by Megha Bansal and Smitha Sharma
In this blog post, second year Wharton Africa Growth Partners (WAG) Investment Associates and Wharton MBA students Megha and Smitha share what they learned about private equity in Francophone West Africa from their trek to Côte D’Ivoire and Senegal sponsored by the Wharton Social Impact Initiative over spring break. The trek visited a wide range of players in the private equity and impact investing space, each with their own approaches to investing and operating in West Africa, including AFIG Funds, Black Rhino, Comoé Capital, Emerging Capital Partners, GroFin, Injaro Investments, Investisseurs & Partenaires (I&P), Noujaim et Frères, and Brightmore Capital.
When we think about private equity (PE) in Sub-Saharan Africa, Francophone West Africa is often overlooked, with investors historically focusing on English-speaking and commodity rich economies such as Nigeria, South Africa, and Kenya. However, a closer look at the Francophone WAEMU region, comprised of eight countries (Benin, Burkina Faso, Côte d’Ivoire, Guinea-Bissau, Mali, Niger, Senegal, Togo) with a population of 370 million, highlights unique characteristics that indicate significant potential for private equity investment.
In 2016, the region exhibited strong GDP growth of 6.2%, compared to the 1.4% for Sub-Saharan Africa as a whole. With a single currency (CFA Franc) that is pegged to the Euro and a Central Bank that prioritizes low inflation, this region provides currency stability relative to other countries in Africa. Furthermore, the WAEMU region has low reliance on natural resources, free movement of people and goods, and common institutions and regulations which provide the infrastructure for companies and investments to scale beyond national borders while limiting overall economic volatility that is often seen in commodity-driven economies.
Private equity is relatively new in Francophone West Africa. Based on research by the African Private Equity & Venture Capital Association (AVCA), between 2010 and 2016, Anglophone East Africa saw 167 deals with a total transaction volume of $1.4 billion, while Francophone West Africa saw only 55 deals totaling $480 million. Furthermore, twenty of the fifty-five deals originated in one country — Côte d’Ivoire, which AVCA named the fifth most attractive country on the African continent for investment (after Nigeria, Kenya, Ethiopia, and Egypt). While the industry is relatively nascent as seen by these statistics, investor interest is rapidly growing and expanding in terms of geographic footprint. Private equity investment doubled between 2010–2012 and 2013–2015, and investment firms such as CrossBoundary and Injaro Investments have entered “secondary” geographies such as Burkina Faso and Mali in the past two to three years.
The Missing Middle
As African PE is establishing itself as an institutional asset class, there are over 200 firms managing more than $30 billion. However, more than 50% of this capital is accounted for by the five largest funds (The Abraaj Group, Actis, Development Partners International (DPI), Emerging Capital Partners (ECP), and Helios Investment Partners), who invest in sizeable investments in order to effectively use capital. In West Africa, private equity is a particularly attractive investment vehicle for what is referred to as the “missing middle” — small and medium-sized enterprises (SMEs) that typically cannot access traditional financing from commercial lenders due to risk profiles, but are considered too large for microfinancing. While there are a number of definitions for the “missing middle”, the Dutch Good Growth Fund (DGGF) offers a characterization based on several studies they conducted on the entrepreneurial landscapes of six West African countries — Benin, Ivory Coast, Guinea, Mali, Senegal, and Togo:
· Small necessity entrepreneurs (established for the sake of providing livelihood);
Moderate growth entrepreneurs (mainly family-owned businesses);
· High-growth startups (young entrepreneurs mainly in the technology sector);
· Opportunity-driven SMEs (entrepreneurs copying successful business models and involved in several businesses); and
· Gazelles (successful startups with high growth rates).
McKinsey & Company and Boston Consulting Group estimated that there are more than 10,000 African companies with revenues between $10M and $100M that occupy this space, and access to capital is one of the biggest challenges they face in getting their businesses to grow and compete. These companies are often operating in underdeveloped, high-growth sectors that have yet to reach scale, like education, healthcare, and financial services. Supporting growth of these types of consumer-facing industries can result in rapid transformation across the economy. Furthermore, growing smaller African companies into larger ones has positive effects on economic development in terms of job creation and capacity development (distinct from the traditional leveraged buyout (LBO) model often seen in Western private equity). For example, of 199 African companies backed by private equity between 2009 and 2015, 10,990 jobs were created (growth rate of 15%).
Private equity in particular is a strong vehicle to support these organizations while they are at a critical point in their growth process. PE funds have a strong ability to add value and partner with organizations through these inflection points, and provide support, mentoring, and stability to companies trying to serve as growth engines in their countries. Furthermore, as there are only about 400 companies in Africa with average revenues greater than $1 billion, there are a limited number of large deals, making investment in the “missing middle” SMEs particularly attractive. Recent evidence from Brookings has demonstrated that SME finance is an important tool used to create positive impacts on economic growth and poverty alleviation, particularly in developing countries, because it indicates a strong, entrepreneurial, and innovative ecosystem and enables existing firms to explore new growth paths to get to a larger equilibrium size.
Key Challenges and Adaptive Models
Despite the demand for financing from SMEs and the supply of financing from private equity funds looking to invest, there are several challenges that continue to pervade the space. One of the biggest challenges is a general lack of understanding about what private equity is, how it can be beneficial to growing a business, and how to partner effectively with a PE investor. Unlike in East Africa where private equity investment has become more common, PE is nascent in West Africa and education is a critical component to growing the sector. This directly impacts fundraising efforts, which — while there is some growing interest from U.S. institutional investors (e.g., large pensions) — is a constant struggle for Africa-based PE funds.
Another key challenge is in the legal structures and institutions needed in place to help PE flourish. Many countries do not have robust enough financial institutions and judicial systems to support private equity’s need for accountability, value, and ethics, and this creates liability for investors. Furthermore, exits are made more difficult because of the lack of robust financial markets. Initial Public Offerings (IPOs) are not the most reasonable exit strategy, not only because capital markets are not as robust, but because of a lack of market education. As a result, most exits are realized through strategic sales or selling back to sponsors (supported by an expanding secondary market for SMEs).
Finally, given that PE is so nascent in West Africa, the size of investment and carry/return are smaller, yet funds will still face the same time commitment and transaction costs. This makes the financial viability of West African SME PE more difficult. For example, funds may have to take on a large operational role to help a company formalize internal processes and use the capital effectively. In some cases, this may be an attractive model to a PE fund who wants to be very hands-on with its portfolio companies, but this model also requires heavy due diligence and relationship building on the ground in order to fully support the growth of the company.
Moving Forward with Francophone PE
While there are a number of challenges, funds have adopted various models to successfully operate in West Africa that can serve as lessons for consideration.
· Lean, country-specific operations:
Investisseurs & Partenaires (I&P), a French impact investing group, fundraises for investment in West Africa as a whole. They then sponsor or incubate a single fund in each country, such as Comoé Capital (Côte d’Ivoire) or Teranga Capital (Senegal) that operate fairly independently and focus on developing an on-the-ground network and investing in start-ups or small enterprises. These funds have lean, focused operations (typically one Country Director and a few support staff) that allow the fund to minimize expenditure and make quick, targeted investments to get a net IRR in the double digits.
· Mixed approach, providing technical assistance and financing:
To address challenges related to limited awareness of private equity, some funds like GroFin actively choose to work closely with the investee to develop a business and value creation plan. Providing this level of support does require additional resources; however, we see some firms add a “technical assistance fee” to support this. After the investment is made, close portfolio management is critical to guide the companies to success. While a minority stake is often preferable, some funds quickly realized that to truly drive value, they need to take a controlling/majority stake. However, negotiating for substantial ownership can be challenging given (1) the prevalence of family businesses who like to maintain control and (2) the common perception of entrepreneurs that private equity is solely for capital, not as much for advisory services.
· Developing an ecosystem to source deals, execute transactions, and generate value:
Relationships are key in West Africa to mitigate risk. For funds with limited resources to provide broader support to portfolio companies, partnerships are critical. These funds prioritize building a wide network in the country they operate. They work closely with trusted intermediaries to source and vet deals and then often partner with (or create) incubators (like Brightmore Capital in Senegal is looking to do) to provide entrepreneurs with early stage assistance.
In summary, private equity in Francophone West Africa is poised for significant growth in the coming years. Despite continuing challenges, firms have developed creative models to overcome, and even leverage, the unique investing environment.
Beck, Thorsten and Cull, Robert. The Brookings Institution. “Small- and Medium-Sized Enterprise Finance in Africa.” (July 2014).
Dupoux, Patrick; Becker, Marc; Hammoud, Tawfik; and El Fihri, Seddik. Boston Consulting Group. “Why Africa Remains Ripe for Private Equity.” (September 2016).
Hruby, Aubrey and Yoo, Joanne. Financial Times. “The Missing Middle in African Private Equity.” (October 2016).
Jhaveri, Ekta. Next Billion Financial Health. “Closing the Gap: Identifying Key Challenges for the Missing Middle SMEs in Francophone West Africa.” (February 2018).
Toure, Abdoulaye and Flahive, Thomas. The Brookings Institution. “Why French Should Become the New Lingua Franca of African Private Equity.” (March 2017).
About the Authors
Megha Bansal is a second-year Investment Associate with WAG focused on the agricultural and financial services/mobile payments sectors, primarily in Sub-Saharan Africa. Before Wharton, she worked as a Strategy Consultant at Deloitte Consulting, a Research Fellow at the Brookings Institution, and a Paralegal at the U.S. Federal Trade Commission. She received dual B.A. degrees from the University of Maryland and a Master of Public Policy degree from Duke University, and spent her summer working for World Bicycle Relief in Kenya, Malawi, South Africa, Zimbabwe, and Zambia. Post graduation, she will be returning to Deloitte Consulting in Washington DC.
Smitha Sharma is a second-year Investment Associate with WAG focused on the food & nutrition and agricultural sectors, primarily in Sub-Saharan Africa. Before Wharton, she worked as an Associate at the Boston Consulting Group, an Africa Mobile for Development Fellow with the Grameen Foundation, and a Strategy Consultant with the Bill and Melinda Gates Foundation. She received a B.S. degree from The Wharton School at the University of Pennsylvania. Post graduation, she will be returning to Boston Consulting Group in New York City.