Private Equity: investing in mid-market companies can unlock jobs for SA
Fund managers and institutional investors can stimulate the domestic economy and create inclusive jobs by investing more in mid-market companies. This was a key message emerging during a closed discussion at Sanlam Investments' sponsored South African Venture Capital Association (SAVCA) Institutional Investor's Summit, held recently.
"Mid-market companies have cemented their position in the sectors of the economy they operate in and have great potential from both an economic and job growth perspective," said Paul Moeketsi, Managing Partner at Sanlam Private Equity.
Sanlam Investments defines the mid-market category as companies with annual operating profits of between R50 and R250 million. These companies are largely established businesses, which have fully emerged from their start-up stage but are yet to achieve scale, maturity and critical mass and are therefore poised to grow faster than the economy.
Fourie Borman, CEO at TradeOn and a KFC franchisee, a 95% investee company of Sanlam Investments, said that companies in this segment offered significant development prospects relative to the capital investments they required. "Every time you invest in a new outlet, you create an opportunity for someone to join the business. We have structures in place to develop new hires into managers capable of running multi-million-rand operations," he said.
Much of the summit debate focused on securing institutional capital for mid-market opportunities that have historically been perceived to be riskier than investments in larger listed and unlisted firms. Dr Susan de Witt, Design Lead on Impact Investment Wholesale Vehicle, observed that development funding sources were drying up. "Development agency budgets are shrinking following Covid-19 and due to the repurposing of investment strategies towards creating sustainable local economies," she said.
It was suggested that pension funds could step up to the plate and take a more dominant role in job-creating investments by increasing the quantity of funding available and demonstrating the mid-market segment's viability in achieving member outcomes. Once pension funds come on board, it would allow more concessionary capital to flow to higher risk, higher impact opportunities at an earlier stage. Another funding solution could be to encourage fund managers to move a small percentage of their diversified, balanced fund portfolios into infrastructure or private equity.
Environmental, social and governance (ESG) and impact investing are decisive factors in the 21st Century capital deployment decision. "When we enter deals in upper-middle-income countries like South Africa, Namibia or Botswana, we begin with understanding the development impact of the transaction," said Vibhuti Jain, Regional Managing Director for Africa at the U.S. International Development Finance Corporation (DFC). The DFC weighs up whether an investment is critical to a country's infrastructure needs or supports low-income groups, among other criteria, before investing.
The United Nation's Sustainable Development Goals (SDGs) have also become a rallying force in capital allocation decisions. "Investors are thinking about investments over and above the risk management aspect of ESG screening, partly because of the sustainable development imperative," said De Witt. Fund managers must ensure that they generate long-term sustainable returns in the businesses they invest in without compromising the environment in which they operate or risk delivering poor outcomes to future pension fund members.
The panelists observed that there were many investment opportunities in the mid-market company space. "Mid-market firms are an important sector of the economy as they have the potential to create meaningful employment opportunities for local populations," said Jain. The DFC has a little under US$1 billion exposure to South Africa, with investments in affordable housing projects and financial arrangements with African Data Centres, the African Leadership Academy and SA Taxi, among others. Future investments will be made in critical infrastructure, digital connectivity and healthcare.
Due diligence and effective risk management are essential aspects to master in African private equity markets. "We invest with incredible management teams that have a track record of running businesses successfully; integrity is of utmost importance to us," said Moeketsi. He urged private equity managers to commit to responsible investing and to reflect on the impact of their investments rather than obsessing over deal-making.
Asset managers and institutional investors will have to create meaningful value for the beneficial owners of the underlying assets and optimise the risk and return from their investment portfolios. "The power that asset owners and asset managers have to drive the reporting and the measurement of impact is significant," concluded De Witt, before adding that it was time for stakeholders in the asset management industry, spearheaded by the pension funds, to better align their investment objectives with SDGs.