Permanent Capital Vehicles In Emerging African Markets
What are Permanent Capital Vehicles?
Permanent Capital Vehicles (PCVs) are becoming increasingly popular in private equity, being deployed in emerging markets and sub-Saharan Africa in particular.
Capital for investments in private entities is typically raised through traditional private equity structures. However, recently we have seen a number of PCVs listing on the Johannesburg Stock Exchange (JSE). The most notable of these is EPE Capital Partners Limited, also known as Ethos Capital. Instead of investing in businesses for a fixed period of time with the aim of returning a profit, a permanent capital approach focuses on growth over the medium to long term. The benefits enable the General Partner (GP) to capitalize on long-term, high-yielding investments without being constrained by exit pressures and the challenges experienced in ongoing fundraising. Listed PCVs further provide a platform for the public to co-invest with managers and financiers, an opportunity that has traditionally been restricted to institutional investors.
In sub-Saharan Africa, we have seen managers such as CBO Capital and African Capitalworks establishing PCV strategies in select industries. This shifting trend is a result of the progressive maturity of the African capital market and its increased appetite for longer-term investments in various asset classes, such as the renewable energy and infrastructure sectors.
A Comparison between PE Funds and PCVs
Private Equity (PE) structures are “closed-ended” in that no further redemptions and subscriptions can take place beyond the closing period (usually between 12-18 months). PE funds strategically invest in illiquid assets and operate for a definite period of time (typically between seven to 10 years). Subsequently, all assets are realized and used to make distributions to investors and the GP.
Seven to 10 years of investment may initially seem to be a reasonable period of time to capitalize on market opportunities in order to generate the desired returns for GPs and investors. However, investors commonly argue that a limited investment period adds extra pressure on GPs to cash out on investments, while the asset value is still substantially appreciating. In addition, the current volatility being experienced in global economies, and Africa in particular, has resulted in sluggish economic growth and low-yielding investments. This may lead to significant commercial risks as investments are affected by macroeconomic fluctuations prior to the exit period. As a result, investments may take longer to mature and may not reach their full potential return under a typical PE fund.
|Typical PE Fund||PCV|
|Fundraising Period||12-18 months, after which no further commitments are sought||May fundraise either on an on-going basis or in several rounds|
|Life Cycle||Limited – typically 7 to 10 years with 1 or 2 year extensions||Indefinite|
|Proceeds||Distribute realised proceeds using waterfall method||Flexibility to reinvest some or all proceeds into future projects|
|Redemption Rights||Will not usually contain redemption rights||May allow investors (often restricted) rights to redeem their interests or at least to achieve liquidity|
There exists somewhat of a quandary in the structuring of PCVs. Traditionally, in South Africa, PE funds have been structured as en commandite partnerships. As there is no restriction on the lifespan of a partnership, a PCV may be structured using the traditional partnership model. However, from an investor perspective, there are a number of practical difficulties with the traditional model including liquidity constraints, exit restrictions and, significantly, the fact that partnerships are not permitted to be listed on the JSE.
As an alternative, PCVs may be structured as private companies. Company structures offer maximum limitation of liability for investors as well as the flexibility to remain private or later list on an exchange. However, South African institutional investors, as tax-exempt institutions, are disinclined to invest in a vehicle that is itself taxable in nature.
There has been a trend toward the utilisation of parallel company structures in South Africa and Mauritius. This parallel model enables the fund to benefit from the corporate tax benefits and incentives in Mauritius, effectively creating a tax-transparent vehicle which is capable of being taken to market by a later listing on the JSE. Although a number of structuring options exist, it is imperative that fund managers use market trends and insights into existing PCVs in an effort to tailor the PCVs’ structure and terms to its specific investor interests, tax considerations and prevailing economic climate.
PCVs may offer a solution to managers and investors alike that are seeking a long-term and cost-controlled investment vehicle. With longer investment holding periods, and comparable fee and carry results, the PCV structure may prove fruitful for both managers and investors alike, particularly with respect to asset classes such as infrastructure, agriculture and real estate, for which a 10-year investment period may not be suitable. The permanent capital model avoids fund-raising burdens and exit pressures at fixed time horizons, enabling the portfolio to grow significantly over an unlimited investment horizon.
It must be noted, however, that PCVs are not suitable for all managers. It is important to take the following into account before making an affirmative decision on a PCV structure for a new fund:
- in sub-Saharan African markets, GPs generally require more time to generate expected returns due to currency risks and political and economic uncertainties prevalent in the market;
- a business with a long circular growth path may be more suited to a PCV structure; and
- the skills set, temperament and resilience of the fund manager will be determinant factors in the overall success of a PCV.
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