As the ‘L’ in Leverage Buyout becomes more expensive, we can expect to see some downward pressure on private equity deal activity. In South Africa, leverage has not been used to the same extent as in more developed markets, but using debt is still a key component of securing returns attractive enough to pull the trigger on a transaction. And with interest rates now higher than before the COVID pandemic, many experts are warning that the receding tide of cheaper capital will reveal who has gone swimming naked with their portfolio companies.
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Africa-focused private equity funds appear to have enjoyed a boom year in 2021. Figures from the African Private Equity and Venture Capital Association (AVCA) show that private capital fund managers in the region raised $4,4bn in ¬final closes and another $2,3bn in interim closes last year.
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This is a drop in the global fi¬nancial ocean, but it does mark a fourfold increase on the capital raised during the depths of the pandemic in 2020.
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The 2021 fundraising totals were boosted by some of the continent's largest ever fund closes. Most notably, Development Partners International's third fund closed on $900m in October, with another $250m in co-investment capital.
Scratch beneath the surface, however, and the picture looks less rosy. Much of the capital raised in 2021 simply represents "deferred investment" from 2020.
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The total volumes raised by funds holding a ¬final close in 2020 or 2021 – $5,5bn – were considerably less than the $6,7bn raised in the two years before the pandemic. Hope that the recovery would accelerate has been dented by the worsening global macroeconomic conditions in the ¬first half of 2022. Today, Africa-focused fund managers face a major test in persuading capital allocators that the time to put their money to work on the continent is now.
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Yet, with rising inflation in advanced economies prompting central bankers to raise interest rates, emerging markets have become less attractive as investment destinations. Higher returns available in the US and Europe mean that investors are less likely to take on the real and perceived risks of allocating to Africa focused vehicles.
This will particularly disadvantage managers unable to demonstrate a track record.
Currency volatility – a longstanding thorn in the side of efforts to boost investment in Africa – is likely to become more severe in the coming months, given that the Federal Reserve's hawkish
policies are strengthening the dollar.
Several of Africa's largest markets have already seen their currencies depreciate against the dollar this year. For instance, according to the Bank of Ghana, the Ghanaian cedi depreciated by almost 20 percent against the dollar between January and July.
An AVCA survey published in March found that 23 percent of GPs "frequently" experience delays in raising capital in Africa because of currency risks. Another 41 percent view currency fluctuations as having a "significant negative impact" on returns.
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Abi Mustapha-Maduakor, the chief executive of AVCA, insists that it is possible to learn from the current situation. She believes that increasing interest from venture capitalists in African start-ups won't diminish. She asserts that "the fundamentals are still strong." Even now, a portion of investors will probably want to invest more aggressively in Africa.
VC ¬firms may be better placed to attract capital in the current environment than traditional private equity players that invest in brick-and-mortar businesses. MD of Endeavor South Africa, Alison Collier says that Fintechs and other tech start-ups have "attracted a lot of international private money because those businesses are looked at as international businesses. They started in Africa, but they can scale up globally."
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On the other hand, she bemoans the enduring wariness among institutional investors of committing to Africa-focused PE funds. "The perception of risk, in general, for Africa is higher than the reality," she says.
Perhaps more surprisingly, even asset owners with impact mandates frequently have reservations about the continent when given the chance to invest in Africa and support the Sustainable Development Goals. According to a report released by the International Finance Corporation in July 2021, only a small portion of impact capital (31 percent) is allocated to African emerging markets funds.
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Mobilising local capital
Institutional investors from outside the continent may be less likely to commit to Africa-focused funds until currency and other macroeconomic headwinds have eased. But what about pools of capital from within Africa itself?
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African pension funds hold assets amounting to at least $350bn, a figure that has grown substantially in recent years. But these funds overwhelmingly allocate to government securities or, in markets such as South Africa, listed equities. Private equity and pension funds should be an ideal fit but, generally, there is a lack of understanding regarding the asset class among African pension funds.
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Progress is being made to reform regulations to allow institutional investors to allocate more to alternative funds. In July last year, the South African government con¬firmed that the country's pension funds would be able to increase their allocation to private equity to 15 percent of their assets from January 2023. Until now, allocations have been limited to 10 percent.
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It is worth noting, however, that South African pension funds are not in danger of breaching the current limit. In fact, South African institutional investors allocate just 0.3 percent of their AUM to private equity, according to research published last year by development agency, FSD Africa.
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Development ¬finance institutions (DFIs) are commonly cited as playing a critical role in convincing institutional investors to back Africa-focused funds. Some of them say that we absolutely need a DFI to be part of a fund, because it gives comfort around the level of due diligence and ESG processes.
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There is little doubt that DFIs will remain indispensable to private equity in Africa.
As private equity law doyen, John Bellew of Bowmans says, “DFIs have, for many years, provided the backbone for private equity managers looking to raise capital to deploy in Africa. We expect them to continue to support the industry, but to encourage managers to also raise capital from commercial LPs, especially in successor funds. A number of DFIs also have an appetite for co-investment, and we expect this also to continue.”