Carolyn Campbell, Managing Director and General Counsel
Emerging Capital Partners
Private equity investment in Africa has been active for many years, with solid track records emerging in the last decade. The most successful deployment of private equity in Africa has applied best practices, including identifying risks, defining the path to liquidity, and anticipating changes in judicial and regulatory frameworks. Understanding these factors is critical to ensuring that private equity investments in Africa will generate attractive returns over time.
Every opportunity in private equity comes with risks that must be mitigated. Portfolio company risk analysis often begins with local factors specific to each country, industry and currency.
Either political or cultural, these require fund managers to vigilantly monitor the surrounding region. While this risk has been steadily subsiding in many African countries with successive democratic elections and improving rule of law, it is often advisable to look for companies that operate across country borders as that will naturally diversify risks specific to a single country. Where politics pose a risk, investments should be structured to transfer country risk outside of the zone or onto the sponsors, who may be more adept at handling sudden developments.
This means that some industries are more vulnerable to crisis situations and market fluctuations while others are more resilient. In Africa, the industries that are among the first to feel the shocks of a crisis are similar to the rest of the world. Portfolio managers should assess just how much a company will be directly impacted in various economic scenarios and how they will plan for secondary complications such as the loss of a major vendor or client to bankruptcy.
In Africa, currency risk has been characterised by the fact that African currencies have appreciated slightly against the US dollar in the past decade. However, currency fluctuation can significantly change investment yields over a typical three- to five-year holding period. This risk can be reduced through diversification across currencies by using hard currency convertible loans and investing in companies with hard currency revenues. While the perceived risk in Africa is generally greater than the actual risk, investing across the continent requires a significant level of risk tolerance and an honest assessment of a company’s operations.
Defining the Path to Liquidity
Exit options are an important consideration when investing in African companies. Only four stock exchanges in Africa have a market cap greater than $50 billion; others do not have the liquidity to absorb IPOs in excess of about $100 million. In addition, local institutions tend to be the primary investors in these markets.
Before investing, fund managers must consider whether a listing on one or multiple African or foreign exchanges is feasible. African companies that trade on international markets do exist – rubber producer and exporter, Societe Internationale de Plantations d'Heveas, trades on the Euronext Paris Exchange. This allows investors to exit via block sales. Trade sales are also common in Africa, particularly as countries in the Middle East and Asia have increased their interest in the continent.
Africa also offers opportunities to enter into structured investments pursuant to which cash flow is paid disproportionately to one or more investors, or one or more sponsors commit up front to repurchase an investor’s stake.
Judicial and Regulatory Framework
African governments are increasingly backing open-market philosophies and improvements in regulation have encouraged outside investment. However, inefficiencies remain in the continent’s judicial and regulatory systems. Fiscal conventions standard in other regions of the world may be absent in Africa and differences in judicial systems must be accounted for in planning.
It is important to consider how various countries approach taxation, repatriation of dividends and capital gains; accordingly, investors should take local policies into consideration in structuring an investment in a tax-efficient manner. For example, East African construction company, Spencon, operates in several countries throughout the region. Due to the absence of bilateral tax treaties, Spencon faced double taxation on its profits. These inefficiencies were overcome by setting up a holding company in Mauritius to benefit from that country’s bilateral tax treaties with most East African countries.
In West Africa, many nations have signed on to the Organisation pour l'Harmonisation en Afrique du Droit des Affaires, a system of business laws that provide for reciprocity in enforcement of judgments. Although such systems are becoming commonplace in Africa, it is advisable to seek impartial jurisdictions, offshore joint ventures and shareholders agreements.
Applying best practices in corporate governance and requiring world-class documentation from a target company before investment makes sense in any market. Contrary to popular views, Africa has a long history of private ownership and relatively well-developed institutional settings compared with, for instance, Eastern Europe. The continent benefits from UK and French law-based legal systems, sophisticated securities commissions and improved banking oversight. Generally, companies across the continent are eager for capital and are willing to work within the structures set up by private equity investors in order to further their businesses. Largely underpenetrated by private equity capital and poised for continued growth, Africa presents a bright future for private equity.
Carolyn Campbell is a Managing Director and General Counsel of Emerging Capital Partners and was a founding member of the group. ECP is the first private equity firm to raise more than $1.6 billion to invest in companies across the African continent and has made over 50 investments since 2000. www.ecpinvestments.com.