Private investors can exit via public capital market
Recently, the Dar es Salaam Stock Exchange (DSE) introduced the DSE Enterprise Acceleration Programme, and its extension introduced a platform, “Endeleza,” for listing of private entities who have needs for long term patient capital and looks for the matching type of capital and investor.
The targeted capital providers are development banks; investment banks; venture capitalists; private equity funds; angel investors; fund managers for pensions, provident funds and insurance funds; crowd funding platforms, etc. As it were, these institutions complement the stock market – in the sense that they are a feeder for exchanges’ listing function. Normally, if the capital markets ecosystem lacks development banks, investment banks, venture capitalist, private equity funds or fund managers the stock market lacks the necessary pipeline of firms available for IPOs and listings but also the necessary liquidity needed during capital raising and trading in the market. Which is currently the case for us – even though it is also fair to appreciate the fact that we are still a young and developing stock market.
Why? because under normal circumstances firms would consider short to medium-term borrowings from commercial banks, then firms will graduate to development banks and private equity for long-term debt and equity financing before engaging the public in a way of initial public offering (IPO) and subsequently listing of shares into a stock exchange. During the IPO process investment banks undertake the underwriting role for the public offering and when listed investment banks (and sometimes commercial banks if the regulatory framework permits) again would play the role of market making and liquidity providers.
And that’s how the capital market eco-system is could function effectively and efficiently for the growth and development of the capital market, and its role in the mobilization of financial resources (domestically and otherwise) for the productive economic activities. In our case, we lack some of these crucial institutions in our capital market ecosystem and hence forming part of the struggle we face in developing the capital market. By the way, private equity, venture capital funds and development finance institutions once invested, in often cases (in other economies) exit their investment positions in private companies via IPOs and listing of shares in the stock exchange.
As it were, most of the abovementioned financial institutions (especially private equity and venture capital funds) operate in the model that involve investing in companies and then engage in their governance and operational management – this is to ensure protection of their investment interests and also ensure sustainability. But then, most would have an investment plan which include targeted investment returns in terms of earnings, capital gain, etc in the case of their decision to exit from the investment they make.
So, in whatever form, these financial institutions do invest in companies for a specific purpose and for specific periods. At the end of that period, there are various exit routes they may opt to pursue. Periodically, new investors make an entry into businesses and others exit from. In our case, exit route consideration has been trade sale/trade buy. This was also the most favored route during privatization of state-owned entities. However, the other most effective and efficient exit mechanism, currently less opted, is via the stock exchange by way of Initial Public Offerings (IPOs). I will explain the three major reasons why firms should consider the local stock market as an exit option.
Prior to that, let us first try to understand how exit occurs. Traditionally, investors — private and government rely on two kinds of buyers: Secondary buyers and Trade buyers — these are buyers who looks to gain market share or gain entry to new markets. These approaches have long served the investment industry. Why? Because it is easy and effective to sale a company to those who is interested, i.e., an interest to increase market share or making a new entry into a new market via buying a company that has experience, customer base, distribution systems, relationships with various stakeholders, etc.
This is the case, except for—one; it is not easy, in a private market to gain a timely access to a trade buyer due to inefficiencies especially those involving lack of information. Two; it takes relatively long and consumes efforts to negotiate fair trades based on fair price and value of the business. In fact, the 2018 report by Deloitte Survey - Africa Private Equity Confidence Survey - indicates that investors are grappling with difficulties in exiting companies due to difficulties of getting the right buyers in the private market.
This is why IPO consideration makes great sense. First, exiting through IPO route provides investors with an exit route with the fastest exit time.
The introduction of the Enterprise Growth Market (EGM) segment, a segment that allows start-ups as well as small and medium enterprises to raise capital and list into the exchange, have made IPOs as exit route even a more viable option that before, due to its lower entry barriers.
Experience indicates that, for private equity and venture capital funds investors’ 5-7 years investment cycle, in which most VCs and PE funds would prefer to exit from their investment, it may be difficult to have effectively build a company into a consistently operationally successful and profitable entity with a secured future.
This being the case, platforms like the DSE’s EGM becomes useful as an exit route.
