New Markets Demand a New Approach

Private equity firms investing in emerging markets must implement a different business model to maximize returns, says Emergo Partners’ Justin Harlow

Private equity professionals know all about the obstacles to success in emerging markets: corruption, political volatility, capricious regulation, a lack of exit liquidity. But there is another obstacle to success that many still don’t recognize: their business model.

“A lot of firms try to employ conventional private equity strategies in emerging markets,” says Justin Harlow, managing partner at Emergo Partners. “But these are inherently incompatible with the maturity of these markets.”

Harlow has spent his career in frontier and emerging markets, working in 33 countries across Africa, Latin America, Asia, the Middle East, Eastern Europe, and Eurasia as a principal investor and executive. He says private equity firms must take a new approach to succeed in emerging markets.

Be more transparent with LPs. “If I’m an LP, I have enough risks to worry about without putting my money in a blind pool and being told after the fact where the money is going,” Harlow says. To give LPs more comfort in emerging markets, he recommends that PE firms tell them exactly what companies they’re investing in before they commit money. “A lack of clarity can be overlooked in developed markets, where investment risks are lower,” he says. “But the inability of investors to clearly see where capital will be allocated prior to commitments in emerging markets is often a bridge too far.”

Downsize deal expectations. PE firms want to invest in Series C. But what about Series A and B? As most firms discover, emerging markets are barely venture capital markets, let alone PE markets. “And even when you do find larger deals, the competition is so fierce that the price paid to secure the deal ensures the ‘winner’s curse,’” says Harlow. This is a phenomenon that often sees the highest bidder overpaying for the asset, which ultimately impacts the returns and inhibits future capital raising. That’s why he says PE firms must be prepared to start small and allocate additional capital over time. He strongly encourages the equity-line-of-credit approach in emerging markets, where the focus is on the total capital deployed and not the initial outlay.

Accelerate target companies. In the developed world, accelerators are for brand-new startups. But in emerging markets, a lot of established companies need basic assistance. “There are great deals to be done, but unfortunately these companies need more upfront work than conventional PE firms are willing to do,” Harlow says. “Before we even present companies to our investor network, we work with them for up to six months to ensure they’re at the quality level investors expect to see.” For instance, Harlow’s firm is working with a company in an emerging market that’s been operating for seven years but is only now drafting its first business plan.

Hire operating partners. Industries in emerging markets have been dominated for decades by international companies, so there is a local talent gap. To fill it, firms must shift their staffing habits. “For the most part, PE firms are packed with former investment bankers, many of whom have never built or run businesses,” Harlow says. “This works when you’re trying to move the needle with financial engineering—but that’s not going to happen in emerging markets, where a more entrepreneurial growth mindset is required.” He recommends that PE firms looking to enter emerging markets bulk up their staff with entrepreneurial executives, perhaps even inverting the traditional 5:1 ratio of managing partners to operating partners. “These are build markets, not buy markets,” he says.