In post-World War II England, the workers at Europe’s largest tire plant, Fort Dunlop, were at a standstill. The company, Dunlop Rubber, could not afford a specific carbon toughening agent that gave a tire its tread. Without this small but highly significant input, the factory’s 10,000 employees were out of work. Soon after, the Marshall Plan’s aid commenced, unlocked the toughening agent bottleneck. The plant went back to work and produced tires for the world to use.
The Marshall Plan catalysed the revival of Europe’s economy – not by being a panacea, but because it was agile enough to intervene in the market where its support could create this sort of multiplier effect. It leveraged pre-existing resources and addressed the gaps where it could maximise additionality.
There’s a little-known investment model perfectly suited to Africa’s economy that can also produce such a multiplier effect: a search fund, also known as “entrepreneurship through acquisition.”
Like the Marshall Plan, it directs resources to market gaps, where this support can have an impact that’s greater than the sum of its parts. Like the Marshall Plan, it aligns incentives by trusting the local market to direct capital to where it’s needed. And like the Marshall plan, there is a duality to its additionality — it fosters entrepreneurship while growing small and medium enterprises (SME) ecosystems.
AN INVESTING MODEL SUITED TO AFRICA
Search funds are vehicles for young, aspiring entrepreneurs to finance, search for, acquire, manage and grow an established SME. The concept was developed at Harvard Business School and Stanford GSB in the 1980s, and it has become increasingly popular in the U.S. and Europe, with returns that are superior to those of venture capital and private equity.
But we contend that the search fund model is even better suited for the African context, as it addresses four key components of the continent’s economic ecosystem:
- Entrepreneurs: Africa needs more entrepreneurs not only to add energy and innovation to the economy, but because successful entrepreneurs will serve as proof that there is opportunity to succeed in business. A search fund is a low-risk path for entrepreneurship and management skills. It’s a viable alternative for Africa’s best young talent to bypass corporate life and to instead gain skills by growing a local business.
- SMEs: Almost half of total employment in emerging markets comes from SMEs, but most fail to reach full potential due to lack of capital and missing capabilities. “Searchers” do not acquire startups: Instead, they invest in “boring,” fragmented industries such as consumer goods, enterprise services and agribusiness — the heartbeat of the economy — that are often ignored by private capital. SMEs in these industries need growth capital, but they also need high-powered human capital, and this vehicle creates a shortcut to accessing this talent. Also, these SMEs are the companies that create local, reliable jobs.
- Financial returns: Most of the SMEs supported by search funds are in the “missing middle” and cannot access outside capital. A successful search fund model will “crowd-in” additional and new capital providers. The search fund asset class does not require “unicorns,” and it does not invest in winner-take-all industries as tech so often does. Instead, it encourages “zebras” in industries where we already have precedent for positive financial outcomes via listings on the local stock exchange and strategic acquisitions by larger corporates.
- Cost and scalability: Unlike other financial instruments, this capital stays local and gets deployed in full. The money raised for a search fund goes only to the aspiring entrepreneur to fund their “search” for an established business to buy and manage, or to the founding entrepreneur or SME owner who sells them that business. It’s a relatively small amount by traditional investing standards, slightly larger than what we define as “angel investing,” usually between $250,000 and $5 million. Often, these deals are structured as earn-outs, in which the founding entrepreneur stays for one to three years to advise and share institutional knowledge with the new owner, thus aligning the financial interest of the operator-investor, the founder entrepreneur and the SME.
Yet in spite of these advantages, the search fund asset class has not made its way to Africa because it does not fit with institutional capital providers’ mandates: The check size is too small and the investments are once-offs. Plus, the most successful search fund investments can take up to 10 years to reach full potential.
THE POWER OF AFRICAN ENTREPRENEURS
At Secha Capital, we utilize many elements of the search fund model – both in where we invest and how we add operational value. We started Secha Capital to fit form to function and tweak the classic private equity value chain of “find – fund – support” to reflect our belief that SME investing in Africa requires both growth capital and boots-on-the-ground human capital. Our approach features smaller, but more impactful checks than many impact investors, directed to a deeper pipeline of established SMEs. These investments are complemented by a Secha team member who joins the SME, day-to-day, for nine months, helping them execute on initiatives, hire new talent or upskill existing employees, and otherwise improve their operations.
However, our approach is different from the standard search fund model in that we invest in more than one company at a time and also take minority equity stakes. Most search funds take majority stakes and take over operations from the company’s founder/operator, but since we need the founder to stay in the company, we take minority stakes and then work with them. The Secha platform enables us to invest in multiple SMEs rather than one, and to hire operator-investors that work on behalf of Secha to enhance the operations of these SMEs. (The SME does not pay consulting fees for these services; it’s part of our value-add.)
Our new impact investing private equity model has already attracted some of the best and brightest talent in South Africa, where Secha is based. For instance, Yusuf Shaikh joined Secha from the Boston Consulting Group, with the goal of creating jobs in South Africa and developing an SME toolkit. In the last nine months, Shaikh’s major value-adds in the Secha SME portfolio include installing a new, cloud-based accounting and reporting system at Geestep (a provider of quality, affordable footwear, and Secha’s third investment); securing a line of working capital for Stoffelberg Biltong (which sells packaged meat snacks, Secha’s second investment); and working with Facebook to refresh the digital strategy of Hair City (a retailer of wigs and extensions, Secha’s fifth investment company), where Shaikh now serves as interim Chief Operating Officer. Similarly, Kuhle Mnisi interned at Goldman Sachs and received her master’s in development finance from the University of Cape Town; she joined Secha to encourage investment in female-owned businesses. She helped perform due diligence and then invested in Rush Nutrition, and will serve as its COO for the next nine months, where she will execute on strategic initiatives, and grow and up-skill the team.
To date, Secha has invested in six South African SMEs. Across our portfolio, we helped create over 70 jobs and increased revenue, on average, by 400%.
Secha’s second $30 million fund is an attempt to scale our initial $5 million fund, which established proof of concept. We will create a platform for 12 new operator-investors to join and grow around 35 SMEs over the next 10 years. Each operator-investor will invest in one SME each year and work with them for nine months. After three years, the operator-investor will hopefully join one of the SMEs as a permanent employee – or maybe start their own business. It’s almost like getting a real-world MBA, but they get a salary and equity.
We welcome more search funds and impact funds that embrace this mission and vision. Secha honestly can’t grow fast enough to really effect structural change. But Africa’s young people can. To unlock their potential, we need to encourage more of Africa’s best and brightest to pursue entrepreneurship – and the investor-operator model is a great way to do it.
Brendan J. Mullen is the co-founder and Managing Director at Secha Capital.