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Acorn: overcoming the challenges of SME investing

Anna Lyudvig
Dec. 15, 2015, midnight
46

Word count: 1363

Acorn Private Equity has recently announced that its maiden fund, focused on SMEs in Southern Africa, completed its final exit and achieved lucrative returns for investors. AGF catches up with Gerhard Visagie, Investment Director at Acorn, to learn more about its success story and future plans

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Acorn Private Equity has recently announced that its maiden fund, focused on SMEs in Southern Africa, completed its final exit and achieved lucrative returns for investors. AGF catches up with Gerhard Visagie, Investment Director at Acorn, to learn more about its success story and future plans

South African based Acorn Private Equity was founded in 2009 by Pierre Malan following his tenure as the CEO of PSG’s private equity vehicle, Paladin Capital. Within a year, Acorn launched its first fund, Acorn General Fund One, which had a Southern-Africa geographic focus and invested in small- to mid-cap opportunities.

Gerhard Visagie, Investment Director at Acorn Private Equity, says it was a small fund focused on high net worth families. He recalls that the fund was raised in two months: "Our aim was to close the fund as quickly as possible and to build up a track record for the long term. We were targeting north of 30% IRR.

Acorn General Fund One was focused on defensive sectors such as food, agriculture, water, healthcare and education. "We did substantial macro and demographic analysis, and realized that we wanted to focus on sectors that we believe will be crucial to human survival and a growing population," says Visagie.

The fund was fully invested within 21 months of first close. It made five investments and realized all of them within six years. Three of those investments were exited to trade players and two were secondary sales.

"When we launched the SME fund, the largest perceived challenge was how we would be able to exit from SMEs since they are not large enough for a listing. We were of the opinion that trade exits would be the best option and we were proven correct," he adds.

The fund generated very attractive returns for investors and delivered 46.2% gross IRR, generating a gross return of 3.5 times the money.

SMEs are able to generate more attractive IRRs due to their superior growth prospects, says Visagie. "Many of these companies can be bought at cheaper multiples. We were buying at 5 P/Es and in exceptional cases at 6 P/Es in 2010-2011. One of the biggest drivers of investment returns is the price that you pay. It’s very difficult to generate a solid return if you overpay," he argues.

"We are very specific and disciplined when it comes to the price that we pay and the companies we invest in. We are looking for companies with solid business models, strong competitive advantages and strong management teams. I think for most of it we got it right," he says.

Investment strategy

SMEs in Africa have a tremendous difficulty in terms of access to capital and it’s one of the main challenges that Acorn wants to overcome. Acorn seeks to acquire significant minority stakes and partners with management teams to help these businesses to achieve their full potential.

Acorn invests in entrepreneurial, often times family owned, owner managed companies, says Visagie, adding that SMEs are opportunity driven and Acorn assists them to strategize and with implementation thereof: "We also make sure that management is incentivized and aligned."

As a private equity manager you need to be a lot more hands on and continually involved in a SME business - Gerhard VisagieHe adds that in SMEs things happen more quickly than in larger companies. "As a private equity manager you need to be a lot more hands on and continually involved in a SME business. You can’t just buy and attend board meetings every quarter. You will lose a lot of money if you have that approach in SME private equity," stresses Visagie.

He adds that on every portfolio company, apart from board representation, Acorn appoints one executive responsible for assisting the SME, so there is a bridge between the investor and the investee company: "We make sure that everything is in place for that company to be successful."

"Because of our active involvement, we are able to capitalize and pursue opportunities much quicker. And also in terms of risk management, you are much more aware of what can impact the business and you are more agile, so you don’t have that slow corporate decision making," he says.

Acorn platform

The alternative asset manager serves the investment needs of a select group of sophisticated investors by providing a platform to directly participate in private equity. Acorn’s platform consists of LLP funds and an investment holding company, Acorn Agri, in which investments are housed.

Acorn Agri was launched in February 2014 with the purpose to participate in the consolidation and growth in the Southern African agriculture sector. The company aims to acquire significant stakes in strategic (secondary) agri and food businesses to create a diversified portfolio by geography, commodity and type.

At the moment, the total assets of the company are approximately $65m with five investments in Southern Africa. Last year, Acorn Agri acquired a 23% stake in Overberg Agri, a diversified regional agri business, for R200m, making it the largest investment to date. Further acquisitions soon followed and Acorn Agri already has a diversified portfolio of high quality assets.

"Acorn Agri is our immediate focus and we have substantial traction with that. We aim to grow the fund to around R2bn ($140m) and list it in the next three to five years. We are very selective on the investors that we bring on board and we only raise capital when needed. It’s not on a commitment basis," explains Visagie.

Acorn is also in the process of raising funds for its third fund, Acorn Africa Fund, with first close expected in 2016. The fund will focus on SMEs in Sub-Saharan Africa with a target size of $250m.

"We believe our first close will be next year, but the timing is uncertain given the dynamics of private equity fundraising," says Visagie.

For the new fund, Acorn is looking to target a more diverse investor base to include institutional investors alongside its existing group of high net-worth individuals and families: "The fund is targeting a combination of international institutional investors like the European DFIs and also South African institutions."

Visagie adds that the strategy in the third fund will be similar to the Acorn General Fund One, but instead of just focusing on South Africa, it will also pursue opportunities in Sub-Saharan Africa.

"The way that we approach investments will be very similar. We will acquire minority stakes with investment sizes of $10-40m and continue to be risk averse."

He adds: "The risks of SME investing are higher, but if you have the correct model and methodology, those risks are manageable. And I think our performance is testament to that."

Risks

One of the most attractive aspects for investors about SME investing is the fact that a significant social impact can be made by the growth of SMEs - Gerhard VisagieWhen asked about risks of investing in SMEs, Visagie says that generally the depth of management teams is limited: "You will find a strong top management, but undeveloped middle management team. This placed strain on human resources and results in key person risk that has to be addressed."

Access to funding is a challenge, he adds: "SMEs struggle to raise capital, but when a private equity firm becomes involved, generally the finance institutions are a lot more open to discussions. Also, external events could have a larger impact on SMEs, than on a large listed company."

Visagie points out that the SME sector is Africa is quite small and is a specialized sector within private equity: "There are very few traditional private equity firms that invest in this area of the market. It’s less competitive and consequently untapped to a degree."

"The size of an SME fund is constrained by the limited investment size in SMEs and number of investments that can adequately be managed," he adds.

Visagie says that the SME sector is the engine room of any economy and one of the most attractive aspects for investors about SME investing is the fact that a significant social impact can be made by the growth of SMEs.

"SMEs play a vital role to support communities by providing jobs, skills development and corporate social investment. Acorn is delighted to play a part in growing the SME sector in Southern Africa, and in time Africa, whilst delivering satisfactory returns to their investors," he says.

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