Private equity firms are having a hard time in Africa. One hindrance is their inability to sell companies that they have acquired for their funds. How private equity can better its chances in Africa.
Capital News Africa: From the Trading Floor – Week 13-2022
In a column, we discussed recently the reasons why the world’s biggest private equity firms have largely failed in Africa. The column prompted a lively debate among our readers. And we would like to thank them warmly for their feedback.
These readers cited a key reason why the firms failed: The size of their funds. For example, one of the funds had taken in USD 600 million in seed money. Why is this a problem in Africa? How can private equity better its chances in Africa?
Well, there is a rule-of-thumb for private equity funds. They can at most manage eight to ten portfolio companies. That means the funds must target companies, worth between USD 60 and 80 million. In Africa, however, there are admittedly not many companies, worth that much which meet three key criteria for the funds. Good corporate governance, a promising market and solid finances are often a problem.
Few options for an exit
We’d also like to comment on another important reason that our readers mentioned. The funds’ few options to achieve an “exit,” as investment bankers would put it. Typically, a private equity fund has a lifespan of ten years. In the first two to three years, it acquires companies for its portfolio with the seed money. In the three to five years following, it seeks to further develop the companies. And finally, they try to sell them. In developed countries, this search for buyers can take the last two to three years. Only when all the portfolio companies are sold, the fund is wound up.
There are, in principle, three ways private equity funds can sell their portfolio companies. The first is to sell the company to another company that has an industrial interest in it. Investment bankers call these buyers “strategic investors.” The second option is to sell the company to another private equity fund or financial investors. And the third option is to take the company public.
Exit options for private equity are rare
But in Africa, such exit options are rarer than in developed countries. For one thing, there are not that many strategic investors. African companies are less under pressure to grow through mergers or acquisitions like their counterparts in Europe or North America. Instead, African companies prefer to grow organically. Equally rare are the number of private investors in Africa that would be interested in such deals.
Taking a company public in Africa is also not an easy task, as many of its capital markets are unable to absorb big IPOs. As a result, several bigger African companies opt for listings in Paris, London or even on Wall Street in New York.
That said, Africa’s capital markets are maturing, so there’s hope for the future. One prime example is the fast growth of Africa’s pension and life insurance sectors, which is creating big (and powerful) new investors.
In the search of investors
Africa’s equity markets should benefit from this trend. To compare: In Germany, life insurers seldom have more than 5% of their assets invested in stocks. In Africa, meanwhile, the biggest pension funds are 90% or more invested in stocks. One key reason for this is that these schemes are still in the savings phase and have very few beneficiaries to pay a pension to.
We therefore support all efforts to further develop Africa’s pension markets – especially if you consider that birth rates in many countries are dropping fast. Since it is definitely in their interest, both domestic and international investors like big private equity funds can make a big contribution here. The only catch for private equity firms is that they have to have a perspective that exceeds ten years into the future.