by Ashford Nyatsumba, Senthil Walter, Alyssa Smith and Mpho Duiker at Webber Wentzel
New and amended legislation and economic pressures across Southern Africa are resulting in new opportunities as well as structural changes in the regions private equity (PE) industry in 2023.
PE is vital to the Southern African economy for a number of reasons. It drives job creation, acts as a catalyst for genuine economic transformation and attracts foreign investment. It introduces growth capital to a range of industries from infrastructure to technology, health care and venture capital. PE funds provide access to funding where more traditional sources of finance may not be available. PE continues to see activity from foreign investors, especially in the fund formation space, where international development finance institutions and other offshore institutional investors continue to target Africa for capital deployment. In South Africa for example, black-managed PE firms are increasingly participating more meaningfully in lucrative PE deals which is having the effect of, increasing the diversity of the PE sector and assisting with directing more investment towards black-owned businesses.
Here are some of the key trends that Webber Wentzel has identified for 2023 and beyond.
Get ready for changes to the regulatory landscape
The Conduct of Financial Institutions (COFI) Bill, once enacted, will further license and regulate new and established managers of alternative investment funds.
Recently, amendments to Regulation 28 of the Pension Funds Act raised the limits on a retirement fund’s infrastructure investments that have to be reported to the Financial Sector Conduct Authority. Now, direct infrastructure exposure across all asset categories cannot exceed 45% of a retirement fund’s total assets (previously 30%), while PE asset allocation is now permitted at 15% (previously 10%).
Merger clearance for private equity deals in Africa is becoming more rigorous, with regulators scrutinising PE firms acquiring extensive investments and intentionally structuring deals to avoid clearance obligations. Public interest considerations, such as job preservation and participation of historically disadvantaged persons, are now formally analysed, adding complexity. Developing a commercially feasible merger clearance strategy early on and finding creative solutions to address public interest challenges are crucial in navigating this evolving landscape.
The “great resignation” has been felt in the PE sector, with portfolio companies continuing to experience high attrition, they remain at risk of losing valuable personnel and with them, confidential information to competitors. Carefully drafted employment agreements, which take cognizance of new issues in this regard, will become increasingly important in providing critical protections.
Many share incentive schemes are under water and will need to be reset to align key personnel. It is becoming increasingly important to navigate the tax consequences of resetting incentive schemes, and as such, this should be carefully assessed.
The Financial Intelligence Centre Act (FICA) now requires fund managers to “look behind the curtain” and conduct deeper due diligence on beneficial ownership, which could for example, include due diligence on the ultimate beneficial owners of the investors in a fund.
Asset managers are accountable institutions and subject to new obligations to collect and retain certain records on the screening and monitoring of current and prospective employees. Managing these records needs to be done carefully to avoid breaching the Protection of Personal Information Act (POPIA).
The Broad-based Black Economic Empowerment (B-BEEE) Commission is cracking down on fronting and in so doing, taking an increasingly restrictive interpretation of the law. It has been scrutinising the terms of transaction documents more closely, sometimes without referring to the provisions of the applicable B-BBEE legislation. Parties drafting a B-BBEE transaction have to ensure that they are compliant with the law.
Public-private partnership procurement is on the rise, with changes to the electricity regulations allowing for an electricity trading platform, which will increase opportunities for PE firms to invest in the sector. Investments in public water and sanitation infrastructure are also opening up to the private sector, representing tangible opportunities for asset managers who are ready for them.
Jurisdiction and domiciliation considerations
Parties to cross-border acquisitions should be aware that the OECD’s Pillar Two (under Base Erosion and Profit Shifting principles), which requires multinationals to pay a minimum of 15% tax in every jurisdiction, may be applicable. It is essential that PE fund structure and location allow the group of entities as a whole to be optimally assessed when determining whether the global minimum tax revenue threshold has been met.
As ransom attacks become more frequent, reliable advice should be sought upfront to ensure that notification obligations, business continuity plans and ransom payments stay on the right side of the law, given recent legal developments on liability for fraudulent electronic transactions.
International remote work can create compliance risks (including adverse tax and regulatory obligations) which are important to understand when considering a local presence in a foreign jurisdiction. Global mobility policies may be the solution to ensure key personnel can maintain flexible work arrangements.
It’s generally easier to enforce an arbitral award in a foreign jurisdiction than a court judgment – this is critical, particularly in a cross-border context. A well-crafted arbitration clause can help avoid significant procedural delays if a dispute arises. When drafting agreements, parties should take care in selecting the seat of arbitration and be aware of the location of the counterparty’s assets because, in some jurisdictions, enforcement of awards can be difficult.
We are seeing increased consolidation, especially of larger asset managers, as the most persistent trend into the future. One of the reasons is that fundraising has become more challenging as a result of continuing global events, including the Russia/Ukraine conflict, which has resulted in commodity price volatility; global inflation; the post-Brexit fallout and financial/ political instability in the UK; and the post-Covid decline in spending. Capital allocators are taking longer to conduct due diligence on PE firms, and it is becoming harder for PE firms to realise value on exits. Investors have become more circumspect, and a significant amount of capital remains unallocated. As a result, South African PE managers are partnering with offshore fund managers to try to attract capital.
A second reason for consolidation is that PE firms are striving to distinguish themselves in an increasingly crowded market, whether through investment profile or targeted sector strategies/ return targets.
Opportunities in Africa, especially in IT and fintech, are becoming more appealing than in more developed economies. Power and water supply challenges, which can be tackled using existing technological advancements in Europe and North America, are also opening up profitable opportunities.
Other sectors attracting attention from PE firms are health care, energy, infrastructure, generative AI, data centres and consolidations of fibre networks. Many PE clients have invested in their own innovation labs and incubator programmes.
ESG continues to remain an important consideration when structuring transactions.
The acquisition of IP from South African-resident companies by companies in foreign jurisdictions is on the rise and requires sophisticated IP and exchange control structuring.
Employee share ownership programs (ESOPs) and black private equity funds are increasingly being considered as viable B-BBEE partners.
While market conditions make exits challenging and several disposal processes have been halted in their early stages, PE firms are increasingly undertaking more active portfolio management to ensure their assets are exit-ready.
(Download the complete Private Equity Sector Trend Report 2023)