In a game changing proposition for global investors, Bryan Turner, Partner at Spear Capital, argues that it is time for the sector to overcome critical challenges including vintage bias and the limited investment vehicles.
In some respects, things have never been better when it comes to private equity in Africa. Despite global economic headwinds, for example, some US$7.6 billion was invested across 626 deals in 2022 (versus US$7.4 billion over 429 deals in 2021, a year in which interest rates were still low and investors could borrow money for practically nothing). It’s also true that there were 82 exits, compared with 36 in 2021. That’s 82 companies where investors saw the potential for growth and helped build them to the point where they were ready for an exit. These stats not only show increased investment in Africa but that the investments made are paying off at an increasing rate. In theory, those numbers should keep growing, helping build better business and investment environments around the continent.
For all the good that private equity has done on the African continent, I can’t help but feel that we could do better. More specifically, I think it’s time for the sector to take its next branch into a full investment proposition for global investors.
Finding room for improvement
Before digging into what that step forward might look like, it’s worth taking a look at where the areas for improvement lies. One of the biggest issues in the sector is vintage bias, where investments made in certain years benefit or struggle due market forces outside of their control. In an African context, this bias can be acute due to the more pronounced and volatile cycles. While the megatrends that make Africa a viable investment destination remain valid (a young, growing population with increasing levels of education and connectivity), those uncertainties can make timing an investment’s entry and exit difficult. In combination with other factors, such as the limited number of players in the African private equity market, this bias means that companies struggle to attract investors and valuations decrease. That, in turn, creates a vicious cycle where companies don’t achieve the valuations they should, disincentivising investors from taking chances on companies. Not only do they miss out on investments because of the bias, but the lower valuations further reduce an investor’s ability to exit investments. As a result, forced exits at suboptimal valuations become increasingly common.
Africa’s smaller investor base and narrower investment vehicles also means fewer buyers and sellers. What buyers and sellers there are remain constrained, especially when it comes to buyout alternatives. Ultimately, this smaller secondary market means that the private equity environment is not able to operate to its full potential.
Time for new thinking
Knowing that, it’s important that investors in African companies start to think a little differently. One solution that could work is if several players come together to launch a continuation fund (or a number of them). Typically, continuation funds involve a private equity investor moving a portfolio company from an existing fund into a new special-purpose vehicle. Investors can then roll their stakes in a company into the continuation fund or receive cash for their stakes from other investors. Such funds offer a number of advantages, including greater time and flexibility. Continuation funds extend the lifespan of investments, which allows greater time for companies to achieve their growth objectives. By giving more time, they allow the potential for higher valuations and better returns. It also means that the original investors can keep investing in more companies rather than desperately seeking out exits in potentially difficult markets.
There may be even more potential if there were continuation funds for different sectors, headed up by experts in those sectors. So, for example, a private equity investor could build up a retailer to the point where it’s ready to go into a dedicated retail continuation fund. The same could potentially be true for players in a number of sectors, including manufacturing, ecommerce, or logistics. A further extension of this concept could be in the tenor of these funds, from a handful of years to realise value and exit to permanent capital vehicles. Given enough time and support, how many more exits would we start to see? More importantly, how many more big exits would we see?
Building a lasting legacy
Make no mistake, I don’t think private equity companies are doing a poor job in Africa. I’ve seen too many companies in our own and other portfolios thrive as a result of investment to think that. But I’ve also been around long enough to know that if players across the sector are really interested in building a lasting legacy on the continent, then it can’t be business as usual. Instead, we need to start thinking about new ways of doing things with the aim of producing more and bigger exits, and more importantly more significant and sustainable African success stories, that advance Africa’s overall business environment.