Private equity: Bringing development capital to Africa? – By Adam Green July 4, 2013
Africa’s private equity industry has been gaining ground. Last year, despite difficult global economic circumstances, deal value reached $1.1bn with East Africa taking the lion’s share. And the sector has raised as much as $3.7bn of capital, in its 2008 peak before the financial crisis, according to data from Private Equity International. While South Africa was once the only serious play on the continent, its share of private equity deals is shrinking, suggesting a major shift in the balance of private equity towards the rest of the continent, with growing interest in a range of industries from telecoms and energy to agriculture. Donors kick-started all this. Their investment arms, such as IFC, CDC (from the UK) and Norfund (from Norway), have attempted to lay a path which private actors could follow, with equity investments one of their key modes of operation. Development Finance Institutions (DFIs) say private equity can strengthen corporate governance of local firms and help them grow. And by bringing cash rather than debt, private equity is delivering ‘development capital’ where it is needed most. But private equity has its critics. In developed markets, the model is seen as short-termist. Private equity groups raise new funds from investors, using the money to finance the buyouts of companies, usually over a three to five year period, after which they are sold and the money returned to investors. Critics say funds are guilty of stripping assets during this period and driving up profits through short-term measures, such as reducing staff costs to improve the balance sheet. They are often fabulously successful on their own terms – over 10 years, US private equity deals generated an 8.8 per cent return for pensioners and savers, higher than public equities, fixed income or real estate, according to the US trade body PEGCC – but some wonder at the cost of their success on the companies they ‘transform’. Lack of transparency is a concern. Private equity funds rarely like talking to the media or the public about their work, and rarely publish comprehensive details on their websites. Since private equity defines any type of equity investment in an asset or a company that is not listed on a public stock exchange, the purchase of shares is privately negotiated which can lead to speculation and suspicion – especially where Africa is concerned. Their frequent use of tax havens is also problematic, and leading fund managers have tax efficient arrangements themselves. Witness the vilification campaign against Mitt Romney during the US elections – due to the way in which private equity managers are often remunerated, Romney paid an average tax rate of 15% while the top US marginal rate for ordinary income stands at 35%. These criticisms are largely levelled at private equity in developed markets, but do they carry the same weight in Africa? The tax issue does – it is a feature of many private equity funds globally and Mauritius provides a convenient nearby tax efficient jurisdiction. At a time when Africa is grappling with enormous public spending needs and a small tax base, there is understandable unease about the rise of private equity in the continent. The short-termism critique is less applicable. Private equity in Africa is high risk and harder to exit, with fairly few high-growth companies around, so the idea of private equity managers burning their way through companies is not the model. Research by Hogan Lovells, the law firm, suggests that private equity in Africa can take up to twice as long to complete as in developed markets – perhaps as long as 10 years. And companies in Africa face a very oppressive business environment when it comes to access to finance, infrastructure and rule of law, even compared to those in other emerging economies at a similar GDP level. The potential for getting involved in projects with unsavoury characters is also a challenge with potential reputational risks (as the European Investment Bank found in Nigeria). And Africa isn’t a province of mega-money yet. Deal flow is limited and big deals a rarity, with only five above $20 million last year. Perhaps a more controversial issue is whether donors should be participating in private equity. Shouldn’t they stick to delivering vaccines or water supply? NGOs have marvelled at the fact that many private equity funds operate out of tax havens, raising questions about donor consistency in wanting to cut down on tax avoidance, while at the same time engaging with private equity funds that utilise such instruments. The IFC has been criticised for its equity investments, which have not shown sufficient interest to the needs of the poorest, say critics. The UK newspaper Daily Mail has hammered CDC in the past for high salaries, expenses and disinterest in poverty reduction. The European Investment Bank, a European equivalent of the IFC, has been criticised for its increasing use of private equity vehicles whose goals – Eurodad says – are incompatible with sustainable development. And the European Court of Justice even issued a ruling specifying that the EIB focus “more particularly in the most disadvantaged” nations, and not lose sight of its poverty reduction mandate. Some of these arguments carry water. It is problematic for donors to engage with the private equity industry directly themselves, or through financing private equity funds, while at the same time pledging to tackle tax avoidance (one of the sector’s signature traits). More broadly, private equity models are not characterised by high rates of job creation, so they are unlikely to be transformative interventions on the employment front – arguably the most important issue facing developing countries today, especially in Africa. There is an unresolved debate on how DFIs balance their need to find viable business models – which are often found in more dynamic and seemingly ‘less needy’ emerging markets – with their poverty alleviation goal. But it is also worth noting that some of the fastest growing emerging markets also have some of the deepest poverty traps, as India shows. Other criticisms are less compelling. While the NGO coalition Counterbalance said EIB participation in private equity funds “should be ended”, this is not necessarily the best approach for donors as a whole. DFIs are better-motivated, better governed and more transparent than their purely private counterparts, so it is better to have them in the field bringing up standards than vacating altogether. They are increasingly conscious of their development mandate, even if they struggle with the challenge of combining it with viable business deals. More broadly, and on the other side of the ideological spectrum, libertarians question the presence of donors in private sector interventions at all, asking what right they have (or, indeed, wisdom) to interfere in private enterprise. This fits the catchy ‘trade, not aid’ jingle. But the mantra lacks nuance. Perhaps the greatest irruption of entrepreneurship in Africa right now – the mobile money revolution – came about thanks in part to financial support given to Kenya-based M-Pesa by the UK Department for International Development. As Jeffrey Sachs argued in a recent interview with This is Africa, we should be moving beyond the neat ‘public and private’ distinction in development discourse. But when it comes to private equity, the role of public bodies in this most private of commercial activities will pose a particularly interesting challenge. Adam Robert Green is senior reporter with This is Africa, a publication from the Financial Times. -- You received this message because you are subscribed to the Google Groups "South Sudan Info - The Kob" group. To unsubscribe from this group and stop receiving emails from it, send an email to [email protected]. To post to this group, send email to [email protected]. 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