Harnessing Private Equity as an Alternative Source of Finance to Further Africa’€™s Economic Growth and Development Agenda

INTRODUCTION

Global foreign direct investment decreased by 18 per cent to $1.35 trillion in 2012 according to the United Nations Conference on Trade and Development (‘UNCTAD’) World Investment Report 2013 ‘Global Value Chains: Investment and Trade for Development‘ . Under the current global economic climate, which is plagued with uncertainty, it is projected that the road to recovery will take longer than anticipated. In particular, UNCTAD predicts that the foreign direct investment forecasts for 2013 are not expected to improve much from the 2012 figures. Africa is the only major region that has remained resilient under the current volatile economic climate and defied the global trend with a 5 per cent increase in foreign direct investment inflows amounting to $50 billion . The increase in foreign direct investment in Africa has been propelled by the wave of positive growth trajectories for the region.

Notably, there has been a rising interest in foreign direct investment in Africa by private equity investors. If this positive trend in economic growth continues in a sustainable manner, Africa could be seen as a desirable destination for private equity investment. Private equity finance is particularly attractive to Africa as it is an alternative source of capital that could foster Africa’s long term economic growth and development agenda.

WORLD ECONOMIC FORUM ON AFRICA 2013

Historically, investment in Africa has been depressed by the negative portrayal of Africa as a high risk continent in which to do business, despite a wealth of investment opportunities across the region. The Executive Secretary of the Economic Commission on Africa (the ‘ECA‘), Carlos Lopez, stressed that the negative stereotype of the continent must be tackled as it hinders the development of the sector: “investors must understand that the continent is not riskier than other regions’ .

In May 2013, at the World Economic Forum on Africa, the ECA held a high level round table forum focused on “Building Private Equity and Private Capital Markets in Africa’ . The purpose of this high level caucus was to promote and accelerate private equity investments in support of long term economic growth and development in Africa. The forum underscored the potential of private equity as an alternative source of financing investments in Africa. This positive stance is fortified by the increase in economic growth across the region which epitomises Africa as a continent that has the foundation to develop markets that could finance its development.

CHALLENGES FACED IN THE AFRICAN MARKET

It has been noted that there are various challenges facing private equity investors in African markets. Some of the key challenges that face industry players include:

(a) Weak exit opportunities

The African capital market is an under-developed market which is often perceived as providing weak exit opportunities for private equity investors as a result of the relative lack of liquidity in the public markets. Together with a general sense that Africa is a risky continent, this perception has hindered Africa’s ability to attract large foreign private equity investors and leads to a high cost of raising capital.

(b) Diverse legal systems

The challenges faced by private equity investors in the African market include enforceability of contracts and negotiating with various governmental authorities which are compounded by Africa’s diverse legal systems. The continent’s heterogeneous legal systems is rooted in its colonial history as Anglophone countries follow English common law, with Francophone and Lusophone countries using civil law and much of Southern Africa is based Roman-Dutch law. However, the growing regional integration and increased cooperation amongst African countries could contribute to the harmonisation of African legal systems and the long term economic development of the continent.

(c) Lack of an adequate skills base

As noted by the round table forum on “Building Private Equity and Private Capital Markets in Africa’ the lack of an adequate skills base in the private equity sector is a key challenge facing private capital investors in Africa.

POTENTIAL REWARDS OF PRIVATE EQUITY INVESTMENT FOR AFRICA

Private equity investment appeals to developing economies as it can be used as a method to support economic development and complement traditional sources of finance. In addition to the injection of development capital in the region, private equity investment offers a spectrum of benefits which could be used to leverage economic growth:

(a) Injection of additional capital to the region

Africa’s continued economic growth has placed the region under the global spotlight and raised interest from foreign investors. The rising interest in foreign direct investment by private equity funds in Africa could lead to an increased flow of capital into Africa that would enable the continent gain access to diverse sources of capital that could contribute to the economic development of the region.

(b) Sustainable investment geared towards value creation

In recent years, there has been an increase in private equity investment focused on “sustainable’ investment, which is geared towards value creation and could improve investment standards, ultimately boosting investor confidence in the region. The long-term financial commitment and the “hands-on’ investment approach of private equity funds in local companies could improve investments standards by: (i) enhancing internal corporate governance policies which would inevitably help improve accountability and transparency in corporate entities; (ii) promoting environmental and social awareness by encouraging management to comply with internationally recognised environmental and social assessment standards; and (iii) sharing industry know-how and expertise and providing technical support for local companies.

(c) Cultivating home-grown talent

Private equity investors can help cultivate the local professional talent pool by investing in human capital, accelerating the transfer of knowledge and expertise to developing markets. Over the years, private equity funds have established local, in-country operations and increased their local presence in Africa. This has contributed to development of home grown talent, all of which adds to the intellectual capital on the continent and further nurtures local expertise. Furthermore, the increase in international private equity funds establishing a local presence in Africa has been an incentive for Africans from the diaspora to return to work in the private equity sector in Africa for comparable benefits as those obtained in developed countries. Africans in the diaspora who have returned to work in Africa have contributed to developing local skills base by knowledge transfer and serving as the link between local African entrepreneurs and investors operating in the global market.

CONCLUSION

Over the past decade, Africa has experienced continued economic growth which has raised interest in foreign direct investment in Africa by private equity funds. The World Economic Forum on Africa highlighted that private equity finance can be used as an alternative source of financing investments in Africa to support long term economic growth and development in Africa. In addition to providing development capital, private equity investment provides a number of benefits for Africa such as improving investment standards and human capacity building by cultivating local talent in the private equity space.

There are several challenges facing private equity funds operating in Africa such as, the high cost of raising capital, heterogeneous regulatory systems and lack of an adequate skills base in the private equity sector. However, it has been noted that there are some positive indicators that could facilitate private equity investment in the region. For instance, the harmonisation of regulatory systems and deepening regional integration, which could be a means to develop capital markets that would transcend borders and foster long term economic development.

If Africa continues on the path towards sustainable economic growth, the prospects are high for continent to be seen as an attractive destination for private equity investment. Africa could therefore harness private equity finance as an alternative source of finance to bridge development finance gap and fuel economic development.