By Ashford Nyatsumba, Partner, Clinton Mphahlele, Senior Associate & Mia Joy Williams, Candidate Attorney at Webber Wentzel

Africa represents an attractive proposition for asset managers and capital allocators seeking new and often untapped frontiers for investment. The primary factors influencing fundraising and capital deployment on the continent, as well as the key considerations for asset managers and investors alike, may generally be distilled into five categories.

Jurisdiction and structure

The choice of jurisdiction typically depends on the investor audience and the objectives of the fund. Such considerations include the target region, sector focus, nature of assets, fund currency, and the contemplated flow of funds.

Mauritius remains the most common jurisdiction for Africa-focused funds due to (among other reasons) its tax efficiency, recognition as an established international finance centre and its proactive strategic initiatives to address prior deficiencies in its anti-money laundering and counter-terrorist financing framework, which saw Mauritius being removed from the Financial Action Task Force grey list in October 2021.

The form of business entity taken by a private equity fund is often driven by three principal factors – investor familiarity, tax efficiency and limited liability for investors. Given that the limited partnership structure is well understood globally, provides tax transparency, affords limited liability for investors, and by contrast, has fewer governance restrictions, it is the preferred vehicle for fund promoters and investors alike.

Tip: Where a fund promoter is targeting a disparate group of investors from multiple jurisdictions, it is practical to make provision for flexibility to establish parallel and/or feeder vehicles. For example, US (or other international) investors may be more comfortable investing through vehicles in jurisdictions such as Delaware or the Cayman Islands. To secure capital from these investors, it may be useful for the fund constitutive documents to provide for the establishment of parallel and/or feeder vehicles in those jurisdictions, to address or accommodate the legal, regulatory, tax or other requirements of prospective investors and facilitate their investment in the fund.

Alignment of interests

The fund formation journey may be considered a fine balancing act, where care is taken to ensure that in achieving the objectives of the fund, the interests of both the investors and the fund promoter are aligned. This alignment ensures that the rights and obligations of the parties are balanced, and the fund promoter is in the best possible position to succeed, while the investors are appropriately protected.

For example, fund constitutive documents typically include provisions that require the fund promoter's investment team (who are responsible for the fund's investment decisions) to make a material equity investment in the fund, so that they share risk alongside the investors – often referred to as a “skin-in-the-game” contribution.

Tip: While "skin-in-the-game" of 1% of the total commitment in the fund is market standard, investors may be comfortable with a fund promoter committing only 0.5% where there is an incubation element or the fund target size is particularly large. Ultimately, the purpose of the "skin-in-the-game" contribution is to ensure that the fund principals are materially invested, with their personal capital – like that of investors – also at risk in the event of non-performing investments.

Governance

Private equity funds are managed by a management company, typically organised and constituted by the fund promoter. The fund manager – often a financial services provider – is responsible for raising capital, finding investment opportunities, implementing value enhancement strategies, monitoring investments and achieving liquidity for the fund’s investments.

As compensation for these services, the fund manager receives a “management fee” from the fund. This fee is typically 2% of the fund’s aggregate capital commitments during the investment period, and thereafter (during the disposal period) 2% of the amount of capital deployed. To ensure that a fund manager is remunerated relative to work actually done, the management fee decreases after the investment period if the fund promoter has not deployed all the capital made available by investors.

Tip: A fund promoter must determine what, if any, licence(s) are required to operate as a fund manager in the relevant jurisdiction(s) in which it proposes to establish or manage the fund and/or solicit investments (as applicable). Often, the costs and licensing requirements associated with setting up, operating, and maintaining substance in a manager entity in a particular jurisdiction inform the commercial decision on how and where to structure the private equity fund.

Investor oversight rights

Given the limited operational involvement afforded to investors in private equity funds, investors require significant governance and oversight rights in the funds they invest in. Private equity funds are "blind pool" investment vehicles, and as such, investors do not have a say in what investments are made and when investments are sold. Instead, an investment committee (IC), typically comprising the fund principals with the relevant skills and expertise in the sectors and asset classes in which the fund invests, sits as the fund's primary investment decision-making body, as a sub-committee of the fund manager.

Investor oversight and governance is achieved through a limited partner advisory committee (LPAC), which provides a platform for investors to obtain information on the fund and its activities. Through the LPAC, investors retain the ability to monitor and weigh in on conflicts of interest, provide certain approvals prescribed in the fund constitutive documents, and consent to waivers of the restrictions stipulated in the fund's investment policy.

Tip: Investor oversight rights should be carefully considered and crafted when preparing the fund constitutive documents to ensure that they do not extend beyond passive oversight, as rights which constitute more than passive oversight and governance risk compromising the limited liability status of investors represented on the LPAC.

Profit sharing

The distribution waterfall provides a framework for how proceeds generated by the fund are distributed between the fund promoter and the investors. In the context of African funds, the "whole fund" model is preferred. Under this model, the fund promoter does not participate in the profits of the fund (also referred to as carried interest or general partner profit return) until the investors have recovered their capital plus a minimum rate of return. This return is often in the region of between 8% (in the case of US dollar-denominated funds) and 10% (in the case of local currency funds). This serves as an incentive for the investors to invest with the fund promoter, while also aligning the fund promoter's commercial interests (being participation in the profits of the fund) with the success of the fund.

Tip: While it is possible for a fund promoter to have bespoke commercial requirements to differentiate itself from other fund promoters, institutional investors often seek out and prefer the tried and tested. In the African context, the deal-by-deal distribution model (often seen in the US market) is uncommon, and as a result, many investors expect to see the whole fund distribution model when engaging Africa-focused fund promoters. Remember, "the wheel exists, avoid the temptation to reinvent it with square edges" – it exists in its current form for good reason!