The post-pandemic landscape has transformed the relationship between private equity firms and business owners.
Gone are the days of inflated valuations. Instead, a more measured approach has emerged, focusing on businesses with robust fundamentals: sustainable earnings, healthy capital structures, and minimal capital expenditure requirements. This shift represents not just a temporary adjustment, but a structural change in how private equity evaluates and approaches potential investments.
Understanding the valuation disconnect
Private equity firms evaluate businesses through various distinctive measurable factors, seeking companies capable of achieving EBITDA growth while managing debt obligations. However, South African businesses face unique challenges: escalating fuel costs, persistent inflation, low economic growth, and policy uncertainty—all of which impact EBITDA, cash generation and, ultimately, valuations.
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​When evaluating their businesses, many owners integrate qualitative elements in addition to quantitative factors, which may include their company’s historical resilience through various business cycles, years of personal sacrifice, and emotional investment in building their enterprise. This divergence in valuation approaches often creates a valuation gap between buyer and seller expectations. Understanding this disconnect is crucial for both parties to reach mutually beneficial agreements.
The current market reality
The elevated cost of capital and subdued economic growth have led to more conservative valuations. Private equity firms thoroughly examine historical performance, customer relationships, management capabilities and growth forecasts, and they assess market position, operational efficiency and technology infrastructure as key value drivers. The lingering effects of COVID-19 have complicated valuations further, leading firms to apply lower perpetual growth rates to account for increased risk.
Risk assessment and mitigation
Today’s private equity investments require a nuanced understanding of multiple risk factors. Economic risks include interest rate volatility, currency fluctuations, and inflation impact on margins. Operational risks encompass supply chain disruptions and labour market challenges, while strategic risks consider competitive landscape changes and technology disruption potential. Successful firms develop comprehensive strategies to address these risks while maintaining return expectations.
Bridging the valuation gap through innovative structures
While independent valuation experts can assist, their assessments can vary due to underlying assumptions underpinning the valuation. This has led to the increasing use of innovative pricing mechanisms. Earnout structures or “agterskot payments”, including performance-based payments and milestone-linked considerations, help align interests.
The new partnership paradigm
Modern business owners seek more than just capital from private equity partners. They value cultural alignment, sector expertise, and strong B-BBEE credentials. Financial acumen and strategic input remain crucial, but equally important are the track records of successful partnerships and exits, as well as access to strategic relationships. Governance expertise and commitment to transformation have also become key differentiators in partner selection.
Future trends and considerations
The private equity industry continues to evolve, with increasing emphasis on ESG integration, digital transformation, and market consolidation opportunities. Environmental impact, social responsibility and governance structures have become integral to investment decisions, and technology adoption and innovation potential significantly influence valuations and partnership decisions.
The South African private equity landscape remains promising despite current challenges. Success requires a balanced approach that considers both quantitative metrics and qualitative factors, supported by innovative deal structures and a clear focus on value creation. Those who successfully navigate these challenges while building trust and alignment between parties will be best positioned to capitalise on the opportunities ahead.
By acknowledging and addressing the valuation gap while focusing on shared long-term objectives, both parties can create partnerships that unlock sustainable value and drive business growth. The future of private equity in South Africa depends on the industry’s ability to adapt to changing market conditions while maintaining its focus on creating sustainable value through genuine partnerships.
Marutha is an Associate | Agile Capital.