Are African businesses getting skeptical about private equity?

Samson Kawalya needs more funds to expand his agro-processing enterprise but going for private equity is least on his mind despite being one of the cheapest options for entrepreneurs to raise capital.

An entrepreneur of 10 years, Kawalya has been discouraged by the different reports on how people have lost their businesses at the hands of private equity firms.  Kawalya is not alone.

While many African businesses are grappling with funding gaps due to lack of affordable credit, a growing number are also becoming increasingly skeptical about adopting private equity financing.

Statistics indicate that about 95% of businesses in Africa, especially small and medium-sized enterprises (SMEs), continue to borrow expensive credit from banks to invest in businesses, compared to 60% of enterprises in the US that get funding from private equity and venture capital.

Private equity is a form of financing where funds and investors invest directly in potentially high growth companies that are privately owned for a specific period. Their main exit route is through listing on the stock exchange, where they sell their shares to recoup their investment and profit before exiting the company.

While a few African businesses had started embracing private equity as a funding option to oil their expansion projects, recent events have seen some entrepreneurs burn their fingers and have slowly forced businesses to back off.

Experts say there is a growing number of businesses that partnered with private equity funders, who then turned against business owners and instead repossessed their enterprises.

A few Ugandan companies such as Cipla Quality Chemicals and Vero Foods seem to have had successful private equity investments in 2009 when the London-based TLG Capital invested an unspecified amount in the firms.

But others are cursing. Among the companies that have burnt their fingers in the past is Spencon, which was once one of the largest construction firms in East Africa. Established in 1979 in Kenya by J. C. Patel, N. P. Sharma and L. R. Patel, the firm had by 2006 grown to become a leading indigenous construction group in the region, with presence in Kenya, Uganda, Tanzania, Sudan, Malawi, Zambia and Mozambique.

It over the years developed solid relationships with a number of financial institutions, including state-backed development finance institutions (DFI) such as the Dutch Development Bank — FMO, which attracted finance from DEG, an arm of the German Development Bank, KfW. Pragnesh Patel, whose father founded Spencon, said the company enjoyed a good relationship with KfW and other international donors, including the EU and Japan International Co-operation Agency (JICA).

Why are businesses weary of private equity?

However, trouble started when a US private equity fund, Emerging Capital Partners (ECP), invested $15m in Spencon together with the founders in 2006, with the aim of listing Spencon on the Nairobi Stock Exchange between 2012-2014.

Patel said Spencon's founders had been introduced to ECP by FMO, who had previously arranged project finance facilities for Spencon. He noted that while the relationship with ECP was initially positive, it turned nasty in mid-2011 when ECP allegedly conspired to wrestle control of the company from its founders.

Patel claimed that unknown to the founders at the time, ECP was in secret negotiations with a UAE-based competitor, who had expressed interest in acquiring Spencon, for which ECP offered to sell 100% of the company shares. However, the sale did not go through as it was blocked by two of the founders, forcing them to enter an arbitration process.

ECP reportedly rejected the founders' proposals for an equitable win-win solution and, instead, they unceremoniously ousted all the founders and took over full ownership and management of the company in early 2014.

Patel said besides grossly mishandling the business, the said team, led by ECP, engaged in massive bribery payments to Ugandan government officials. He claimed that while the payments were reported to the authorities in the US and UK as well as to ECP's donors, including DFID, CDC, and EIB, ECP used its international public relations agencies to misrepresent and distort the facts and instead accused the founders of foul play.

Additionally, Patel said when the original team failed to ‘turn around' the business, the second team of questionable integrity was appointed by ECP and that management ultimately drove the company into bankruptcy.

According to a documentary by BBC's Africa Eye team, the new bosses appointed by ECP and sent to Nairobi in November 2014 to rescue the collapsing construction firm - Andrew Ross and Steven Haswell, were allegedly involved in fraud, bribery and other highly questionable business practices.

The reports indicated that while the firm was struggling, Haswell was to be paid $25,000 (about sh93m), while Ross received $30,000 (about sh11.2m) monthly.

While their job was to turn around Spencon's fortunes in 18 months so that ECP could sell it by the end of 2016, they failed at that, leading the company into collapse in November 2016, as they were involved in lavish expenditure.

It is said the bosses spent $70,000 (sh259.4m) on their own company cars — a Range Rover and Volkswagen Touareg. According to the BBC's Africa Eye team, Haswell said the cars projected an image of an organisation of substance rather than one close to insolvency, while Ross said the vehicles were deemed appropriate by the board.

They are also said to have sold off company equipment that was still in good condition, using Tony Sanghani, a security consultant they hired.

In addition to taking a big salary ($20,000), it is alleged that Sanghani was living in an expensive serviced apartment paid for by the company, was given a car, driver, and cash bonuses.

While the proceeds from those sales should have gone to paying off the firm's bank debts in Uganda, the money was instead deposited in Sanghani's personal account.

After Spencon went bust, the administrators — international accounting firm PricewaterhouseCoopers (PwC) — discovered a huge black hole in Spencon's books — at least $1.6m had not been accounted for.

Haswell, however, said the equipment sale cash was deposited in Sanghani's account to protect it from creditors who had "dubious" court orders to seize it and to allow Spencon to "disburse the funds as it chose."

While it said PwC pressed Sanghani to hand over his accounts in 2016, he refused to co-operate. The firm is currently under receivership, managed by PricewaterhouseCoopers.

Others affected Other African firms that have burnt their fingers in such private equity funds are Zuku TV parent firm — Africa Telecommunications, Media and Technology Fund (ATMT Fund), which a US government-backed private equity fund — Overseas Private Investment Corporation (OPIC), took over in 2017.

The ATMT Fund controls Wananchi Group Holdings.

The fund is said to have written to owners of triple-play service firm Zuku to invoke a rule, technically known as ‘bright-line test', to protect the $50m senior debt it advanced ATMT Fund and which had so far accrued $12m in interest.

It was reported that OPIC ordered that East Africa Capital Partners (EACP) step aside as manager of the fund and holdings pursuant to its rights under the amended and restated finance agreement. It also kicked out the fund's three directors — Richard Bell, Ali Mufuruki, and businessman Mark Schneider — from the Wananchi board.

The trio were representatives of EACP, a venture capital fund that According to the Financial Times report of April 17, 2012, the UK government-backed private equity fund, CDC, had been dragged into the controversy surrounding the former governor of the oil-rich Delta State in Nigeria, James Ibori, who had been charged with laundering public funds.

It was reported that it helped fund three Nigerian companies for providing a front, behind which associates of Ibori could launder money. The fund is said to have put £62m into Emerging Capital Partners, a US-based fund, which in turn bought shares in Nigerian companies that anticorruption campaigners said were used by Ibori's allies to process money gained through fraud.

Oloko alerted the development department in 2008. British officials asked ECP to investigate and were told by the US fund that the allegations were not true.

Experts indicate that in the high-powered and big-money world of private equity, investors who have committed capital nearly always make sure to meet capital calls in a timely fashion because of common and strict default penalties that kick in if they do not.

Failure to perform on a capital call might not seem like a big deal and boring technicality, but it can result in investors losing the bulk of the cash that they have already contributed to a private equity fund.