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Imagine this scenario; you are the Chief Executive or Founder of a company. It may be a new business, a company in the growth phase, or a company that is best described as mature and established. I come to you and offer to give you money, technological infrastructure, access to new markets, training for existing staff and I bring in some other experts for areas you are seeking to enter. Additionally, I will help you solve a host of startup issues, support your engagement with suppliers and buyers, customers, regulators, etc. In exchange, you provide me some reports about your business, you permit me to sit with you every three months to hear what you are doing and provide recommendations for how you can do better, and after a few years of this relationship, you give me back the money I gave you plus some profit because you are now much larger, and more profitable that when we met, and I go away.
What would you say to my offer?
This is a scenario that is of significant relevance today and one about which I have had discussions with numerous entrepreneurs and established businesses alike, ultimately ending up in the same place – Private Equity is not an option. Few businesses appreciate the value that external equity partners can bring to a business, particularly in its growth phase, or if they are aware then there is profound resistance to having “somebody in my affairs” or else they may have heard horror stories from a failed investment and the challenges that presents. Consistently, the view is that they prefer to borrow money from a bank to support their growth with the idea that once their business is larger and more established, if they do elect to sell a stake in it, they will get better value.
Most corporate finance discourse around financing a business sets out the order of priority for financing in this order; personal funds, funds from friends and family (angel investors), funds from venture capital firms (early stage “high-risk” institutional investors), private equity firms or other institutional equity investors (later stage “low-risk” institutional investors), quasi-equity investors (mezzanine funds) – after which if a business is sustainable and generating stable cash flows, one could consider debt funding either from banks or other debt-oriented financing partners such as development finance institutions like DEG and IFC. We have seen the merit of this model in the tech industry, notably epitomized by Silicon Valley, where firms such as Facebook and Google have grown over a fairly short period to become titans of industry on the back of significant equity investment and are now capable of securing attractive funding from lenders. Similarly, companies in industries such as mining, telecoms, oil and gas, media and even innovative industrial manufacturing concerns like Tesla have witnessed a similar evolution.
It is frequently said that we fear that which we do not understand, a quote which in one form is attributed to Dan Brown and in another to Andrew Smith, but which seems to me like it must have been brought to light centuries ago. It is easy to dismiss equity investment as a stepping stone for early business growth, either out of fear, out of a legitimate misunderstanding, due to stories about companies that may have been scarred in difficult transactions involving private equity, or more commonly because of what is generally regarded as a preference to limit external involvement in our affairs. Whatever the reason may be, I believe a better appreciation of what private equity represents, will enable our entrepreneurs to make an informed decision regarding a key funding opportunity, which while available, has remained underutilized in this market for quite some time.
As one might expect, not all private equity investors are equal. Even a great firm on paper may turn out to be a terrible partner for you. Just as one would cautiously approach making a long-term commitment to a spouse, it is imperative that a great deal of introspection, due diligence and interrogation be brought to bear when considering, which fund to seek out or accept funding from. A great funding partner can drive exponential growth and unlock avenues for success that would otherwise be inconceivable, similarly the wrong partner can destroy a business.
What exactly is private equity and how does private equity work?
Private equity is simply money from private investors. Typically, a group of seasoned financial experts (The General Partners) come together in a partnership (The Private Equity Firm), they identify a market or a group of opportunities (Targets) that can be improved and will generate significant profits if effectively funded and well managed. They go out to a range of capital sources such as high net worth individuals, companies, pension funds, governments, etc. (The Limited Partners) and make a case to these parties to give them significant sums of money (Private Equity or Capital) for a period of usually up to 10 years with the offer of the opportunity to benefit from these profits. During this 10-year period, the firm will usually spend the first 2 to 3 years identifying and investing in these Targets, each investment is expected to remain with the Target for about 5 years and they then spend the remaining 2 to 3 years to exit the investment, either by selling their stake back to the Target’s other shareholders, to another private equity investor, to a strategic partner or to the public market via an IPO. All together as an investor in a private equity firm you should expect to get your initial capital plus any returns due you no later than 10 years after you give it out.
Below is an illustration of how a private equity fund makes money:
• The fund invests GHS 4.9M for 49% of the business which is valued at GHS 10M. It pays with a combination of debt (70%, GHS 3.4M) and equity (30%, GHS 1.5M) at the end of Year 2 and after a 5-year term, exits the investment netting a value of GHS 25.1M (based on a valuation of GHS 51.2M).
• During the 5-year term, free cash flow generated by the business is used to pay down the GHS 3.4M of debt such that there is none remaining at the time of exit.
What does an equity investor do for me?
They provide fairly priced, patient capital and often invaluable technical expertise and other resources to drive your growth. If you have sufficient capital of your own to fund your business, then by all means make the best use of that and retain 100% shareholding in perpetuity. If, however, as is the case with many businesses, you don’t have sufficient capital readily available to grow as you wish to or are capable of, then an equity investor can bridge that gap.
For example, consider if you were to launch a media company by putting together sufficient funds to buy equipment for the radio business. You run that for 5 years while you save up what money you can to start building the infrastructure for a TV business, you invest all your savings into building a studio and therefore need to pace your growth till you have sufficient additional capital to pay for equipment, staff salaries, utility bills, etc. Eventually you get off the ground but still have to raise additional funding to purchase attractive TV content to gain a strong viewing before you eventually start to make real money as a business.
If you were to raise money from a bank at any point in this journey, you would be under pressure to generate cash from day one to service the interest and might find that you need to show sub-optimal content to achieve this, thus compromising your true aspirations for the TV station.
If you find a good equity investor, they will give you cash in year one so that you can start developing the TV business right away, you don’t have the pressure of servicing the investment in the interim and if they are a really good partner, they may even have another portfolio company in the media space such that they can facilitate skills transfer, staff education, provide attractive content and enable you to accelerate your growth dramatically.
The result is that in 5 years or so when they need to exit their investment, you are already profitable and generating sufficient profits that you can buy back the equity you sold to them, or other investors may be happy to buy the stake from them. Additionally, because you are now generating steady positive cash flow, if you wish to raise additional capital, banks will be willing to lend to you at competitive rates and you will be well positioned to service any borrowings. You therefore no longer need to sell additional equity to investors and dilute yourself. You may elect to but the compulsion is removed.
What are the categories of equity investors?
• Venture capital: This typically comprises firms with mandates to make investments at an earlier stage in the development of a business. Because they come in early, they have a high-risk profile and commensurately anticipate achieving much higher returns on success. They take more frequent small bets and have a higher risk of failure with individual investments but expect a single success to more than make up for several less successful investments
• Growth equity: This is the segment of the private equity spectrum that is typically most relevant for African businesses. Firms look to deploy capital in business with good operational structures and an identified market, where a capital infusion can be targeted to enhancing certain aspects of the business to take it to the next level. There is a reduced risk appetite relative to venture capital investors but this is still a bet on future performance. Many of the regional and Africa-focused funds listed fall in this category
• Leveraged Buy-Out firms: This refers to the category of investors whose focus is on large ticket investments in established institutions. The term “leveraged” in the descriptor, refers to the fact that these firms often create value via financial engineering in addition to the value from the growth of the business itself. They combine equity with new debt to make an investment larger than the equity on its own would support. As the business operates and uses its own cash flow to pay down debt, the value of the equity in the business increases so that at exit the investor realizes a much larger equity amount that if they had put in only equity. Most of the global investors fall in this category.
• Other institutional investors (Development finance institutions, Sovereign wealth funds):
o Development finance institutions such as IFC, DEG and Norfund have been allocated funds from a government or larger multilateral fund of funds to focus on critical development needs in a particular region around the world. They typically have a commercial focus but due to their unique constitution, they may be more flexible on certain terms such as required return and tenor of the investment
o Sovereign wealth funds typically obtain their funding from a particular nation or government. They are expected to invest proceeds assigned to them in projects that will create a good return on investment and thus expand the funds available to the nation. The source of these funds is often from the sale of natural resources but the ultimate target investments are quite diverse
Who are the players in private equity doing deals in Ghana?
There are thousands of Private Equity firms operating around the world and among these are various categories relevant to Ghana and the continent. First there are a number of emerging markets focused funds who are aggressively investing on the continent; Actis, Amethis Finance, The Abraaj Group, 8Miles, Duet Group, DPI, Emerging Capital Partners and Helios Investment Partners. The next group are those regional funds based in and doing business across Africa such as AFIG, African Capital Alliance, AfricInvest, Bamboo Capital Partners, CardinalStone, Ethos, Investec, Kagiso Tiso, Sanlam and Vantage Capital.
Finally, there are those who could be characterized as indigenous by virtue of their ownership or their primary operating jurisdiction, these include Accion, Adenia Partners, Databank Agrifund, Golden Palm Investments, Injaro Investments, Mustard Capital, Oasis Capital, PCM Capital Partners and several others. These funds based in Ghana have varied sector preferences ranging from Agriculture to Real Estate
