In some respects, there’s never been a better time to be an African business looking for investment than in the last couple of years.
In the high-growth technology sector, for example, start-ups raised a record $5.4 billion (R101.2bn) in venture capital funding. The continent’s broader business sector also saw record levels of investment in 2022.
But in an inflationary environment with rising interest rates, we may well be at the end of that particular boom cycle (even if it takes a bit longer for the fall to reach Africa than it has the rest of the world). With the era of “free money” effectively over, investors cannot simply throw vast sums of money at multiple projects hoping that something will stick. More accurately, they’ll likely have less money to throw at fewer targets.
Instead, they’ll have to be more careful and considered. They may even need to consider alternative financing models that are better suited to the needs of most African businesses. And for private equity, that may well mean making greater use of debt-based funding.
Fast exits work, but not for all
Make no mistake, traditional private equity funding (where the investor takes a stake in a company) will always have a place in the African investment space. After all, there are several prominent examples of African companies that were backed by private equity investors and ended up being bought out by international corporations.
In 2019, for example, pan-African telecom tower company Eaton Towers was bought out by the American Tower Corporation for $1.85bn.
A year later, the American Tower Corporation also acquired a 51% stake in Helios Towers Africa, a telecom tower company with operations in several African countries that was backed by several private equity firms. More recently, TymeBank acquired Retail Capital, a South African-based SME funding business, which was also the beneficiary of private equity investment.
The investors in those companies were undoubtedly happy with their exits, which likely occurred within the timeframes they’d set out for themselves. But that isn’t the case for every African company. Some businesses, no matter how good they might look on paper, simply aren’t going to grow fast enough to achieve a substantial exit in five (or even 10) years when their investors need to make a successful exit in order to begin their next funding round.
But those kinds of businesses still need funding. They can also have immense economic value, create jobs, and improve the lives of the people who live in the communities they operate in. Enter debt-based financing.
The power of debt-based financing
There are a number of advantages to debt-based financing for both investor and investee.
Rather than relying on a company to achieve a massive exit, for example, all the investor needs is for the company it’s invested in to pay back the money (with interest) over time.
It is an approach that requires more patience, but it’s also probably better suited to many African companies and investors. The companies that typically give investors the most benefit from equity funding typically have low staff complements and outlay costs, making high growth and fast exits easier. But that’s not true of every company that needs investment. Some companies need high employee headcounts to be viable and require more time to grow.
While there’s always risk involved, there’s nothing wrong with an investor taking this approach knowing that there’s a strong likelihood that they’ll get back the money they invested (plus more) in 10 years or longer.
An added advantage is that it’s a model which doesn’t leave private equity investors forced to make “bad exits”. They can back companies for as long as they need to and, should the economic temperature change, make an equity-based investment further down the line.
In 2021, private debt accounted for just $0.2bn raised by African companies in private capital deals. If the private equity sector embraces this mode of investment, it could be a lot bigger.
Better together?
It is, of course, important to underline the fact that it doesn’t have to be a case of either/or when it comes to debt and equity. Investors and businesses alike can benefit from having a mix of the two.
Debt, for example, can be used to leverage equity returns, while equity can provide a buffer for the debt and the business as a whole. There are several other benefits too, including increased financial flexibility, lower overall capital costs, and reduced risk. In other words, a mix of funding types isn’t just something that investors should look for in prospective companies, it’s something they should actively encourage.
Finding what works
I’ve always believed in the immense potential of businesses on the African continent. But if we’re to ensure that the continent reaches that potential, we can’t just rely on equity-based funding. Instead, we need to use all the available weapons in our arsenal. And, where appropriate, that includes debt-based financing.
Bryan Turner is a partner at Spear Capital. He is a qualified CFA, CGMA and CAIA with 17 years of Financial Services experience. During his banking career in London, Bryan developed skills in portfolio management, valuation, risk management and structuring.
