Investment or Deal Size: While this will vary by country, the reasonable bite that one can propose for funds attacking what I called “growth oriented smaller enterprises” (the ugly acronym GOSE being amusing to me – using in place of the vacuous ‘SME’ in use among the development people) financing issue will be generally be in the 1 million to 3 million USD range per tranche / deal. This is based on an estimation tied to average firm sizes as I known them from the data and from the economic profile of the developing MENA countries. I note this is my personal guestimate. In fact, for a number deals I can think of one would really have to look at half-size tranches (500 k USD),

That is too small for your standard private equity fund along the standard lines. This absolutely requires majority local participation (lower expense profile, never mind better deal sourcing profile).

Stage: Growth stage is the probable ideal focus, meaning not start-up or firm creation stage, otherwise known as seed capital, nor “firm maturity” or mezzanine financing. Mezzanine is less operationally problematic (not unnecessary one should note), but merely less requiring of public versus private capital in my opinion – although one might clarify this as relative to company size. While in development capital terms the seed stage is most attractive, this stage is very hard to get right, and expensive. Until a good infrastructure is built, while it makes sense to devote some development capital to the seed stage, it is probably best to build the overall investing infrastructure for the growth stage. Seed stage investing in the MENA markets approaches a kind of artisanal-micro credit level, with perhaps realistic initial investment sizes in the 500 k USD range

Fund Size Fund size, at least on the country level is effectively tied to the investment profile chosen. Taking the above as given, funds with an investing lifetime of 5 years and an ultimate lifetime of ten years should be in the 20-70 million USD range (say a rough rule of thumb would be 1 million per inhabitant for a country with a per capita income of 1000-1500 USD per capita).

A further thought on Fund size, and that in regard to the market size (of private equity), which I believe someone asked me about. The answer is no one knows. Absolutely no good survey data. For North Africa I can provide a decent guestimate of perhaps 200 million USD in region money (which appears to be largely invested now), with more out region funds potentially available for larger projects. Gulf is anyone’s guess, depending on how you define private equity. Egypt, probably had raised around 200 million USD or so, but my understanding is performance was utterly atrocious. Lebanon, unclear, may 100 million USD. Jordan about the same. By those numbers, private equity, properly speaking over the past ten years may have invested, ex-Gulf, 500 million USD over the region. Given that is a regional spread over a decade, not that impressive.

Further to this, it seems useful to share a light analytical article in a similar vein published in The Journal of Applied Corporate Finance entitled Private Equity Investing In Emerging Markets [n.b. link to the EMPEA site, PDF] which I shall selectively quote from on a few issues.

First, the article’s summary on the broken noses suffered during the first round of private equity attempts to enter emerging markets:

These fundamental shortcomings magnify the reality of a private equity environment that is starkly different and more difficult than what practitioners were accustomed to closer to home. The basic assumptions underlying the U.S. venture capital approach are largely missing in emerging markets, with a predictably adverse effect on performance. Results will improve, therefore, only if the fund managers align their business model more closely with emerging market realities. Go local. Initially, many funds preferred to locate in the U.S. or Europe, bowing to convenience and the preferences of Western professional staffs. But just as a vibrant venture capital presence mushroomed in Silicon Valley in response to the proliferation of new technology clients, fund managers belatedly are recognizing that a local base of operation is even more necessary when the target companies reside in distant, unfamiliar emerging markets. Generating market intelligence, investigating new investment opportunities, conducting due diligence, and maintaining ongoing direct involvement can be much more complicated and less effective when the investment team literally commutes between the home office and company headquarters on other continents. As one badly burned Latin American private equity pioneer—who originally located most of his professional staff in New York—acknowledged, “We will no longer do an investment in a country where we don’t have eyes and ears on the ground.” More fund managers now recognize that it makes sense to hire local professionals who are culturally attuned and have a deeper understanding of the unique circumstances that differentiate emerging markets from countries with more hospitable investment climates. “You need to have people that live there,” explained one fund manager, “have the passport, and are committed to the community. That is the only way you will gain the critical intuitive sixth sense about what is going on, what are the good deals and who are the people you want to work with.”

Now I frankly find it rather extraordinary that anyone could have thought (although the IFC still does this) that long distance investing in difficult markets is possible or even a vaguely good idea. However, excessive confidence can lead one to do stupid things.

Go local, here, of course means not just having staff on the ground, it means having probably predominately local staff, although given bad things I have seen, I am a strong believer in having at least one non-local with interests more closely aligned with “Home” to make sure practices are up to snuff and that local staff mind their Ps and Qs.

I don’t necessarily think “having the passport” is key, but certainly you have to have staff that know and like the field of investment, but don’t like it “too much.” That is, just like investing say in technology, you need people who know and understand and even like technology (although it is good not to have a pure Techie team) but are critical, who don’t love tech too much…. Same issue.

I also note knowing “who to deal with” is a key item. And a hard one, even for locals. From afar, of course, the challenge is worse: one is not going to know from afar (as I did in killing a deal which IFC went in on) that the financial backer of Deal X with Company Y was actually married to the CEO of Company Y and they had been pimping the deal to rescue her little game. A real life case.

Some further items, this item to me is the key observation and the one where I think few outside observers really don’t necessarily “get” in re emerging markets. As a private equity investor you’re almost part of the company, this is hyper active investing (and doubly hard for it) – not the check-box PE that can be done now in say the US (I chatted recently with an investment officer with Citibank PE who described his function as making sure the proper reports rolled in, got fed into a system…. Automated. Impossible in an emerging market)

Add value. The management role of the private equity investor in emerging markets is even more important than in developed countries, given the extraordinary challenges of creating a viable exit opportunity. Fund managers must re-think the professional expertise required for these tasks, recognizing that the analytical and negotiating skills required to make an investment are not same as those required to enhance corporate value during the post-investment phase. Initially, the industry relied too heavily on former investment bankers trained to “do deals,” collect their fee, and move on to the next transaction. They badly underestimated the amount of hands-on time required to monitor portfolio company performance. Attending periodic board meetings, reading financial reports, and observing performance from afar is not sufficient. Instead, professionals must take on the difficult and time-consuming tasks of strengthening corporate governance practices, restructuring management, and positioning the company for a profitable exit. “Value enhancement is becoming the most important part of this business,” noted one fund manager. “When you sign the deal is when the real work starts, not ends. Finding the right skill set in emerging markets is tricky. We need to know how to build company value—to say: ‘Your brother has to go, or you must sell this subsidiary.’”

I could not agree more. The hardest part is not negotiating the deal, it’s making sure the company adds value, and that means becoming like a consultant. It’s a real value added function and I firmly believe if done right, can see some real stars emerge. But it is hard, and has to be done right from the get go. That also means that the Fund has to be like the entrepreneur’s buddy – in this region as in much of the developing world you better have that personal relationship. Close personal relationship – but that of course is equally dangerous…. Hard game to play.

More discerning deal selection. After years of working with a range of mid-size companies, one fund manager concluded that he could no longer justify the time, expense, and frustration of investing in traditional family-owned firms, regardless of the sector or historical performance. “It simply is not worth the aggravation and tension,” he explained, “so we are concentrating only on the ‘new economy,’ where both the firms and the managers are younger, more flexible, and less likely to have acquired many of the bad habits that hinder good relations with traditional family firms.” Funds also are becoming more proactive in deal selection, rather than waiting for business proposals to land on their desks or for investment bankers to make a pitch on behalf of a client. Echoing a growing consensus, one manager of a prominent Asian fund observed, “The best deals are ones we create. In our most successful transaction, we proactively approached the company once we had decided that we wanted to be in the sector. We looked for an attractive company where we would not be in a bidding auction.” Good deals must fit the skill set and industry knowledge of the fund manager, and offer identifiable opportunities for enhancing value.

This is one item I don’t fully agree with. Writing off family firms takes too many operations off the plate that might be interesting, for all that it’s pretty clear that you probably don’t want to go into a firm where the old Patriarch is still in charge. The old Arab Patriarch ain’t really gonna play ball with you. On transition, yes, his son may.

Creative exit strategies. “Now, every time we look at a new investment opportunity we rigorously assess our exit strategy before deciding whether to make the investment,” according to one emerging markets fund manager. Notwithstanding the inevitable uncertainties about an event that will not occur for at least three to five years hence, there is increasing rigor applied to the exercise of mapping out a viable exit at the outset, whether by an IPO, a management buyout, or a strategic investor, and then ensuring that company management understands and commits to the strategy. Are the owners willing and able to execute a management buyout after a prescribed time period? Or if a strategic investor is the preferred alternative, who are the likely candidates, and what must be achieved by management during the intervening years to attract these buyers? One practitioner explained his fund’s approach to attracting a strategic investor: “We try to get into the head of the strategic corporate planner. What’s their strategy? We are starting to think like a consulting firm, trying to think through industry strategies, understand industry trends, learn about the key players and whether consolidation is likely to occur.” There also must be a greater willingness to experiment with new, more creative approaches toward exit strategies. One Latin American fund, for example, launched a mezzanine fund that offers debt financing with many of the same characteristics as equity, but provides investors with a greater assurance of a steady income stream. Another has begun to recapitalize some successful portfolio companies, which allows the fund to realize some capital gains while waiting for a more opportune time to exit. And some are seeking to take control over underperforming funds, positing that the key to success is more effective, hands-on fund management….

And absolute must, I may add, creative thinking. Whinging on about the IPO environment, for example, gets one nowhere, but there may be interesting ways to exit with more value.