Private equity is an alternative investment class and consists of capital that is not listed on a public exchange. Private equity is composed of funds and investors that directly invest in private companies, or that engage in buyouts of public companies, resulting in the delisting of public equity. Institutional and retail investors provide the capital for private equity, and the capital can be utilized to fund new technology, make acquisitions, expand working capital, and to bolster and solidify a balance sheet. In its broadest sense, private equity encompasses various activities aimed at securing funds from investors, utilizing those funds in a range of investment transactions and eventually delivering a superior return on investment to the investors. The overarching idea of private equity is thus to invest in companies that are not publicly listed or to delist traded companies through a negotiated process where the buy-out can be friendly or hostile, depending on whether or not the negotiation is with the party that has the controlling interest. The private placement of new shares or the sale of pre-existing shares by the controlling interest or minority shareholders characterizes most private equity deals.
A developing country refers to the nations that have low living standards, undeveloped industrial base, and low Human Development Index (HDI); Countries where markets haven’t reached saturation and still lacks infrastructure investments. It is the countries which are economically and socially trying towards betterment by economic and social maintenances and proper policy implementation. According to the World Bank, Uganda is a developing country as it fits the criteria. Emerging economies while not so different from a developing country differ in the sense that they are characterized as having a fairly efficient macroeconomic framework accompanied by an appreciable level of international competitiveness. Second, it should be a market economy with reasonably efficient and competitive domestic markets. Third, the level of human resource development as well as that of the quality of infrastructure and institutions would be consistent with the needs of an economy set for rapid expansion. Fourth, a properly functioning economy is partly the result of an adequate level of governance and political accommodation. Last, an emerging economy is expected to become gradually less dependent on aid, relying more on domestic savings and foreign private inflows for investment. Its debt burden also ceases to claim more than a modest share of total resources. Uganda falls just short of this category because it doesn’t meet all the expectations of an emerging economy but indicators point that if it continues in its policy and structural reforms as well as infrastructural development it could very much achieve this benchmark.
Uganda still being a fairly nascent market, there is need for robust economic growth as well as substantial growth in the private sector. This means there is need for more and more businesses as well as SMEs to access alternative investment such as private equity funding (which also very much involves Venture Capital funding to young and growing business). Private equity offers a compelling business model with significant potential to enhance the efficiency of companies both in terms of their operations and financial structure. This has the potential to deliver substantial rewards both for the companies’ owners and for the economy as a whole. The four main characteristics of private equity model could explain why it can be appropriated for developing and enhancing the private sector of emerging markets/developing countries namely; the long term investment horizon where PE fund managers have a long-term investment horizon, with the regular lifespan of a closed-end PE fund being ten years and the average holding period of an investee company being five years.
The long-term commitment and involvement of a private equity investor ensures that there is sufficient time and a stable environment to put an expansion or professionalization plan to work. This is a prerequisite for successfully growing a business in developing markets, as constraints in the business environment – such as bureaucracy, access to energy or unreliable tax regimes, call for patience, value creation where a strong focus on improving a company through active management such as through board seats is key to the PE model. Fund manager team members often have previous boardroom experience, a good business network and specific sector or technological expertise. Companies can tap this expertise and use the network of its investor. This focus on growth and knowledge transfer is unique to the PE model and is in great demand in developing countries, the flexible investment approach to fill the financing gap where A strong focus on improving a company through active management such as through board seats is key to the PE model. Fund manager team members often have previous boardroom experience, a good business network and specific sector or technological expertise. Companies can tap this expertise and use the network of its investor. This focus on growth and knowledge transfer is unique to the PE model and is in great demand in developing countries and lastly opportunity to improve environmental, social and governance (ESG) management of a business, mainly for two reasons. Firstly, due to a general lack of knowledge of the business case for sustainability in developing markets, PE fund managers can play a crucial role in introducing or improving ESG management. Secondly, PE’s long-term horizon provides the prerequisite for ESG improvements to really materialize. Patience and time are needed, as improvements in this field are not usually quick fixes. They may even require a change of culture among employees, such as in the case of enhanced health & safety procedures. According to the National Development Plans II, it is estimated that in Uganda 42% of its total financing originates from the private sector, however, to be fully integrated in development process, they themselves need to be adequately financed before they can invest in the interventions required to meet SDGs shall attempt to highlight some of the best potential benefits private equity funding that a developing country such as Uganda needs.
First and foremost private equity provides an alternative means of accessing medium to long term business financing. In a developing country like Uganda, there exists little to no access to funding which they require to grow and compete. As a result, these firms underperform relative to their potential. This linkage between access to capital and firm performance is indisputable, and is reinforced by countless surveys of business owners in a broad range of developing countries who consistently assert that the difficulty of obtaining financing ranks is one of their biggest problems. According to a World Bank study, in low-income countries, 43 percent of small enterprises and 38 percent of medium-sized firms report access to finance as a major obstacle to their business operations; in high income countries, only 17 percent and 14 percent, respectively of firms report this as a constraint. Demand for capital has risen in transition economies. The combination of new, growing private firms, a distressed banking sector and voucher privatization in the transition economies has led to heavy demand (and opportunities) for equity financing from both portfolio funds and private equity/venture capital funds. According to the World Bank Group, when private equity firms decide to invest in developing countries it is because in developing countries there is a harder time accessing loans. There is limited borrowing from Local Finance Institutions (LFIs) due to high economic risks and the costs manifested in high interest rates. LFIs tag the high cost of capital to operational costs, inflation, high risk of default and high levels of non performing loans in sectors like Agriculture etc. Private equity seeks to bridge this divide because unlike banks they don’t seek payment with interest after allowing to assist a business with capital rather than they seek a piece of equity in the business which they seek to profit off with relatively more favorable terms as opposed to a bank loan.
Secondly, private equity investment not only brings funding to businesses in developing countries but they also provide much needed professional and experienced management to businesses as well. Equity investing comes with experienced investment managers who provide managerial support for the business. They improve corporate governance by putting in place internal control systems and external oversight. Equity financing comes with its fair share of demands that may be challenging for Ugandan SMEs yet on the brighter side it provides opportunity for them to develop. Private equity investors are in the business of providing a combination of scarce capital and performance-enhancing expertise for the purpose of strengthening the competitiveness and profitability of individual companies that meet their rigorous investment criteria. When these efforts are successful, company value is significantly enhanced, eventually generating attractive financial returns both for the investors and the owners of the target companies. Private equity investors direct their efforts toward identifying and eliminating inefficiencies in a company’s performance, aimed at raising the invested company’s value, private equity investors provide extensive assistance to management in various areas. Ultimately, they contribute to greater efficiency and improved financial standing of acquired businesses. Efficiency gains achieved at private equity-backed enterprises may then spillover to other firms in the same industry, related and unrelated firms, via transfer of more efficient technologies and business practice.This is indeed true because private equity have a mandate to make sure the venture is profitable to shareholders and investors meaning there is little or no room for error.
Furthermore, private equity provides a platform to more entrepreneurship spirit which only serves the country well. This is because there is easier access to business funding and other added benefits such as improved management. Private equity funding is likely to encourage private entrepreneurship and so release some of the energies and skills of local people. No country can be developed from outside; it is essential to get the people of the country working for its development, and one of the essential ways of doing so is to tap this rich vein of the desire to run one’s own shop or business. A completely regimented economy is likely to lack the ebullience of one where private interests are harnessed to the development process. Private equity investments provide solid support to entrepreneurship and private sector development in a recipient country. They help to illustrate techniques that can be used to restore the health of businesses. They may also help in encouraging the government to undertake reforms that would improve the country’s investment climate. They help newly created firms to start up and grow and more mature companies to develop into profitable and highly-competitive businesses. This encourages the setting up of more ventures as well more job opportunities most likely to benefit a country like Uganda With an entrepreneurship rate of 28 per cent, ranks in first place with almost double the entrepreneurship rate of Thailand, who comes in second place with 16 per cent.
Private equity also provides the potential of operational value creation in businesses. Operational value creation goes far beyond slashing costs or implementing a land-grab for revenue growth. A sustainable operating model should be established to execute on the corporate strategy, but without jeopardizing efficiency or flexibility of the business. You find a lot of entrepreneurs in emerging markets that have produced a great service or product but don’t know that it can be improved upon. Or perhaps they have perfected their product but don’t know how to brand and sell it. Or perhaps a company is doing well and moving up the value chain but doesn’t know how to handle competition, which it is now facing for the first time. All of these scenarios inhibit growth, which is why the entrepreneur needs a private equity partner—it is their job to identify the gaps and help a company reach its full potential. This is done through focusing on operational aspects such as enhancing products and services, improving production and supply chain management processes, restructuring internal operations, and expanding marketing and distribution channel, human capital by recruiting experienced and/or skilled senior managers, professional training for workers, and ensuring compensation structures are competitive in order to attract and retain key personnel, corporate governance by establishing an independent Board, introducing acceptable accounting and financial reporting practices, and codifying best practices for the Board of Directors, environmental factors by implementing environmental practices, which in recent years have been recognized as having a high degree of correlation with overall firm competitiveness; and financial aspects by advising management on an efficient capital structure, assisting in raising additional debt and equity, and providing input during negotiations to secure attractive financing terms.
Last but certainly not least, private equity investment has the potential to promote effective competition in industry. The impact of National PE associations in promoting the industry is great in addition to the efforts of advocates in an effort to influence the regulators; investors and entrepreneurs in emerging market/developing countries. This is also manifested through increased access to growth capital, better management techniques and more access to resources. This leads to more research and development which also leads to creation of better quality and more affordable goods and services amongst competitors in industries which only serves to benefit the economy as a whole and foster private sector development.
However, according to the World Bank group, private equity which is an important force in financial markets and accounts for over $200 billion worldwide, only 10% reaches emerging markets/developing countries which means that for all the potential benefits private equity investment can bring to a developing country like Uganda, there exist barriers and bottlenecks to attract such investment as well as access to such alternative investment. I shall attempt to dive into the most frustrating barriers.
First and foremost the low development of financial markets and sector of emerging markets/developing countries make it difficult to execute exit strategies effectively. According to the Economic Policy Research Centre, 50% of Ugandan firms/enterprises are informal and by 2013, only about 8% were limited by shares of which 2.6% had tradable shares. Perhaps the most vexing aspect of private equity investing in developing nations has been the difficulty of exit. The fortunes of private equity investors in the developed world have been largely linked to those of the market for initial public offerings (IPOs). Private equity investors in developing countries cannot rely on these offerings. Even in “hot markets” where large foreign capital inflows are occurring, institutional funds are usually concentrated in a few of the largest corporations. Smaller and new firms typically do not attract significant institutional holdings, and have much less liquidity. Consequently, private equity investors in developing countries have tended to rely on the sale to portfolio firms to strategic investors. This can be problematic, however, when the number of potential buyers is small. The purchaser can exploit the private equity investors need to exit the investment, and acquire the company for below its fair value.
Furthermore currency risks also pose a challenge to private equity in developing countries/emerging markets. Currency risk, commonly referred to as exchange-rate risk, arises from the change in price of one currency in relation to another. Investors or companies that have assets or business operations across national borders are exposed to currency risk that may create unpredictable profits and losses. Many institutional investors, such as hedge funds and mutual funds, and multinational corporations use forex, futures, options contracts, or other derivatives to hedge the risk. Currency risks, and more specifically, foreign currency shortages and exchange rate fluctuations, have been identified as a major challenge facing private equity investors in Africa. For instance, in response to the fall in oil price, the Central Bank of Nigeria ended the naira’s peg to the US dollar in June 2016, prompting the Nigerian currency to lose a third of its value in a short time. This situation resulted in a shortage of dollars in the country, making it difficult for many companies to convert their naira earnings into dollars.
Also, the lack of good corporate governance in developing countries/emerging markets poses a challenge to private equity financing. lack of accuracy, timeliness and transparency for investors about financial and operational information in addition to the absence of interest by managers for having some level of accountability to outsiders as the first huge imbalance in these economies PE formula they added by pointing out that “Even in the best of circumstances, relationships between investors and the managers of their portfolio companies are complex and often contentious, but the absence of sound corporate governance practice has sharply accentuated that tension. The corporate governance instruments and undertakings in emerging markets are usually below the expected standards these are associated to significant structural and cultural elements. Hence minority investors often find that their voice is all but unheard, and the tradition of autonomy (and secrecy) is very difficult to break in family-owned emerging market companies, all of which leads to less transparent company reporting, a consequence of somewhat less rigorous record-keeping regulations in some emerging markets. This larger prevalence of informality in company reporting when compared with developed economies mostly affects family enterprises and although the number of local companies aware of the importance of having audited financials and transparent records is increasing, it is still a relevant concern.
Last but certainly not least, there exists the potential threat of political unrest in Uganda which tends to scare off investment in the private sector including equity financing. An example can be seen in a report by Human Rights Watch, when Uganda’s Constitutional Court upheld Parliament’s 2017 constitutional amendment to remove age limits for presidential candidates, paving the way for President Yoweri Museveni, in power since 1986, to run in all future elections. Allegations of widespread repression and intimidation of parliamentarians during debates marred the amendment process. Violations of rights to freedoms of association, expression, and assembly persisted, as security forces beat and at times, tortured and arbitrarily detained protesters, journalists and opposition members. Thirty-three people, including six parliamentarians, arrested during by-election campaigns in Arua, northwestern Uganda, faced treason charges and alleged torture by security forces. Police and soldiers beat and detained journalists reporting in Arua and at ensuing protests. Despite various government commitments to hold security forces accountable for their conduct, many investigations into military and police abuses of civilians failed to progress, including into the November 2016 killing of more than 100 civilians in Kasese, western Uganda, and the killings of protestors in September 2009 and April 2011. According to the International Crisis Group, President Yoweri Museveni’s growing authoritarianism and the country’s weak institutions are multiplying Uganda’s challenges. Conflict risks at the local level are rising due to uncertain political succession, economic stagnation, a youth bulge and an influx of refugees from South Sudan. The state’s repression of political opposition and its increasing reliance on security responses to political problems is fostering discontent in politically and economically marginalized communities. Political instability can affect the following cores of any business such as decision-making process and the strategic financial decisions, inconsistencies in supply chain, sales, and distribution, business continuity strategies and plans, safety of human and material resources in organization, reputation in the global market and expansion vision.
In conclusion, there is need for private equity financing in a developing country like Uganda especially more so now than ever if Uganda is to catch up with other countries that are expanding economically at a faster rate on the global stage. The benefits accrued to the private sector through private sector through the main characteristics of private equity funding can only serve to give a much needed helping hand and boost to the business sector. Despite the risks posed, there have been encouraging steps to mitigate some of these risks one being the Ugandan stock market that has been ranked among the best performing in Africa for years running. Equity financing for sure should be much welcomed and practiced in the country.