Private equity in Africa is on the rise. As major institutional investors seek to increase their exposure to the continent’s expanding consumer class amid a backdrop of solid economic growth and improving political stability, Africa-focused private equity funds are raising ever-increasing amounts of capital.
In the past few months alone, Helios and Development Partners International exceeded their fundraising targets, closing their funds at $1.1 billion and $725 million respectively. Fundraising was also strong in 2014, reaching more than $4 billion, the highest amount recorded by the Emerging Markets Private Equity Association (EMPEA) since it began tracking such statistics in 2006.
In the same year, the value of private equity deals on the continent hit a seven-year high of $8.1 billion, according to data from the African Private Equity and Venture Capital Association, not far from the 2007 record of $8.3 billion.
As the number of private equity-backed companies on the continent looks set to grow, understanding the key factors affecting the performance of these companies is crucial. How do private equity investors assess and enhance the effectiveness of management teams of their portfolio companies and what are the main challenges they face? How have they dealt with underperforming CEOs or CFOs and what role does the board play in maximizing value?
In order to answer these questions, Africa Advisory Group spoke to senior private equity executives with extensive experience investing on the continent. Four common themes emerged, each critical at different stages of the investment process.
Backing winning teams
When it comes to assessing the capabilities of senior management of portfolio companies, private equity investors look at the historical performance of the business, how well positioned it is in its particular sector or geography, and management’s ability to drive value in the future.
In recent years, Standard Chartered Private Equity has worked with its human resources department and industrial psychologists to develop a proprietary assessment tool for senior management of its portfolio companies, according to Peter Baird, Head of Africa Principal Finance.
“First, we figure out what needs to happen in order for value to be created in terms of our investment thesis,” Baird explained. “Second is who’s got to actually make these things happen. And then, the hardest part, determining whether the management team is fit for purpose in delivering the investment thesis.”
Carlyle, which has five companies in its Africa portfolio, only invests in businesses with proven management teams, noted Mohamed Wann, a Vice President. The firm closed its maiden sub-Saharan African fund last April, with $698 million in commitments.
During its due diligence and interaction with management, Carlyle gets a sense of how well they understand their business and the dynamics of the company and the industry, Wann observed.
If we don’t get comfortable that the management team in place has an impressive track record in the performance of the business and has a very good handle on the business and have some sort of strategic plan that makes sense going forward then we won’t even invest to begin with.Mohamed Wann, Vice-President, Carlyle
For Kagiso Tiso Holdings (KTH), the South African investment holding company, which has 32 companies in its portfolio, operational expertise, ethics and vision are key, stressed Aliya Shariff, Director of Investments. The net asset value of KTH’s portfolio is around $900 million excluding debt.
“If you have all of these three things that are largely aligned with our own vision…anything else you can bolster,” Shariff emphasized. “For example, if a company is strong operationally, the founder or CEO has a good vision for growth and has good ethics…you can usually bring in CFO capability or financing capability or we can provide more help on capital-raising.”
But she added that it was more challenging to strengthen teams that were very strong on fundraising and outward reputation building but less so on operations. It was “much harder, post-investment, to really strengthen operations if that’s not already there,” she reiterated.
When private equity investors need to bring in outside talent, they tend to rely on their own networks or on recruitment firms. All the investors AAG spoke to agreed that recruiting talent is more challenging in Africa than in developed markets with a deeper educational and skills base.
Although many young Africans educated in the United States or Europe are starting to return to their home countries, investors highlighted a severe lack of skills and training, especially in leadership positions. One investor noted that it is still difficult to find a complete management team that doesn’t need some sort of augmentation.
One dominant theme expressed by private equity investors was the importance of increasing alignment between private equity investors and management teams. Generally, firms strive to ensure management is adequately incentivized in order to achieve the greatest possible alignment.
Having management and senior management as owners is critical for KTH. As an investment holding company, the firm takes an even longer–term view on investments than a typical private equity fund.
“(In) situations where we look at an investment where management doesn’t have a shareholding in the business, that’s almost one of the first things that we want to ensure, that whoever the shareholders are have appetite to change that,” Shariff remarked.
Catalyst Principal Partners, a $125 million fund in Kenya, generally tries to link the performance of management directly to the performance of the business, according to Biniam Yohannes, Managing Director.
For example, if we have an expectation to harvest our investment within a certain time frame, the management team can invest alongside with us, sometimes with a ratchet, to participate on the upside over that same period.Biniam Yohannes, Managing Director, Catalyst Principal Partners
When investors are able to influence the composition of a portfolio company’s board, they look for individuals with strong public reputations and industry knowhow. Investors view boards as a forum to push management, shape the company’s strategy and raise questions when goals are not met.
“It’s the board that decides ultimately where it makes sense to go, whether in terms of regions or products, whether it makes sense to make acquisitions,” explained Wann. “That’s why it is important to have the right sort of people and the right setup at the board level to have constructive dynamics and to have an engaging forum.”
In addition to requesting a seat on the board (alongside other major shareholders of the company), investors may also strongly encourage the appointment of independent directors. In particular, investors may advocate for electing board members who are knowledgeable about a particular sector or relevant business dynamic (for example, taking a company through the process of listing on a stock exchange, or completing a major acquisition). This practice of integrating an outsider’s perspective ongovernance and value creation can further enhance the performance of the business.
The degree of alignment can also impact the willingness of management teams to accept the high level of active engagement from private equity investors. While some portfolio companies welcome the external support and recognize its potential to create value, investors acknowledged that not all are happy with the intense monitoring and probing.
Baird has encountered CEOs at both ends of the spectrum. At one extreme was a CEO who was completely resistant to Standard Chartered’s involvement and unwilling to have the team engage beyond the bare minimum of the shareholders agreement.
“At the other end of the spectrum, we have a CEO who during our diligence he and I sat down together and made a long list of all the things that Standard Chartered could do to help him create value in his business,” he recalled. “The week after we closed he pulled out the list and said ‘let’s get started.’”
Baird has found that most people start closer to the first side of the spectrum, but over time if both parties are well aligned and his team is sincerely helping a company with value creation, they move towards the second side. “The alignment is critical,” he stressed.
Wann noted that Carlyle leans towards being engaged. “When we invest, we have a plan of what we would like to do or see the business do and we get very active in making sure management is driving that agenda,” he explained. “We watch the performance of the business very closely. If it starts to be off base we really get in there and lean in and try to understand what’s going wrong and what is management doing about it.”
Wann feels this approach has paid off, with Carlyle’s intervention often leading companies down a different, more efficient path.
“If I look at what we’ve invested in today, there have been portfolio companies which when we came in were very good at just literally running the business more by intuition or by flair, having done it for years,” he reflected. “We helped them put more structure into how the business is managed and its performance systematically tracked.”
One of the toughest challenges for investors is dealing with underperforming CEOs and CFOs. Baird noted that where Standard Chartered and other financial sponsors own a small percentage of a company and the owner/managers own a large percentage, it can be hard to make definitive change. He added that in such a situation, the options would be to get the CEO or CFO to the point where they see the need for the additional management or to work on strengthening them.
It can be challenging. A company where the owners and managers are the same people has to be considered differently from a company with dispersed shareholders and a professional management team.Peter Baird, Head of Africa Principal Finance, Standard Chartered
When another firm faced a situation where a portfolio company was underperforming, the board decided to let the CFO go and eventually fired the CEO about a year later. But bringing in a stronger COO was what eventually solved the problem, according to the firm. The main lesson, it added, was to place a stronger emphasis on management’s operational strength at the time of investment.
Beyond the financial considerations, management teams of high-growth companies in Africa need to consider the leadership implications of raising capital from private equity firms. Once the decision has been made to pursue an investment, stakeholders on both sides of the table would benefit greatly from establishing clear expectations about the investor’s level of involvement in the governance and management of the business. Ultimately, the potential for value creation and growth rests in the balance between leveraging the capabilities and vision of the existing team, and integrating the resources and oversight of the investors.