Private Equity Funds: Rwanda’s solution to bridging the capital gap?

Private sector led investment is critical for increasing the competitiveness of Rwanda’s economy, creating jobs, and leading innovation. There is strong latent potential for such private sector growth, but there are economy-wide constraints in financing and management skills that are required for sustainable corporate expansion. A proven instrument for addressing these shortcomings is private equity. Private equity and venture capital (by definition, venture capital is a sub-component of private equity) have been historically inadequate and improperly implemented in Rwanda to date, thus the government must follow the example from most successful developed and developing countries to spur the establishment of the industry by backing a model fund. Most countries with successful private equity industries started them through government-backed initiatives. Private equity was pioneered in the US where it played a key role in the growth of pillars of the economy such as Intel, Apple, FedEx, Microsoft, and countless others. Though the US has a vibrant private sector private equity industry today, the watershed moment in its development was government led. In 1958, during the height of the cold war, the Small Business Investment Companies (SBIC) program was launched to provide subsidized venture financing to companies with the goal of stimulating technological advances. With a government-backed private equity concept in place, private funds proliferated and led the further evolution of the industry. It is therefore not by coincidence that private equity financing has played an important role in the rapid growth and innovation in the global economy over the last 50 years. Prior to World War II, the sources of capital available to firms were limited to friends, family, government, or banks. Entrepreneurs had difficulty securing bank financing because of their high risk and lack of collateral. To fill this gap between self-financing and traditional capital markets, private equity financing emerged to provide capital to firms with potential for significant value appreciation. In return for taking on the risk, private equity investors expect commensurately higher returns on their investment. Such higher returns are achieved through “exits” including initial public offerings (IPO) in the public markets or trade sales. As of the end of 2008, there was US $2.5 trillion under management by private equity firms worldwide. Additionally, private equity’s track record for spurring economic growth is well documented. In the US, venture capital backed firms were directly responsible for over 10.4 million jobs and $2.3 trillion in sales in 2006. This corresponds to 9.1% of total private sector employment and 17.6% of GDP. In a separate study conducted in the US, it was concluded that between 1970-2000, firms backed by private equity generated twice the level of sales, paid almost three times the amount of federal taxes, and generated almost twice the exports of firms not backed by private equity. For job growth, the IFC found that companies backed by its funds had averaged job growth of 22.3% per year compared to 2-3% average for the economy as a whole. The British Venture Capital Association estimated that between 2001-2006, the number of people employed worldwide by UK private equity backed companies grew on average by 9 % compared to 1% for companies in the FTSE 100 index. Finally, a World Economic Forum study showed that industries where private equity funds have been active have higher growth in total production, value added, and employment than industries with low private equity activity. In conclusion, Rwanda’s economy has experienced significant growth over the last decade due to its growing middle class, cost advantages, and ease of doing business. There are many growth opportunities available for local enterprises but there are constraints in capital. As proven in the developed and developing economies over the past 50 years, private equity has been an instrumental means to provide such growing enterprises with risk capital. Such private equity has been underdeveloped in Rwanda and must be developed to provide finance and management expertise to fuel further growth. liban.mugabo@gmail.com