The surest way to lose a business is to bring on board new investors into the company built on the blood, sweat and tears of its kin. This is the thinking among many family-owned enterprises in Kenya.
Private Equity (PE) Funds and Venture Capital (VC) firms are seen as outsiders, with little understanding of the sacrifice that a family has put in to grow a business to a point that is attractive to external investors.
If anything, private equity Funds and Venture Capital firms are usually in it for the short-term. They leave once they have made a good return.
The 2018 World Bank Survey of the Kenyan Private Equity and Venture Capital Landscape noted that while family-owned businesses are increasingly becoming a source of capital for small and medium-sized businesses (SMEs), the owners of these enterprises would rather go for a ‘less institutional source of financing’ such as family and friends, commercial loans (where banks will not seek an insider view of the business) or investment groups (chamas).
Business advisory firm PricewaterhouseCoopers (PwC) also reported a similar observation in its Kenya Family Business Survey 2018. It noted that while there is an increase in the number of enterprises that would consider private equity and venture capital firms, they mostly rely on internal resources (family funds) and debt financing for growth capital.
For Chets Mukherjee’s Software Technologies Ltd (STL), PE offered the most viable source of growth capital. About a decade ago, the tech company that his mother Jyoti Mukherjee started in 1991 was looking to expand.
Chets observes that the firm’s options included banks that were then lending at unreasonably high interest rates and in many instances still asked for collateral, selling a stake to high net-worth individuals or bringing on board a PE Fund.
Upon evaluation, the first two options would not offer STL the structures that would enable it to grow into the next phase and hence settled on a PE firm.
“We were at a stage where we had the options of going to wealthy individuals who could invest to grow the business or we could go to private equity or borrow from banks,” he said.
"Borrowing for SME was not easy then. Even today it is not easy. Today, we have rate caps but then the rates were as high as 30 per cent and even then you had to pledge your assets."
“We had offers from high-net-worth individuals but we opted for PE because they bring structures to the business. They help prepare the company for the next level of growth. If we brought in rich friends, chances are that nothing much would have changed other than access to money, there are few individuals who are sophisticated and may bring governance but that is rare," he observed.
STL sold a minority stake to TBL Mirror in 2009, which exited last year, after which the company brought on board the South African Enko Capital Managers.
Both funds have had the impact of professionalising STL including putting in place proper management and oversight structures according to Mukherjee.
“The big difference that a PE brings is governance. They will help a business put in place structures that will tighten things that you would ordinarily take for granted like succession planning, controls, compliances and reporting requirements,” he said.
“We were a family-owned business and our board meeting would take place around the breakfast table and everybody would commit to doing the best they can," he said
"After we brought on board the first PE Fund, all these changes and among the first things that we did was to put a proper board in place with independent directors and board committees. We now have to do planning early and get approvals at the management and board levels before execution starts.”
PE funds globally have a reputation for short to medium terms stays in a company, usually exiting when they have made healthy margins.
This is among the issues that make SMEs wary of bringing them board, with the thinking being that they will ship out at any sign of danger.
Mukherjee noted that while PE funds are after a return on their investment, the notion has been taken out of context noting that good returns for the new investors also meant the same for the old investors.
“PE Funds usually stay for a few years and will leave when they have made their money, which is among the reasons that businesses tend to have a negative perception about them,” said Mukherjee.
"But though they tend to be transitional, they help you grow because they also want a return on investment. This is different from when it is your business and you are not able to see it from an outsider’s perspective."
He added that a firm looking to bring on board a private equity should take time to understand its needs as well as undertake a due diligence on the PE firm that they have identified.
“If you are looking for PE Funds, realistically give yourself 18-24 months to bring the money on board. We started talking to Enko in 2017 June and the investment was finalised in October 2018. In our case, it is our second case where we are bringing a PE Fund on board and have a lot of things in place unlike other firms that have not had the chance but it still took 15 months,” said Mukherjee.
PE Funds look for firms that are ready for transit from being run by families or founders to entities that are run professionally including having independent boards and management teams that are competitively selected.
Enko, the second PE firm that has bought into STL noted that this includes opening up their processes to scrutiny.
“Governance is a key issue. We need to know there are processes in place and board decisions are taken openly. This gives us the confidence that there are systems in place. We cannot invest in a business where they are not ready to take partners on board,” Ralph Gilchrist co-founding partner of Enko Capital Managers.
"In this case (investing in STL), we know little about ICT but we can help frame the strategy around the business. Some companies might not be ready for that. They may want the money but not ready for transparency."
Mr Gilchrist said they have to fit the basic profile – they have to be an established business with good and competent management as well as a good position in the market which we can see great prospects of growth.
"They should also have a stable cash flow, so no ups and downs. We are part of that process of transforming family business into more formalised entities. Businesses also want to see people contribute to the business. There also has to be chemistry between the PE Fund and the investee company,” he noted.
The East Africa Private Equity and Venture Capital Association (EAVCA) in its recent report noted an increase in local firms that are seeking out PE and VC firms. Currently, local the association’s members are mostly investing in the technology sector and working mostly with founders, as opposed to family-owned entities that have transited from founders to second or even third-generation family members.
“Uptake of private capital has been growing. Small and family businesses are starting to look at alternative sources of growth capital outside the family kitty or even banks. Private equity and venture capital are becoming more appealing,” said EAVCA Executive Director Eva Warigia.
“Most of the firms attracting venture capital are tech but do not have a legacy of family businesses, so we are largely working with the founders.”
She explained that PE and VC firms in the region rarely make hostile takeovers and instead work with owners as minority shareholders.
“We tend to position ourselves not as taking over. Takeover model does not work in Africa. For most PE Funds, they invest to bring in growth capital and take a minority stake," she said.
That perception, noted EAVCA Executive Director, comes from the west where the industry is slightly more developed. "We are still at the growth stage and a PE Fund would take a minority stake and enable businesses to grow,” she said.
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