Update the Private Equity Model for Africa with Human Capital: Buy Right and Create Value Early
At Secha Capital, we believe that to create alpha, we need to re-think the private equity model for Africa and apply it to our local context.
We are confident that our unique and differentiated strategy means that we can outperform in terms of both returns and impact. But don’t just take it from us, industry experts at Harvard and INSEAD also agree:
Harvard Business Review’s June 2021 article, “Private Equity’s Mid-Life Crisis”, written by Karim Khairallah and François Mann Quirici, summarises our beliefs by stating that “there’s trouble on the horizon for [classic venture capital and] private equity.” As the number of firms and capital reach record levels, returns are “largely competed away”. And with funds paying more for businesses than ever before, “the return potential is meaningfully reduced”.
Much like Secha, HBR calls for a new way for private equity funds to create value: “The next frontier of value creation is to design and manage PE portfolios as a business ecosystem” and create value through “revenue enhancements, cost efficiencies, higher valuations and some downside protection.” HBR also contends that this value-add ecosystem approach creates a competitive advantage in deal sourcing and deal pricing. In sum, “the value creation is a major source of alpha (the industry term for outperformance).”
Our first investment, nativechild, has grown over 100X in four years. and we believe that our value-creation strategy means that we can replicate this growth story throughout the rest of the portfolio and that we can do this again and again in the future.
According to INSEAD professor Claudia Zeisberger’s 2017 tome “Mastering Private Equity”, Secha’s strategy of “buying right and creating value early” should focus on “entry multiples rather than IRR models, buying assets of value” and “finding opportunities where value creation can be engineered through multiple levels.”
Secha agrees with INSEAD’s Zeisberger that while the upside is high, “this differentiated approach is not easy to execute and it requires three key conditions to be met:
1) The availability of a rich pipeline of differentiated opportunities;
2) The ability to make judgements to avoid the pack;
3) A toolkit to transform the business.”
Zeisberger researched successful managers in other markets, such as Siraj Capital and Mekong Capital, and Secha is applying these lessons in Southern Africa.
1) The availability of a rich pipeline of differentiated opportunities
“The dearth of [deals] in emerging markets means that an effective in-house sourcing model is a great advantage. Self-generated deals start with a philosophy that opportunities are everywhere and, like Michelangelo’s angel enclosed in a block of marble, are waiting to be revealed.” — Zeisberger
While most funds are bottom-up and rely on inbound deals from contacts, entrepreneurs, and bankers, Siraj and Mekong, respectively two of the best-performing funds in the Middle East and Southeast Asia, are thesis-driven by both check size and company vision. Siraj believes that “proprietary deal flow” is possible via smaller deal sizes and Mekong’s “deal origination strategy evolved towards a top-down approach” in which it identifies growth sectors and seeks out its potential winners.
Secha Example:
Secha is also thesis-driven. We do not rely on inbound deals coming to us. We come up with investment theses in sectors and verticals and then go find companies that fit this criterion. We first did this with nativechild: Natural hair care for women of colour was a niche, growth vertical adjacent to a large market; yet, the multinationals failed to respond to the end-consumer pain points and thus failed on the key purchasing criteria. We met with five different companies in this space and Sonto Pooe of nativechild fit all of our “must-haves”.
After working with Sonto for two years, we gained unique insights into the “dry hair” aka wig market: The wig market was even larger than natural hair care and even more fragmented with even less brand equity. We sat on this thesis for 18 months as we looked for the right wig company until we found Anisha and Wikus of Hair Town.
In both cases, we were the first institutional capital provider to reach out to these entrepreneurs. And in both cases, they sold us shares because they wanted to work with our unique Operator-Investor model.
2) The ability to make judgements to avoid the pack
“Private equity firms with operational capabilities have a distinct advantage in sourcing unique investments in emerging markets.” — Zeisberger
Both Siraj and Mekong avoid the pack by looking where others do not and writing checks where others can not. They raise funds not to maximise assets under management, but to enable them to write the check sizes that are most impactful. And they focus on sectors that are large, fragmented and take advantage of growing consumerism and region-specific demographics.
Secha Example:
We state that we look for “boring” companies in part because it demonstrates our differentiated strategy. At first glance, investments into iG3N and Cultura Fresh, representing the renewables and agritech sectors, respectively, do not sound “boring”. In fact, these sectors are “trendy.” However, we knew that to succeed in these sectors, we needed to find value where others could not.
Thus, with iG3N, we focused on the battery storage step in the renewables value chain as batteries play a crucial but often ignored role in renewable adoption. And Cultura Fresh, its hydroponic technology is world-class, but it offers an industrialised alternative to traditional farming, a local solution that is more replicable and cost-efficient than vertical farms or controlled environment solutions.
After all, we subscribe to the adage “in a gold rush, don’t mine for gold, sell the pickaxes” and this is what we have done here.
3) A toolkit to transform the business
“Beyond the investment phase, operational activism [is] crucial to success” — Zeisberger
Both Siraj and Mekong know that growth capital alone is not sufficient to grow these SMEs. It requires a comprehensive value-add approach: Siraj focused on what Secha calls the ground game and “established an investment monitoring unit to work specifically [with the investment] for the first six months” because an SME investment required “a more hands-on approach than investing in larger players”. Mekong installed what Secha calls an air attack: “Helping businesses improve operationally had become the cornerstone of Mekong’s value-creation strategy” when they “created a value optimization board [to give] its portfolio companies access to world-class expertise that was otherwise unavailable.”
Secha Example:
Secha combined these two different, but equally important approaches from Siraj and Mekong and the results are positive. Despite being a small fund of comparatively limited resources, in the past twelve months alone we have leveraged our contacts from our investors and via our networks at Bain, BCG, Goldman, etc. and we have worked with experts from PicknPay, Nestle, Unilever, Facebook, Google, etc. — all to the benefit of our portfolio companies. And we complement this expertise with our Operator-Investor model. The experts help identify the opportunities and what should be done; the Operator-Investors do the day-to-day work to help the entrepreneurs execute and realise value on these growth initiatives.
We can therefore confidently state that: Secha’s “Operator-Investor” model gives small, growing businesses (SGBs) a unique advantage to solve the “missing middle” and “management gap” via a “growth and human capital arbitrage” strategy. We’ve invested in ten (mostly Black and women-led) South African companies, creating 180+ jobs and growing each company 3–100x.
And this model is highly replicable and modular. To build out this asset class, to create the jobs and impact we all want to see on this continent, we encourage other people and more funds to follow this approach.
Written by Anesu Shoko and Brendan Mullen.
Anesu is an Operator-Investor and Brendan is a Managing Director at Secha Capital.
Secha Capital is an early-stage impact private equity manager. Secha’s “Operator-Investor” model gives small, growing businesses a unique advantage to solve the missing middle and management gap via a growth and human capital arbitrage strategy. Secha Capital focuses on established companies in the FMCG, agribusiness, health care and manufacturing sectors throughout Southern Africa. sechacapital.com — @SechaCapital — associate@sechacapital.com — +27 76 376 1629
