Worldwide: Rising To The Challenge Of Growth Capital Equity Investment In The World's Poorest Countries – A New Model

Last Updated: June 14 2017
Article by Peter O'Driscoll

The Challenge

One of the biggest current challenges for the impact investing community is the aggregation and deployment of growth capital equity in the world's poorest countries. Few would argue with the proposition that for the world's poorest countries to move out of poverty there must be a much higher volume of growth capital equity provided by private investors. However, in view of the absence of local private equity, growth capital and venture funds in those countries, as well as the relatively small deal sizes, there is a challenge with respect to the way in which growth capital can be aggregated and deployed. It is unquestionably a 'bottom of the pyramid' problem.1 But if the Sustainable Development Goals are to be achieved and the poorest countries are to benefit from impact investment, it is crucial that a new model is developed for impact-driven growth capital equity investment in those countries.

Current Situation

For purposes of this article, I have considered the world's 23 poorest countries (which I refer to as "the 23").2 There is nothing special about the selection of the 23 – the analysis does not change significantly if one considers a data set comprised of the poorest 25 or 30 countries.

Private equity and growth capital investment in the 23 is almost non- existent. In 2016, only five of the 23 had any private equity investment – Madagascar (two transactions), Togo (one), Burkina Faso (two), Rwanda (three) and Ethiopia (two).3 The Democratic Republic of Congo had one private credit transaction in 2016.4 Transaction size figures are not available for any of the countries other than Rwanda (US$27m in aggregate for the three transactions) and Burkina Faso (US$1m in aggregate for two).5

The picture improves rather dramatically with respect to financial inclusion and microfinance commitments in the 23. The table on the following page, which is based on data from CGAP, sets out the financial inclusion and microfinance commitments for the 23 in 2015.6

The data supports the conclusion that the microfinance community has risen to the challenge of lending in nearly all of the 23, even though a number are frontier markets. There are reasons for that. In such markets, local microfinance providers with access to external funding are usually established before local growth capital, PE and venture funds.7 It is generally easier and quicker to lend money to an emerging or frontier market borrower than to make an equity investment. Equity investments, particularly minority stakes, involve negotiations with a company's management, as well as existing shareholders. A loan generally requires a negotiation only with the borrower, and can be documented through a relatively simple loan agreement and possibly a guarantee or security agreement. Growth capital equity investments typically require a share purchase or subscription agreement and a shareholders agreement, as well as changes to a company's constitutive documents.

Country Aggregate Financial Inclusion and Microfinance Commitments – US$ millions Number of Projects
Central African Republic 1 1
Democratic Republic of Congo 221 40
Burundi 19 28
Liberia 26 13
Niger 43 9
Malawi 26 11
Mozambique 140 31
Guinea 6 2
Eritrea N o data available
Madagascar 50 28
Comoros 0 0
Togo 11 5
Guinea-Bissau 8 5
Sierra Leone 22 4
The Gambia 36 4
South Sudan 2 5
Haiti 183 30
Burkina Faso 49 42
Kiribati N o data available
Rwanda 102 61
Ethiopia 256 72
Zimbabwe 67 5
Afghanistan 254 13

Need for a New Model

Although comprehensive data is hard to find, not surprisingly, development financial institutions such as the International Finance Corporation (DFIs) are active in most of the 23.8 A DFI could, in theory, develop a program for impact-driven growth capital investment on a large scale across the 23. However, in my experience, due to the nature of DFIs, DFI-led transactions are costly and take a long time to negotiate and complete. In countries like the 23, DFI- led transactions almost inevitably involve a government component and may not always directly benefit the private sector. It would be difficult for a DFI to do a large number of small growth capital equity transactions across 23 countries within a relatively short period.

Today, there are only five local PE funds in the 23 (one in the Central African Republic, one in the Democratic Republic of Congo, one in Ethiopia and two in Afghanistan).9 That suggests it may not be realistic to expect that more local PE funds will be formed in the near term or that newly formed funds will have meaningful capital to deploy. In many of the 23, there will only be a handful of possible target deals. The average deal size for all but one or two countries is probably US$1 million, and most deals will never exceed US$5 million. At any given time, several of the 23 may not be 'investable' due to ongoing wars, civil unrest or government policy. But over time – for instance, a growth capital fund's seven year investment period – the investment dynamics in the 23 will change. Some countries will suddenly become investable; others may cease to be investable; one or two will experience dramatic economic growth and leave the club entirely. Taken together, those dynamics beg the question of how impact-driven growth capital should be aggregated and invested in the 23.

The state of affairs in most of the 23 is such that only impact motivated investors and DFIs are likely to be willing to invest in the first instance, a fact borne out by the CGAP data.10 The virtual absence of local PE, growth capital and venture funds means that there is very little for a traditional emerging market fund of funds in which to invest. The small size of some of the 23's respective economies and the limited number of target deals make it uneconomic for a global or regional PE fund to set up a local office or actively pursue transactions. In a few cases, there may be security issues for investors' local teams. And in an era in which institutional investors in PE funds prefer larger tickets (~ US$50 million) and fewer manager relationships, the small deal size also presents a challenge.

For the 23 to move out of poverty, microfinance and DFI lending is not enough. Growth capital equity is required for SMEs, early stage companies and startups. For such investment to have a meaningful long term impact, there must be a high volume of relatively small transactions, accompanied by investor follow-up to ensure that local management teams benefit from external advice and mentoring. An impact-driven private fund is better placed to meet that challenge than a DFI. Although there are people and organizations who are beginning to think along these lines, to my knowledge, such a fund does not yet exist. For the challenge to be met, it must be created.

The New Model

What would a fund designed to do growth capital investment across the 23 (which I refer to as the "23 Fund" or the "Fund") look like?

Form. For over 100 years, the traditional limited partnership has proven to be the most enduring and flexible vehicle for investment across a wide variety of sectors and asset classes, including the emerging market private equity, growth capital, venture and impact sectors, providing both tax transparency and investor protection. Institutional investors, including family offices and leading impact investors, understand it and have a high degree of comfort with it. To mobilize the maximum amount of impact capital from those investors, the 23 Fund should be set up as a limited partnership.

Size

To have a meaningful impact across 23 countries, the Fund would need aggregate capital commitments from its limited partners of between US$600 million to US$1 billion. If the Fund size was US$1 billion and same amount of capital were invested in each of the 23, without taking into account fees and expenses, approximately $43.4 million would be available for investment in each country – a modest amount in the modern private equity context. The fact that the Fund's portfolio investments would be spread across 23 countries would, in contrast to single country and regional PE funds, provide investors with a healthy degree of diversification.

The Manager

The manager and general partner of the Fund should be a newly formed entity with one objective - impact- driven growth capital investment in the poorest countries. Initially, the manager should have a single central office in a location suited for finding staff with relevant emerging markets experience. The focus should be on attracting highly motivated, mission-oriented team members and developing a deep knowledge base within the manager with respect to the 23 countries and the efficient deployment and management of growth capital in those countries.

The manager would need small teams focused on:

  • Deal generation and negotiation of term sheets
  • Legal, diligence and compliance
  • Transaction execution
  • Economics, research and impact measurement
  • Post-transaction support and training for local management teams
  • Investor relations

Technology should be maximized across the investment life cycle – from allowing entrepreneurs to file pitches and business plans online to monitoring investments, as well as providing post-transaction training for management teams.

Replicability

Emerging markets generally share more in common than they do differences, including a common set of investment risks.11 That commonality makes replication possible. To undertake a high volume of small growth equity transactions across the 23 within a relatively short period, replicability would be the key to achieving the Fund's objectives and must therefore be a principal consideration in structuring the manager and general partner of the Fund, as well as the Fund's operations. One of the ways in which capital markets develop and grow in volume is through standardization of documentation. Over the past 30 years, this has happened in emerging market debt trading, mortgage-backed securities, corporate lending and US venture capital. Recently, the higher profile microfinance institutions have standardized their documentation so that they can use the same loan documents across the markets in which they lend, with the only modifications being those required to reflect differences in local law and regulation and deal terms. There is no reason why the same thing should not happen in the impact-driven emerging market growth equity sector. One key to the Fund's success would be to lead the charge in this area.

Fund terms

In view of the investment environment across the 23 countries and the corresponding challenges in deploying capital and realizing investments, the Fund should have a seven year investment period and a seven year realization period. European style-end of fund carried interest provisions would not make sense for a 14 year fund, so the manager's carried interest should be calculated and distributed on a deal-by-deal basis, with an escrow fund (but no clawback) to cover any true-up adjustments to distributions of carried interest. In view of the higher legal, travel and training costs associated with a fund of this type, there is a compelling argument for either a higher management fee – probably 2.5% of aggregate capital commitments during the investment period, with a modest step-down at the end of the investment period – or a more generous set of fund expense provisions. Finally, because many exits will involve a sale of the Fund's interest in a portfolio company to its local management, the Fund should have the ability to take back notes from management team purchasers.

Conclusion

Investment data shows that, while most of the 23 poorest countries currently benefit from microfinance investment, only a few benefit from private equity investment and, in those cases, the amounts available are very small. The absence of local private equity, growth capital and venture funds in those countries, and the relatively small deal sizes, prevent emerging market funds of funds from having much, if any, impact. DFIs would be challenged to roll out a high volume of small deals across 23 countries within a short period of time. For the 23 to move out of poverty there must be a much higher volume of growth capital equity provided by private investors. To achieve that, a new model – a large private fund and a manager focused exclusively on growth capital equity investments across the 23 – is necessary. Because such a fund does not yet exist, it should be formed and launched on an expedited basis.

Footnotes

1. See C.K. Prahalad, The Fortune at the Bottom of the Pyramid (2005).

2. In 2016, these were the Central African Republic, Democratic Republic of Congo, Burundi, Liberia, Niger, Malawi, Mozambique, Guinea, Eritrea, Madagascar, Comoros, Togo, Guinea-Bissau, Sierra Leone, The Gambia, South Sudan, Haiti, Burkina Faso, Kiribati, Rwanda, Ethiopia, Zimbabwe and Afghanistan. Jonathan Gregson, The Poorest Countries in the World, Global Finance, Feb. 13, 2017, https://www.gfmag.com/global-data/economic-data/the-poorest-countries-in-the-world.

3. Year-End 2016 Emerging Markets Private Capital Industry Statistics, Emerging Makets Private Equity Association (EMPEA), Feb. 20, 2017, http://empea.org/research/data-and-statistics/year-end-2016-emerging-markets-private-capital-industry-statistics.

4. Id.

5. Id.

6. CGAP – 2016 International Financial Inclusion Funding Data, Dec. 13, 2016, http://www.cgap.org/data/2016-international-financial-inclusion-funding-data.

7. As an example, Ethiopia has one local private equity fund, EMPEA, supra note 3, but has 12 active microfinance and financial inclusion funders, CGAP, supra note 6. The Democratic Republic of Congo has one local private equity fund, EMPEA, supra note 3, but 12 active microfinance and financial inclusion funders. CGAP, supra note 6.

8. See Matthew Soursourian and Edlira Dashi, Taking Stock: Recent Trends in International Funding, CGAP, Dec. 13, 2016 ("Funding commitments increased among both public and private funders [in 2015], with public funders continuing to represent just over 70 percent of total funding. Development finance institutions provide the majority of funding, followed by multilateral and bilateral development agencies"), http://www.cgap.org/publications/taking-stock-recent-trends-international-funding.

9. EMPEA, supra note 3.

10. Soursourian and Dashi, supra note 8.

11. See Peter O'Driscoll, De-Risking Emerging Market PE Investments: A Checklist for Investors, EMPEA Legal & Regulatory Bulletin (Autumn 2011).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.