In recent years, private equity in Africa has started to gain momentum and interest from investors.
There are almost 300 private equity managers in Africa, according to Rory Ord, a private equity valuation specialist and head of South African-based RisCura Fundamentals.
“Probably the biggest misconception is that there is not much happening in private equity in Africa, and I think there is a lot more happening than people think,” he told How we made it in Africa.
However, private equity is still relatively young in the unique and challenging markets of Africa. While the potential exists for private equity managers to make solid returns on African companies, so does the potential to make mistakes.
According to Ord, there are loosely two groups of private equity managers in Africa: those who are homegrown, and those who have come from a private equity background in the US or Europe. “And I think that the two groups actually make different mistakes that we can see from our point of view,” highlighted Ord.
Western fund managers need to think about Africa differently
For the group of private equity managers coming from outside Africa, Ord explained that the biggest mistake they can make is to try and implement the Western model of private equity directly into Africa.
“In most cases it does not really work,” he said. “From a structuring point of view it certainly doesn’t work because there isn’t as much access to debt funding in Africa as there is in the developed world.”
Another mistake Ord said his firm has seen these fund managers make is the assumption that certain structures, such as logistics networks and supporting services, are already in place to help their target company grow. For many African companies, the lack of adequate infrastructure in their market raises the cost of operation and is a major limitation on their growth.
“It’s extremely important for investors to make sure that what they assume is in place is actually in place otherwise they can actually have to incur a lot more costs than they expect in that particular deal,” emphasised Ord.
Homegrown fund managers need more experience
While the homegrown private equity managers might know their markets very well, Ord explained that they often lack the skill and experience of developed market fund managers. This is because private equity on the African continent is generally new and many of the local managers might have come from a corporate finance or banking background.
“So some of the structuring of deals is quite simple and perhaps could be done in better ways,” he continued. “It is always difficult in Africa because of a lack of a long track record of private equity. So company management is not really used to being approached by private equity for investment in their companies and they are not really sure how to handle it. So often deal structuring has to be quite straight forward just to get a deal done whereas in developed markets or even in South Africa you may be able to do a better deal structure that is going to give better result for investors.”
Western model questioned
The 2/20 model of private equity, which refers to the 2% management fee and 20% outperformance fee, is common in developed markets. However, Ord explained that there has been some pushback around that model in Africa as investors want to see some more justification as to why it is the right model for the continent.
“And the private equity model in general gets questioned a lot in Africa because it is not something that people have dealt with for the last 20 years. A lot of the time it is new to investors on the continent so a lot of thinking has to be done around just the way that fund is presented to investors for investors.”
Advice to foreign investors
“I think if I was a foreign investor I would want to invest with managers who know their markets very well,” said Ord. “It would be quite difficult for me to see why I would invest with a manager who is not based in their target market, who doesn’t have a local network in their target market… because I think it brings additional risk if the manager is not actually seeing day to day what is happening on the ground in their particular market.”
He added that fund managers based in their target African markets are better equipped to identify challenges and opportunities earlier on.
“The most successful fund managers that we see have a strategy right from the start of being very involved in the company that they invest in. So the fund managers must actually have a plan to work with the companies to help take them forward, to put in good governance practices, to put in good financial reporting. Those are actually some of the basics that are often missing in the target companies throughout Africa.”
He added that another strategy he has seen work in Africa is fund managers bringing in experts in particular industries, generally from other parts of the developing world.