The New Playbook Behind Private Equity’s Quiet Boom In Africa
Private equity (PE) investment in Africa has seen a remarkable upswing in recent years. This surge can be attributed to strong economic growth, favourable demographic trends, and growing investor interest.
According to industry reports, private equity investments in Africa have been consistently increasing, with sectors such as technology, healthcare, consumer goods, and infrastructure attracting significant capital.
This increase in investment activity shows that investors have more confidence in Africa’s long-term growth prospects and the continent’s immense potential to offer attractive returns. This trend is expected to continue, which makes Africa an attractive destination for private equity investors who want to leverage the continent’s growth potential.
The value of investments made by private capital firms in Africa remained strong despite economic uncertainty throughout the year, closing 2022 with private capital firms reporting investments worth USD 7.6 B. The number of full exits made by private investors hit a remarkable 82 deals in 2022, the largest number of exits ever recorded in a single year on the continent.
Although Africa presents some promising opportunities for private equity investors, the industry is not without its challenges. Regulatory complexities, political instability, currency risks, and inadequate infrastructure can pose significant hurdles for those operating in the region. Additionally, finding quality deals, conducting thorough due diligence, and managing portfolio companies in diverse and often unfamiliar markets require specialized expertise and a deep understanding of local dynamics.
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Private equity activity in Africa is driven by the continent’s thriving entrepreneurial ecosystem, which is home to a wave of innovative startups and high-growth organisations. To understand how private equity firms make investment decisions in this continent, where business models are still being established, I spoke with Arul Thomas, Partner at Lightrock, a global investing platform that focuses on impact-driven growth equity, with operations across Latin America, Europe, Africa, and South Asia.
The Background
Lightrock is a global private equity platform that backs purpose-driven companies. Investing across five continents, Lightrock has a portfolio of 90+ companies and manages over USD 4 B of assets.
Lightrock has a dedicated team and leadership for Africa. The partners leading the Africa team have been investing on the continent for over two decades and are among the pioneers of private equity in Africa. The establishment of the team in Africa demonstrates Lightrock’s recognition of the continent’s importance in its broader platform, and its capital commitment indicates the opportunities available on the ground.
Lightrock typically invests at the growth stage, with a ticket size between USD 10-20 M, in commercial businesses that have a clear impact thesis built into their core fundamentals. Lightrock’s team spread across Nigeria and Kenya, works closely with the businesses it backs to help them scale.
The Lightrock portfolio includes several well-known names in the African ecosystem, such as M-Kopa, 4G Capital, Moniepoint, Copia Global, LulaLend, and MAX. These startups have collectively raised close to USD 2 B.
Navigating the African Landscape
Africa is a lucrative market with 1.2 billion people spread across 54 countries, but there are only about 4 to 6 attractive countries which can attract investments of sizeable amounts. So, the key to working in an investment environment that is still formative is that the PE funds need to work patiently, partnering with portfolio companies over longer durations and adopting a business-builder attitude.
Arul, who has been with Lightrock since 2018, oversees its East and Southern Africa investments. Africa overall, and Kenya in particular, has witnessed incredible growth over the years, he shares. The state of infrastructure, the investment community, and the way companies have scaled up are highly contributing to a thriving PE landscape.
The private equity investor says he derives his experience from the growth trajectory Lightrock’s deals have followed. Lightrock has evolved its investment approach in Africa, initially focusing on high-impact earlier-stage investments, he explained, where at times, social impact was prioritised over commercial returns. “Some of the initial deals were meant to be patient capital that allowed for very innovative but untested models to be explored. This phase was very similar to how a venture capital (VC) fund operates by taking on some early-stage interest,” Arul shares.
As of today, though, Lightrock is cutting back on early-stage bets and supporting proven models. So, in a nutshell, Lightrock today invests in businesses that have positive unit economics and are on the path to getting to EBITDA positive, the investor explains, adding that they “come in at this stage with capital and expertise to help such businesses scale.”
Today, on the continent, there is a clear distinction between VC and PE. There are numerous early-stage VCs like Launch Africa and Kepple Verod, which are working right after the minimum viable product stage. And then there are the likes of Amethis, Adenia Partners and AfricInvest which are very much operating in the PE space. Lightrock and other growth investors form a key linkage between these two stages of investment.
The growth investors form the linkage between that USD 100 K to USD 1 M check and an Amethis or AfricInvest, that form the other part of growth investments, can deploy USD 50 to USD 80 M in a highly cash-generating business because their exit would be on an EBITDA multiple and not on a revenue multiple.
But Arul goes on to acknowledge,
“I think there is a bit of a gap in the growth space.”
This gap is precisely what Lightrock is trying to fill, together with the likes of Novastar and Norrsken, which are also playing the missing middle.
Lightrock’s Africa fund is smaller than its funds in South Asia and Latin America. “The ecosystem in Africa is a lot smaller than the other geographies” Arul opined, “If you look at the Indian ecosystem versus the African ecosystem or the Latin American ecosystem versus the African ecosystem, the size of the opportunities and the scale of the ecosystem are on completely different levels.”
The capital commitment is in line with the size of the ecosystem and the size of the opportunities it offers. The dealmaker notes that as of now, in Africa, a Series B ticket would hover around USD 10 M to USD 15 M. Whereas a similar Series B ticket in India could be around USD 50 M, and between USD 30 to 35 M in Brazil.
Investing in the continent also requires a certain level of flexibility and adaptability. The ecosystem itself, he notes, is not as large as Western Europe where there are several hundred VC firms, growth firms and PE firms. “Typically in such markets, companies tend to have the same distribution channels, probably the same suppliers, and perhaps even the same VCs because they’ve understood this model well. Thus, the scaling and growth patterns are more predictable if the companies simply keep replicating it,” Arul tells me.
“For African companies, however, there is hardly any reliable templatised growth model,” he adds, “and many startups in the growth phase are still perfecting the business models or hammering out product market fit.”
Eventually, terms like “Square of Africa”, “Amazon of Africa”, or “X of Africa”, while useful from a perspective of understanding the business model, hardly hold up in terms of building an operation or a scale-up strategy because the reality on the ground tends to be very different, the PE insider points out.
Also, there aren’t as many super niche opportunities, compared to Western European counterparts, Arul argues. “Evidently, fintech in the Western European market is addressing very niche pain points since the broader problems have already been addressed, whereas,” he says, “African fintech is heavy on credit-led models or payments-led models which form significant pain points in the market.”
But interestingly, there aren’t many differences between India, Latin America, and Africa outside of scale,” he contends. “These markets are scaling up at a different pace from their African counterparts. Scaling is unique in the African market as most companies think of scaling in two ways: scale in the current market or dip into the next market,” says Arul.
The investor also emphasises that as funding partners in the stated growth phase, a PE firm has to be more hands-on and on the ground with the startups.
“There are proven templates in India, and as an investor, one can kind of step back a little bit because there is a map that a founder can follow”. He adds:
“You need to really be in the passenger seat, and you can’t just be that board member who goes in once every quarter and tries to sound smart”.
2024 and ahead
After the unusual upswing in scaleup funding in 2021, deal flow got healthy for Lightrock and the platform has grown exponentially since then, the Lightrock Partner tells me. The brand recognition has also helped Lightrock grow its portfolio to 9 companies across Africa and over 90 companies globally.
What has emerged after 2021 massive funding numbers is also something worth noting. The recent macroeconomic headwinds have acted as a litmus test for companies in Africa as they face a squeeze in valuations, forcing them to focus on profitability. “What the African continent will experience is a phase of consolidation,” he opines. “In most markets, multiple players are trying to do the same thing without enough differentiation in the business models. This will lead to a lot more communication between companies and investors in trying to see how they can find commonalities and synergies.”
Recently we have seen a decrease in external fundraising as investors have, on the one hand, sought to double down on the best-performing companies in their portfolio and raise internal rounds or to support the promising but struggling companies where they can, on the other hand.
The investor, however, thinks 2024 will be different. “With businesses looking inward and thinking about capital efficiency and operational improvements over the last 18 months, many more businesses have become profitable or are on the path to becoming profitable. This, combined with the fact that existing investors might be running out of dry powder, could lead to a raft of attractive new opportunities coming into the market this year,” Arul claims.
The Lightrock executive also hopes to see a lot more debt activity because as business process improvements are happening, a lot more businesses are getting to a point where they can raise debt. “Moreover, given how valuations are uncertain right now, there will be a preference to raise non-diluted capital,” he adds.
He quips,
“In some ways, the current funding winter is good for the industry because it really separates the wheat from the chaff”.
Now, with geopolitical turbulence subsiding and macroeconomic conditions gradually improving, the appetite for emerging markets, including Africa, should grow.
