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What is private equity?
Private equity is a form of company financing, in which investors pool their capital to take meaningful stakes in firms that are generally not listed on a stock exchange. Private equity provides entrepreneurs with access to alternative forms of capital to grow their businesses. In due course, private equity investors aim to sell their interest in these companies at a higher value, thus making a profit. During the investment period, private equity fund managers are typically active owners who invest their time and expertise to grow these companies. Exits are usually via a managed auction process leading to sales to trade or financial buyers or through a listing on a stock market.
A notable private equity success story is Old Mutual Private Equity’s recent sale of glass packaging producer Consol Holdings to Luxembourg-based Ardagh Group, one of the biggest glass producers in the world, for an equity value of approximately R10-billion. Old Mutual Private Equity had been an active shareholder in Consol since 2007, when the business was delisted as part of a private equity consortium that included Brait, Sanlam and management. Consol subsequently increased its turnover from R2.5-billion to more than R10-billion last year and expanded its operations to Kenya, Ethiopia and Nigeria. In another recent private equity success story, Imperial Logistics agreed to acquire 100% of logistics company, J&J Africa, for over R4-billion, providing a full exit for the Carlyle Group and Ninety One.
The SAVCA 2022 Private Equity Industry Survey found that the industry made investments of R14.9-billion in 2021, up from R14.5-billion in 2020 and as in previous years, infrastructure attracted the greatest portion of capital. Funds under management rose to R206.2-billion at the end of 2021, up from R195.1-billion at the end of 2020 and R184.4-billion at the end of 2019.
What is venture capital?
While both private equity and venture capital refer to investments in private companies, venture capital refers to investments in new businesses or start-ups, while private equity refers to investments in established companies. Venture capital firms back new ideas with high growth potential, helping to finance and commercialise them. Venture capital firms have backed some of the most disruptive and fastest growing companies in the world.
The SAVCA 2022 Venture Capital Survey found that although investment activity by value of deals decreased slightly from record levels reported in 2020 (amounting to R1.31-billion in 2021, down from R1.39-billion the previous year), there was an 11.4% increase in the number of deals, with 129 entities receiving venture capital investment in 2021, up from 122 in 2020. At the end of 2021, the local venture capital asset class had R8.13-billion invested in 1021 active deals. This is a substantial increase when compared to the end of 2020 when R6.87-billion was invested in 841 active deals.
How do private equity and venture capital create value in businesses?
Fund managers select assets where they see the potential to significantly improve and even transform businesses. Private equity’s advantage over other asset classes is that its fund managers have significant influence over portfolio companies, allowing them to add value during the holding periods of the investment. While a common perception is that private equity means retrenching workers and cutting costs, today the focus is on growth by means of offering new products or services, increasing production and hiring new talent, as well as improving corporate governance and thereby making companies more attractive and resilient.
Research commissioned by SAVCA shows that private equity companies become more innovative, typically registering more patents and reducing the time taken to commercialise new discoveries. They also increase the export intensiveness of firms, so more of their output reaches foreign markets.
For more insights, read the public policy report here.
How do private equity and venture capital create jobs?
Well run, mid-sized companies are one of the biggest employment bases in the country and offer growth opportunities to private equity investors who provide not only capital for expansion but management support, making this one of the best ways to stimulate the economy and create employment.
As venture capital promotes the development and expansion of young companies, it too creates employment opportunities. Many new businesses cannot access traditional sources of funding and for these businesses, venture capital is a source of financing which leads to growth and job creation.
Private equity is also active in improving wider economic performance by backing education companies, companies in the technology sector and those developing breakthrough medical care. These are often focused on the most intractable problems we face in South Africa, having an impact on economic activity far beyond the investee firms themselves.
For more insights, read the institutional investment report here.
Why do venture capital and private equity incorporate sustainable investment strategies?
Regulation requires pension funds to consider sustainability when investing. Many other institutions and individuals also are concerned to ensure their investments meet sustainability objectives.
Private equity and venture capital funds have often led the way by incorporating sustainability concerns into their investments. As active investors with significant influence, private equity fund managers can influence their investee companies strongly to improve their sustainability performance. Investors are increasingly considering sustainability when making investment choices, both in South Africa and internationally due to their concerns about issues such as climate change and inequality. There is also a realisation that ESG factors will be important when it comes to delivering adequate returns.
The SAVCA 2022 Private Equity Industry Survey found that most private equity firms in Southern Africa take ESG risks and opportunities very seriously when making an investment decision and have a mature ESG policy process with 76% of Southern Africa private equity firms stating that they very seriously consider ESG risks and opportunities during an investment decision-making process.
For more insights, read the institutional investment report here.
How does private equity fund infrastructure?
The development of infrastructure in South Africa is crucial to attaining the country’s economic and social goals. Infrastructure delivery will enable South Africa to transition from a minerals focused economy to one that is globally and regionally integrated, inclusive and low-carbon.
Infrastructure investment can provide positive financial results from opportunities not readily available in the market. In addition, the expected benefits from these projects to South Africa are extensive. They include electricity generation, easier access to markets through ports and roads, health and educational services. While in the process of being built, these projects create a significant number of jobs, but also create many more jobs through the economic activity they enable.
Projects in sectors like renewable energy, ICT, water supply, and transport offer private equity investors stable and diversified long-term returns while also making a positive difference to South Africa’s economic growth. Private equity plays an essential part in new infrastructure projects, providing the risk capital to enable lenders to confidently take exposures to new projects. Equity investments can be leveraged five- to 10-times, so private equity plays a catalytic role in mobilising finance for infrastructure. The industry includes several specialist infrastructure funds that have invested widely in infrastructure projects in South Africa and the rest of the continent.
Infrastructure investment requires specialist skills, with unique due diligence requirements and approaches to managing risk, particularly during the early phases of large infrastructure projects. Private equity has built capacity for these challenges through its active involvement in local infrastructure projects going back to the first toll road projects in the 1990s and honed particularly during the Renewable Energy Independent Power Producers’ Programme. These skills are often not available directly at institutional or portfolio investors.
Amendments to Regulation 28 of the Pension Funds Act, which came into effect in January 2023, allow pension funds to allocate up to 45% investment in local infrastructure projects, subject at the same time to the other asset class limits of Regulation 28 (i.e., so funds must ensure both that their total portfolio contains under 45% exposure to infrastructure and 15% to private equity). The amount of assets pension funds can allocate to private equity has risen to 15% (from 10% previously, bundled with hedge funds).
Private equity provides one mechanism for pension funds to build their exposure to infrastructure projects. Retirement Funds’ assets are usually substantial and available for the long term. By matching these longer-term obligations with long-dated assets such as infrastructure investments, retirement funds are able to mitigate their risks, while also creating jobs. According to National Treasury, these amendments “provide government’s response to calls for retirement fund investment in infrastructure to bridge the infrastructure gap”. Funds will be required to report on their top 20 infrastructure holdings and a duty has been placed on retirement fund trustees to educate themselves on infrastructure investments. In countries such as Canada, Australia and the Netherlands, pension funds have been investing in infrastructure for some time.
For more insights, read the institutional investment report here.
Who invests in PE and VC?
In South Africa, pension funds, insurance companies, investment holding companies, government agencies (including DFIs) and high-net-worth individuals, dominate the private equity and venture capital space. Many South African private equity funds also raise investments abroad, including from development finance institutions. For ordinary retail investors, the asset class is complex due to high minimum investment amounts and other considerations access to these investments is being broadened to include the retail client base.
For more insights, read the institutional investment report here.
What kinds of companies do private equity and venture capital firms invest in?
The SAVCA 2022 Private Equity Industry Survey found that most investments were in the energy and related services and infrastructure sectors as well as financial services.
Jan-Jan Bezuidenhout, CEO of MetroFibre Networx, believes that private equity is vitally important to the country’s economy. “Private equity provides a source of capital for private businesses seeking to achieve their objectives. This capital may not be available via other means such as bank debt or public markets./It’s also important to note that private equity investors bring structure and governance to many organisations transitioning from their start-up phases into more mature businesses.”
The private equity investment into Jachris made it possible for the company to rid its balance sheet of debt and double down on its investment in Africa. “The company has subsequently expanded its footprint from 10 to 14 countries by entering Mauritania, Ivory Coast, Morocco and Mali,” says CEO Warwick Bouwer.
Michael Redfern, CFO of Alternative Power, the company that manufactures Switch energy drinks, says that private equity provides the framework and the knowhow with which to turn small businesses into middle tier businesses. “Private equity grows businesses – not just for the owners but for our economy.”
Interim CEO of OneCart Gladwyn Leeuw says that three months after the private equity investment, the company was making steady progress towards meeting its budgeted goals and milestones. “The Covid restrictions granted OneCart a licence to operate as an essential service, and so started a period of exponential growth.” The SAVCA 2022 Venture Capital Survey found that food and beverage companies attracted the largest rand value of investments followed closely by ICT Fintech.
How does private equity boost BEE and other transformation?
The SAVCA 2022 Private Equity Industry Survey results show that private equity is moving ahead on transformation and diversity with 51% of fund manager respondents having greater than 50% black ownership and 65% of fund manager respondents having greater than 50% black management. In addition, the survey’s findings show that increasing gender representation was a priority in hiring employees for both Southern African and global PE firms, and that from 2020 to 2021, Southern African PE firms improved their gender diversity. Firms also have a positive impact on the BEE performance of their investee companies.
A study commissioned by SAVCA found that investee companies tend to improve their BEE scorecard levels, with significantly more firms becoming compliant with BEE legislation post investment, and most firms also improving their BEE level post investment.
For more insights, read the institutional investment report here.
Do private equity and venture capital investors asset strip companies?
Particularly in the US and UK some private equity and venture capital investors have been accused of asset stripping, meaning that they take over companies in distress at a price that is below the value of that company’s assets and make a profit by breaking up the company and selling its assets for more than the total buyout price. Often employees are also let go. The RJR Nabisco leveraged buyout in the US in 1998 is one of the most prominent examples of asset stripping and was the subject of the book Barbarians at the Gate. However, this famous example tends to dominate the reality of what private equity in fact does across the world, especially recently. The focus has become much more on growth assets, and private equity is better known for investing in and developing assets like Facebook, SpaceX and Airbnb.
SAVCA's 2022 Private Equity Industry Survey shows that by sector, infrastructure continued to attract the largest portion of capital (20.4%), albeit down from 2020 (22.8%) and 2019 (34.7%) levels. The largest increases were in the retail and technology sectors – 18.1% and 6.1% of investments in 2021 vs less than 6% in retail and 1% or less in technology in both 2020 and 2019.
The aim is to accelerate the growth of companies to generate returns. In the case of distressed companies, private equity aims to manage turnaround processes that save jobs. There have been several turnaround examples in the past, most recently when private equity bought out several assets from the business rescue of Edcon and ensured they could continue trading. Such restricting have been shown to create jobs in the longer run, but restructuring businesses to become sustainably profitable. This report provides more evidence on how private equity buyouts of larger mature firms internationally improve their long term performance and ability to create jobs.
For more insights, read the institutional investment report here.