CATALYST FOR GROWTH AND JOB CREATION

South Africa’s private equity industry has gone from strength to strength in recent years, with total capital now topping R172bn. While this is very positive for the industry as a whole, the vast majority of funds are allocated to a few managers, meaning that Black private equity managers remain undercapitalised. Since fees are generated directly based on size of capital, this means that Black managers often struggle to reach sustainability. It also means that investors looking to allocate smaller amounts of capital to Black private equity managers, struggle to find the right way to do this.

Private equity is a proven tool for economic growth, with private equity owned businesses growing faster than JSE listed companies, growing tax revenues faster, and creating jobs at much faster rates than public companies. Private equity could be used to a much greater extent in South Africa to earn outperformance for investors, and create sorely needed jobs through growth.

It is against this backdrop that 27four has launched the Black Business Growth Fund (BBGF) to pool investor capital, provide investors access to a number of managers and a broadly diversified underlying portfolio of investments, to manage the selection and monitoring process and allocation of the necessary capital to Black managers.

The innovative fund, led by Rory Ord, 27four’s Head of Unlisted Investments, is designed to invest into mid-sized South African companies through Black private equity funds. The BBGF will invest in up to seven underlying Black-owned private equity funds – out of a universe of around 20 – and also invest directly alongside them into private equity opportunities.

“Some clients are looking for ways to invest in the real South African economy outside the listed markets. Pension fund members want to inject capital, create jobs, and boost economic growth,” says Ord. “Many already have lots of offshore exposure, and investing in the stock exchange often means they are merely replacing existing capital. Private equity pushes new capital into companies to drive growth, and if you do it enough, it can create meaningful economic change.”

The fund is a generalist one, and all underlying investments are South African, with a strong transformation element and job creation focus. The mandate excludes primary agriculture, mining and sin industries (notably arms, tobacco and alcohol). While it cannot invest in farms, it can invest in related areas such as food processing.

“We need to ensure we invest in deals that are all about growth and expansion,” says Chad Potter, Associate on the Fund. “It is much easier to transform the workforce if you are doing it from within a growing company.”

Most deal activity will be in the areas of manufacturing and consumer goods and services, and industrial services, telecommunications, infrastructure and related components. Smaller niche areas such as healthcare and education are also attractive.

When appraising managers to include in the fund, 27four takes care to ensure there is as little overlap in deal sources as possible. “It is a very important part of our due diligence process to have a range of deal sizes and ensure diversification in the portfolio,” says Potter. “At present, we are choosing one in three Black private equity funds to include in the portfolio. More are coming to market all the time, so we have enough to work with, but we need to ensure they are not all doing the same thing.”

The fund invests only in the mid-market, with no venture capital, start-ups or large PE buyouts so as to meet the requirements of growth without taking on too much risk.

27four follows a commitment and drawdown model, drawing capital from end investors as and when it commits to underlying funds. The fund has a 12-year lifespan, while each underlying fund typically has a 10-year lock-up. It expects to return capital to investors around the 5-7 year mark as each round of financing matures.

The fund anticipates annual returns in the high teens with underlying managers targeting around a 25% gross return on each deal. The minimum investment into the BBGF is R50 million.

According to Ord, the segment of the market the fund looks at has been slow in recent years, with recent changes in the political environment providing more clarity and improving business confidence.

“The typical business we invest in would be a large family-owned business with turnover of a few hundred million rand each year. Management in these types of companies has been concerned about the environment and they have not expanded in recent years. We are hoping that the investment we commit can be used to fund new growth”.

The fund can invest up to 20% of the portfolio in a single underlying private equity fund, and each of these underlying funds will typically have 7-12 underlying investments.

“We believe this will result in a more highly diversified portfolio than a listed investment, tapping into about 50 underlying companies. It also gives investors access to a totally different part of the market, offering diversification and an attractive long-term premium over the listed space,” says Ord.