Conduits of Capital: Onshore Financial Centres and Their Relevance to African Private Equity
Across the emerging markets, private companies face two persistent growth constraints: expansion capital and expertise. Frequently, small and mid-size businesses are unable to secure bank lending to finance their aspirations for growth, particularly if they lack hard assets that can serve as collateral. Local banks often tend to prefer vanilla, asset-based—and frequently short-term—lending, and shy away from cash low-based lending, let alone more exotic structures. Moreover, for the most part, local capital markets remain out of reach for all but the largest emerging market companies.
In addition to the financing gap, companies frequently face an expertise, or human capital, gap. Whether it’s corporate governance, financial management or operations, there are often many international standards and efficiency that can be implemented to enhance an emerging market company’s enterprise value. These two constraints of financial and human capital are particularly evident in Sub-Saharan Africa, the focus of this report.
Private equity is uniquely suited to ill these gaps. On the one hand, private equity fund managers are a source of long term, patient capital that can help to finance a company’s growth. On the other, private equity fund managers can take companies to their next level of development by instilling management expertise, inculcating global best practices, and leveraging experience and networks to help companies achieve scale—either organically or through acquisitions. Indeed, private equity fund managers are incentivised to work closely with entrepreneurs and company management teams to create value—it is how they make money.
Overview of Private Equity Fund Structuring and Considerations
Private equity funds are typically structured as limited partnerships, wherein the fund sponsor (the private equity fund manager, or general partner (GP)) raises capital from qualified investors (limited partners or LPs) for a pooled fund, whose capital the GP then invests in portfolio companies. The LPs retain limited liability (meaning their financial liability is limited only to the amount that they have committed to the fund), whilst the GP, which retains decision-making authority, faces unlimited liability.
Many African private equity funds, however, are not structured as limited partnerships but as companies due to the popularity of Mauritius corporate structures for funds. Whilst there are significant differences between limited partnerships and corporate structures, the commercial terms for both tend to be similar.
The prevailing wisdom is that taxation and a credible legal and regulatory regime are the key drivers that LPs, GPs and their advisors contemplate when structuring a fund, along with limited liability for investors. In broad terms, there are three levels—the fund level, above the fund, and below the fund—that come into consideration.
The fund level – fund vehicles are usually located in a jurisdiction that enables a limited partnership structure. The fund itself typically operates as a pass through vehicle, and is often located in what the GP views as a tax-efficient jurisdiction so that there is minimal leakage of cash lows among the LPs, the fund and the underlying portfolio companies. In addition, the fund domicile may have investment and / or tax treaty networks with the market(s) the GP is targeting for deals, providing favourable tax treatment and enhanced legal protections. As noted above, corporate structures may be preferred in some jurisdictions, such as Mauritius.
Above the fund (i.e., where the LPs are based) – some of the LPs that commit to private equity funds (e.g., banks, insurance companies, high net-worth individuals and family offices) face tax liabilities in their home jurisdictions, while others may enjoy tax exemptions (e.g., pension plans, endowments, international / development finance institutions). Regardless, a layer of tax at the fund level effectively reduces the net return to the LP, thereby decreasing the attractiveness of international investments. Tax efficiency in fund jurisdictions thus facilitates international capital lows, an important consideration for regions that suffer from a paucity of local financing, such as Sub-Saharan Africa.
Below the fund (i.e., where the portfolio companies are based) – the selection of a fund domicile can impact the ease and flexibility with which a fund can deploy capital into a portfolio company. In addition to double taxation avoidance agreements (DTAAs)— bilateral agreements that seek to avoid or eliminate double taxation of the same income in both countries— some jurisdictions, such as Mauritius, have networks of investment promotion and protection agreements (IPPAs), which aim to provide equitable treatment of investments, protections against expropriation, and agreed-upon means of enforcement.
However, beyond taxation, there are additional factors that stakeholders consider in the fund domicile selection process. This survey seeks, among other goals, to determine just how important tax considerations are in selecting a fund domicile, while exploring market participants’ overall views toward other hard (e.g., legal and regulatory regimes) and soft (e.g., availability of support services) components.