A friend of mine planned to expand his ice cream business but he couldn’t because he lacked capital. Someone advised him to try a private equity fund, as most banks he approached were unwilling to lend him money without any collateral. He wanted to know more about private equity funds before deciding whether to approach one.
A private equity fund is an investment company that finances fresh and innovative business ideas and existing businesses that need to expand but have no access to capital or businesses that are going through a rough patch but have the potential to swing back.
In Rwanda private equity funds include, Rwanda Enterprise Investment Company, Thousand Hills Venture Fund and Grofin.
A private equity fund will typically offer to finance a business in two ways; firstly, through an ordinary loan to the entrepreneur, which often is given at a lower interest rate than offered by commercial banks. Secondly, through equity finance i.e. the fund buys shares in the entrepreneur’s business, and the entrepreneur can use the proceeds of the share purchase to finance his/her business activities.
It is imperative to note that by buying a stake in the business, the fund becomes co-owner of the business, and will normally insist on being part of the management of the business.
It will also be involved in formulating business strategy of the business with a view to improving profitability and increasing the value of the business before offering its shares for sale after a period of say 5 years, ideally at a higher price that it bought them, and hence making a profit on the initial investment.
In order for the private fund to agree to invest in your project you will normally be required to make detailed business plan outlining your vision for the future of the business. It will also have to be satisfied that your idea has market potential, is sustainable and you have a capable team to execute it.
Private equity is an attractive form of finance for Rwandan SME’s. Unlike banks which offer loans at high rates of interests without any value added, private equity funds offer an alternative source of finance and offer business advice.
Also, if a business is in difficulties, a private equity fund will more likely work towards a turn around, unlike a bank which upon defaulting on the business defaulting on a loan will immediate apply for the business to be put in receivership to safeguard its loan, and enforce personal guarantees by directors/shareholders.
However, if you are an entrepreneur who likes to have full control of the business, then a private equity fund may not be ideal as the private equity finance is conditional on you involving the fund in making management and business decisions and the fund has veto rights.
Secondly, private equity involves giving away ownership of part of the business to the fund, and this may not be suitable for certain business e.g. family owned businesses.
Ultimately, private equity finance is a trade off: by obtaining capital from a private equity fund you are signing up for potentially faster growth of your in exchange for lesser freedom of action.
As Rwandan SME’s seek capital, it is important that they consider the possibilities offered by less conventional capital sources like private equity funds.
Richard Balenzi is a lawyer