Kenya were also investing in companies within sectors

that had high consumer-driven growth. These firms had investments in some or all of the

following sectors in Kenya—health care, agriculture, education, fast-moving consumer goods,

financial services and logistics. The representatives believed that these sectors had the highest


growth potential in the country, and were also providing the highest returns on investments. Fund

managers believed their returns would be anywhere from 25 to 30% on equity for these sectors,

especially among businesses that were targeting the local market. However, they expected

returns to be lower in export-oriented businesses that depended mostly in the European market.

They attributed the lower returns to the Euro crisis and the slowing down of European

economies.

Furthermore, the fund representatives also stated that they were most comfortable in getting

involved in sectors that had least government interference and had a tradition of attracting private

sector actors. They feared that government interference could decrease their pricing power and

also force them to concentrate on products and markets that were not the most lucrative. For

example, within the agriculture sector, most fund managers mentioned that they would avoid

businesses with maize-related products. Although maize is a staple crop in Kenya, it is a highly

political product and sees a lot of government interference in its pricing and the quantity that can

be sold. Moreover, they also mentioned that they would not invest in cooperatives, as they were

unclear how the shareholder rights would be legally protected in such cases.

Furthermore, most representatives also disclosed that they were not willing to take higher risks

by investing in early-stage companies. These fund managers also mostly concentrated on growth

companies and avoided investments in early ventures or riskier sections of the value chain, a

trend that seems to be true also for investors in the rest of the continent. According to a

representative of the East Africa Venture Capital Association, with whom the author

communicated, almost all of the Private Equity firms in Kenya concentrated on growth equity.

The interviewee also stated that in a pool of over 30-40 regional PEs in Nairobi, there are barely


one or two venture capital firms. These VC funds concentrate only on the technology sector and

invest in IT start-ups.

A quick scrutiny of the agriculture sector clearly shows how investors tend to avoid early

investments and other Greenfield ventures. Although all fund managers interviewed saw

agriculture as a very lucrative sector, only one of them has considered undertaking Greenfield

investments in agriculture. Most of the firm representatives interviewed believed that such

investments, which mostly involve businesses within the primary production value-chain, are

highly risky due to uncertainties related to weather and land rights, a complicated issue in Africa.

Therefore, most of them were inclined to invest in agribusiness that manufactured value-added

products, dairy products or were engaged in the processing and distribution of these different

agriculture products. Some fund managers also declined Greenfield investments, as they require

a much larger sum of investment than what other SMEs would need.

The only fund manager with a slightly different risk tolerance and with a willingness to invest in

agribusinesses within the primary production value chain was a PE firm that mostly receives

funds from large foundations for developing the agriculture sector in East Africa. Although the

PE firm does not define itself as an impact investing fund, its investors, at least for its most

recent fund, are the same actors that invest in the impact investing space. Finally, the impact

investment fund that the author communicated with also provides debt only to agribusinesses.

However, to decrease its risk, it still avoids primary production and Greenfield investments.

Rather, the impact investment fund targets business that are well-managed and are at least

generating revenue of 1-10 million USD.


3.7 Regulations

The Capital Markets Authority (CMA) of Kenya, is the regulatory body for capital market

activities in the country. A publicly accessible CMA handbook provides requirements to register

as a “fund manager.”38

Although the document defines equity managers as managers mostly

investing in public equities, it does include Venture Capital as an asset class. It requires venture

capital firms to register with the CMA. Moreover, as the definition of the term is quite broad it

could also include private equity funds.39

With regards to foreign ownership of funds, it states

that “foreign investors are allowed to acquire up to 49% of local brokerage firms; and up to 70%

of local fund management companies” to encourage transfer of technology and skills.40

While

foreign investors are not allowed to hold more than 75% of a listed company, there are no

restrictions on foreign investors in owning shares in private limited companies in Kenya.

Most of the representatives who were interviewed from the funds were unable to speak about the

legal regulations governing private equity in Kenya and the legal structure of their funds. As

most of them were investment associates, they did not deal with legal matters and were unaware

of the legal requirements. However, one of the key management figures of a reputed firm within

the SME space claimed that PE firms have no licensing requirement from the government of

Kenya. He stated that if the company was to invest in public equities in Kenya, it would be

38 Capital Markets Authority, Capital Markets Authority Handbook, 2012.

39 In the handbook, Venture Capital is defined as: “These are companies incorporated for purposes of providing risk

capital to small and medium sized business which are new and have a high growth potential, whereby not less than 75% of the funds so invested consist of equity or quasi equity investment in eligible enterprises.” Ibid. 40

Ibid.


required to get a license from the CMA. However, to invest in private companies, the firm

claimed it only needed to register itself under the company act. Moreover, the firm representative

also claimed that most PE firms in Africa, including those in Kenya, were domiciled in tax

havens like Mauritius. This information is consistent with AVCA’s report that states that

Mauritius has been the primary domicile for PE funds investing in Africa, as “it has extensive

network of tax treaties with Africa countries and meets the constitutional requirements of many

of the DFIs that are cornerstone investors in African funds.”41

However, the report claims that

“as the African market expands and matures, the domicile mix is changing, driven by the

requirements of new investors.” For example, it states that there is increasing interest in locating

funds in EU jurisdictions in order to access European investors more easily.42

3.8 Challenges Facing Fund Managers

When discussing the main challenges that fund managers face, a few firm representatives

mentioned currency risk, which either stems from currency mismatch in revenue generation and

investment or exchange rate volatility, as their main risk. Additionally, they mentioned lack of

knowledge regarding private equity among SMEs or family businesses in the country as another

major obstacle. They revealed that most businesses in Kenya are only exposed to the idea of

getting loans from investors, and thus, getting their buy-in for equity investment takes more time.

Similarly, they also stated that it was extremely challenging for them to find SMEs with good

41AVCA, Guide to Private Equity in Africa and 2013/2014 AVCA Member Directory.

42 Ibid.


management and business operations skills. They claimed it is quite difficult for them to find

SMEs of the right size, with the right growth potential and proper management. Finally, one of

them, raising funds at the time of interviews, mentioned it was quite difficult to raise funds

without proper networks. The competition among PE firms investing in SMEs has increased in

recent years. He mentioned there were quite a few heavily capitalized PE firms in the Kenyan

market investing in the SME space. As such, he claimed newly established fund managers like

him find fundraising even more difficult.

4. Key Discussion Points and Policy Issues

The analysis of the private equity landscape in Africa and a much closer look at the operations of

a few firms investing in Kenya give rise to some pertinent issues regarding such investments in

Africa. This section will raise some key concerns, with an acknowledgement that a much deeper

analysis would be required to address them in the future. It also offers recommendations for

future research and for policies and actions that governments, as well as the private sector might

consider to correct inefficiencies within the PE sector in Africa.

4.1. Effects of Impact and Commercial Investors Investing in the Same Space

The maturity of the private equity sector in Africa has allowed for a multitude of firms to emerge

in the SME and even mid-market space, including impact investors, although there is no single

agreed-upon definition of the term. Both commercial PE firms and self-defined impact investors

are largely operating alongside each other in the SME (deal sizes of approximately 50,000 to 2

million USD) and mid-market (deal sizes of approximately 2 million USD to 20 million USD)

niche. The concentration seems more pronounced in the space of above 100,000 USD, as deal


sizes that are as small as 50,000 to 100,000 USD are much more difficult to find and are referred

to as the “missing middle”.

An important question that arises from this observation is: What are the consequences of impact

and commercial investors operating in the same space? An important piece of information

necessary to answer this question would be the differences or similarities in deal pricing and

structuring among impact and commercial investors. Such information would be crucial in

understanding whether the presence of impact investors is deterring or supporting the presence of

commercial PEs within the SME investment space in Africa. Future studies of the private equity

space in Africa should focus on these details.

In a 2013 report, J.P. Morgan looked at similar information for impact investments in emerging

markets across the world. First, it found that out of the 46 billion USD in capital managed by the

surveyed 125 impact investors, “62 percent is invested through debt instruments (44% Private

Debt, 9% Public Debt and 9% Equity-like Debt) and 24% is invested through Private Equity.”43

This report shows that a total of about 11 billion USD was allocated as equity investments by

impact investors globally in 2013. The median investment size for the sample was 20 million

USD. The report also segregated the data on total asset under management regionally and found

that 15% of the 46 billion USD (i.e. 7 billion USD) is allocated for Africa by impact investors.

However, the report does not include breakdown of equity versus debt investments for investors

43 JP Morgan, Spotlight on the Market, 2014.


only targeting Africa. Such information would be crucial in confirming that impact and

commercial investors are competing together in the private equity space in Africa.

The report further states that the management fees and carry charges for impact investors are

similar to other commercial investors. An important consideration in any further analysis is

whether or not the same is true in Africa. Moreover, it would be important to compare firm

characteristics, such as economic value, EBITDA, revenue among other during origination and

exit, of portfolio companies with investments from commercial PEs versus impact investors.

Such an analysis would help provide some answers as to how these two classes of investors are

pricing equities of similar companies, and how their returns compare. In doing so, picking a

sample of impact and commercial investors working in the same sector with similar deal sizes

would be useful.

Furthermore, it would also be important to compare the interest charge being levied by impact

investors compared to commercial ones on loans to these portfolio companies. In many cases

impact investors have provided loans at below market interest rates to help companies catalyze

more investments from other commercial investors. Following some of these investment cases

would show whether these portfolio companies were indeed able to secure capital from

commercial investors or whether such efforts were futile.

In addition, a more in-depth analysis could look at the LPs investing with impact investors and

compare them to those concentrating on commercial investors. Such a comparison would be

useful in understanding whether these two classes of investors are actually distinct. Considering

these different aspects of the interactions between impact and commercial investors will provide

a complete analysis on how they are affecting one another both in the SME and mid-market


space. It would also help us in developing models for deals as well as investment strategies,

where they can collaborate in a more sustainable fashion.

4.2 Providing Operational Support to SMEs

A second issue, which is equally important and in need of analysis, is how PE firms can get more

proactively involved in the operations of SMEs to increase EBITDA multiples and subsequently

their exit values. With only about 2-3% management fees, most of the PE firms that conduct

trans-border transactions with several companies are facing difficulty in providing operational

guidance to these companies. With very low probability of increasing management fees, how can

PE firms overcome this hurdle?

Many foundations and grant-making organizations have typically tried to help impact investors

by giving them a separate grant for providing technical assistance to portfolio companies. It

would be really important to understand what kind of business support SMEs are getting through

these technical assistance funds. Proper support would involve not only setting up governance

structures within the portfolio company, but also creating incentives for management and staff to

follow to increase the business’s bottom line. Studies to understand how grant-making bodies

can effectively aid the operations of SMEs would be extremely important, as even commercial

PE investors investing within the SME space could use their services.

However, grants for operational support are not a sustainable way for PE firms to support SMEs.

In the long run, they could discourage PE staff to increase value in portfolio companies, if

incentives are not aligned well among staff providing operational support through grants and

other investment professionals that choose between and/or decide to invest in portfolio

companies.. As such receiving grants cannot be a lone approach to bringing systematic changes


in the operations of SMEs. To deal with these issues systematically, PE firms could increase

their understanding of and collaboration with their co-investment partners and could choose to

share resources to provide operational support to SMEs. As most investments are cross-border,

PE firms that are established in different countries within a region can collaborate with co-

investors with offices in other locations. Further studies would be useful to understand whether

and how firms are already working collaboratively, and what other strategies they have adopted

to navigate the higher costs of helping SMEs operations.

4.3 Attracting Venture Capital in Africa

A third issue that rises after analyzing the private equity landscape in Africa is the absence of

venture capital firms in the region. The few VC firms that are present there seem to follow the

trend of investing in tech start-ups as in the United States or Europe. There has been a surge of

interest in tech-hubs in countries like Kenya and Nigeria, with a special focus on developing

innovative tech-based solutions for payments and other sectors.

However, venture capitalists need to see that most of the countries in Africa can still benefit from

investments in products and solutions that are not necessarily only tech-based. By tapping into

the growing educated and entrepreneurial class, VC firms could invest in new ventures and

solutions in other sectors that have the ability to reach scale. They can diversify their portfolios

by concentrating on different countries within a region, and by targeting enterprises in different

sectors.

However, one of the main challenges such diversification is again the high cost involved in

providing operational guidance to these enterprises. Moreover, in lack of a proper business eco-

system that provides a platform for entrepreneurs to connect to investors or vice-versa, VC firms


would have to depend on their internal networks to tap into promising start-ups. This information

gap is a big hurdle for many VC funds that are operating outside of Africa and do not have the

right resources to tap into the region. Like SAVCA, the VC association in South Africa,

governments and donor agencies across the African continent could support other membership

organizations for VC funds in different regions of Africa. Furthermore, like many countries

including South Africa, governments could encourage new ventures and VC funds by providing

them tax breaks and access to low interest loans. A more thorough study on the kinds of

incentives already provided to VC funds and new enterprises by governments in South Africa

and elsewhere would be useful for policy guidance.

4.4 Increasing Government Attention to PEs in Africa

Although private equity has been growing as an asset class in Africa, many African governments

and capital market authorities are still unaware of the legal and financial intricacies related to PE

investments in the region. With most funds domiciled in tax havens like Mauritius, Cayman

Islands and so on, governments need to understand the financial and monetary consequences

such funds can have on their economy.

Furthermore, fund managers also need to have a clearer understanding of what kinds of legal

protection they are accorded in case their portfolio companies do not operate successfully or go

bankrupt. More legal research needs to be targeted in the future to understand how foreign

investors and fund managers that are incorporated abroad are legally protected through domestic

jurisdiction in various African countries. In addition, research could also focus on understanding

how governments can make foreign fund managers more accountable and transparent. It will be


incumbent on governments to ensure that their citizens and businesses are not exploited in any

way.

Finally, African governments should also increasingly incentivize and motivate prospective

domestic LPs like pension funds to actively participate in the domestic or international private

equity market. Doing so could help them diversify their portfolios and also make it easier for

fund managers to attract capital.

5. Conclusion

The rise of private equity in Africa is a phenomenon observed both in the data and on the

ground. There are encouraging trends which show growing PE activity in Africa’s frontier

markets. Although South Africa has historically been the main private equity hub on the

continent, other regions are now attracting more capital than the country. While some of the data

sources still vouch for the primacy of South African PEs, growth of African frontier markets like

Kenya, Nigeria and Ghana have inevitably made these countries new favorites among investment

firms. Moreover, in terms of sectors, there is also a move away from extractive industries to

more consumer-driven industries on the continent. Although in terms of value, sectors such as

mining, telecommunication and infrastructure still make up the majority of private equity deals

in Africa, consumer-driven sectors such as agribusiness and financial services, among others, are

leading the way in terms of number of deals. Furthermore, these sectors are expected to grow

much faster and attract more PE investments in the region.

While there is lot of hype surrounding PE expansion in Africa, a closer analysis of deal

structures and some of the challenges that fund managers face is usually missing. Through both


primary and secondary research, this report highlighted that most private equity is focused on

smaller deals. There are some high-value and high-profile deals, like the Fan Milk 400 million

USD acquisition mentioned and emphasized in most trade publications. However, the rise of

private equity has more to do with the steady increase in these smaller deals. According to an

AVCA report, deals of 10 million USD and smaller comprise the majority of PE activities, in

terms of number of deals. Primary research in Kenya showed that among the private equity firms

interviewed, most were investing in the SME sector (50,000 – 2 million USD). Those that had

investments larger than 2 million USD were mostly established fund managers with multiple

offices throughout the region.

An issue that remains unaddressed is the presence of impact investors and commercial investors

in this SME investment space, which is seeing a flurry of activity. There has been no analysis of

how they impact each other’s operations and pricing of deals. Usually, reports separate these two

classes of investments and do not explicitly mention how they chose their sample of investors.

However, as is evident from cases in Kenya and elsewhere, impact investors are also investing in

the 50,000-2 million USD deal size space. Commercial and impact investors are inevitably

operating as competitors within this investment spectrum.

Moreover, many reports on private equity do not explicitly state the challenges firms are facing

finding the right companies to invest in and ways to support them operationally. Qualitative

interviews highlighted that fund managers had a difficult time finding SMEs of the right size

with proper management structures. Even after finding portfolio companies to invest in, they

only minimally commit themselves as minority shareholders and do not offer much in the way of

operational guidance. High costs of involvement were cited as one of the reasons fund managers


are reluctant to get involved in business operations. Firm representatives, however,

acknowledged that many of their portfolio companies did not only require strategic investors but

investors that could guide them operationally. Many fund managers had co-invested in portfolio

companies and could use more understanding of and collaboration with investment partners and

possibly ways to share resources to help those companies operationally. Grant-making bodies

and foundations are showing interest and getting involved in providing resources to firms,

especially impact investors, to provide the operational assistance these portfolio companies seem

to need. But a continuing search is required for a sustainable model to systematically support

SMEs in their operations by involving fund managers and building better operational incentive

structures for management.

Finally, African governments must be more involved in helping the PE space grow in their

countries. Incentives and policies have to be put in place to attract venture capitalists to spur

innovation and entrepreneurship, beyond the technology sector within the region. They could

also help by incentivizing and motivating prospective domestic LPs like pension funds to

actively participate in the private equity market. Furthermore, government-run investment

promotion offices should be involved in decreasing information asymmetries within the PE

sector. They could act as the first stop for both PE investors and portfolio companies, and thus

decrease the information gap for investors looking for opportunities and companies looking for

suitable investors. Also, African governments themselves will need to build their capacity to

handle this alternative investment class, whether as promoters of investments or regulators of

activities within the sector. Their influence in setting legal codes and standards would protect

fund managers, who need to develop their knowledge of the domestic legal structures that impact

PE investments, and the portfolio companies themselves.

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