'Overcome investing biases and cash in on thriving companies'

Gareth Bale and George Best, for example, are two examples of footballers who are legends at the club level but whose national teams often struggled to even qualify for international tournaments. The same is true in business. 

More specifically, you can get businesses that are shooting the lights out despite operating in struggling economies. In fact, there are more of them than you would think. 

Were these companies based in countries with booming economies, they would be serious acquisition targets.

Just because an economy is struggling, does not mean that a company cannot do well or grow.

But for a variety of reasons, they often have to overcome barriers that their counterparts in other markets do not have to. And by keeping those barriers in place, investors are missing out on the potential for serious returns.

Overcoming those barriers does not have to take a massive amount of effort either. For the most part, it is simply about shifting mindsets.

That said, there are things that investors can do to ensure they take the safest possible path when it comes to making investments in economies that are perceived to be riskier.  

Private equity in times of economic crunch 

Before digging into how companies can apply judicious risk management, it is worth taking a deeper look into some of the reasons behind investor trepidation in these markets. 

In many ways, it is understandable that businesses in struggling economies have to work harder to achieve good exits.

During periods of economic uncertainty, no matter where you are in the world, exit options generally reduce and valuations drop.

It should hardly be surprising then that bad economic overviews can significantly decrease exit options.

The economic difficulties in many of the countries that investors are wary of will not last forever.

It is not the individual company’s fault, this logic dictates, but the primary market it is based in. How much can a retailer grow, for example, if its potential customers are not getting wealthier and able to spend more at its stores? 

But there are inherent flaws in this logic. Just because an economy is struggling, does not mean that a company cannot do well or grow.

Take the UK, for example. Brexit and political turmoil have only worsened its already moribund growth rates. And to a degree, economic outlook made firms wary of doing deals in the UK.

But there are many good companies in the UK whose economic trajectory was untouched by the waves of Brexit, or even, companies who innovated and excelled in the face of uncertainty. In fact, 2021 – when the country was still experiencing varying levels of lockdown – saw mergers and acquisitions reach record levels.

Risky companies in ‘safe’ markets 

It is also important to remember that companies operating in more stable markets come with a significant degree of risk. Even just looking at some of the figures to have graced the cover of Forbes Magazine in recent years should be enough to tell you that. 

For a moment in time, people like Elizabeth Holmes, Theranos founder; Sam Bankman-Fried, FTX founder; and Charlie Javice, Frank founder, were portrayed as visionary entrepreneurs.

Many thought they would take on the mantles previously occupied by the likes of Steve Jobs, Mark Zuckerberg, Sergey Brin, and Larry Page. Today they are all either awaiting sentencing or are in the middle of major criminal trials. And yet, none of their investors saw it coming. 

It is also likely that familiarity bias plays a role.

Despite that track record, investors showed no sign of slowing down when it came to backing young, apparently maverick entrepreneurs in the tech sector. Indeed, things only really started to slow down when interest rates started rising towards the end of 2022. 

That is because those investors went in knowing there was a significant degree of risk. But if one of the companies came good and the investor saw massive returns, it would have made up for any losses they saw from the companies that didn’t.     

Why then should they not take the same attitude with companies in frontier markets in places like Southern Africa? 

Overcoming biases, understanding the potential 

Some will argue that it is because those markets have a less-established track record, meaning that any economic ructions are likely to impact businesses more severely.

That may be true at a macro level, but I have seen thriving businesses in such economies time and time again over the past 10 years. 

It is also likely that familiarity bias plays a role. This tendency for investors to favour investments in sectors and markets that they are familiar with and comprehend is understandable, especially when it comes to risk mitigation. But it is still a bias that investors need to be wary of. 

As many developed countries struggle with ageing, shrinking populations, these frontier markets will keep growing.

That is especially true when you consider the potential investors are missing out on by holding onto the above logic and biases. 

The economic difficulties in many of the countries that investors are wary of will not last forever. And when their fortunes turn around, they will likely do so in a very big way. That is because they have a lot of things going in their favour that even the most developed countries do not have right now. 

Take population demographics for example. As many developed countries struggle with ageing, shrinking populations, these frontier markets will keep growing.

By 2050, for example, half of Sub-Saharan Africa’s population is expected to be under the age of 25. And in 2021, the region’s population grew by 2.6 per cent, according to data from Statista. 

By comparison, Europe’s population is expected to be just 0.6 per cent higher in 2026 than it was in 2019, figures from Eurostat show. 

Those young people will not just be vital from a labour perspective, they also represent an increasingly connected and savvy consumer base (to say nothing of the potential wealth that will come from the region’s renewable energy resources).

And the best way to reach them is by acquiring the companies that have already succeeded in those markets.  

Reducing risk 

Even knowing those advantages, however, investors will still want to manage their risk. Here again, though, there are a number of simple steps they can take. 

The first is to spread the risk by investing in multiple companies in multiple countries.

Remember, there are 16 countries in the Southern African Democratic Community region alone. Each country has a different economy where different sectors are either doing well or poorly.

By investing in a broad spread of companies across a broad number of sectors, investors can significantly reduce the risk they face in any market. 

Focus on the rich opportunities and how you can grab hold of them before anyone else does. 

Additionally, investors can bolster whatever due diligence processes they have in place. The right due diligence will give a good indication of how primed a prospective investee company is for growth.

And given the scandals of recent years, it is probably something they should do for any prospective company, no matter where it might be located. 

Another risk management strategy is to invest upstream and to ensure that they invest in companies with good earlier-stage investors.

Those earlier-stage investors should not just have a good track record of picking winners either. You also want investors that have demonstrated their ability to grow and develop companies to the point where they are ready for exit.

There is risk in every investment, no matter which economy it operates in.

Tied to that, those earlier-stage investors should also have a strong track record when it comes to having boots on the ground in any market they are thinking of investing in. Both of those things indicate to investors who understand the risks in those economies and have factored them into their decision-making 

If they have additionally set the company on the right path when it comes to things like environmental, social, and governance standards, so much the better.     

Move now or regret it later 

By the time that becomes obvious to most organisations in a position to make an acquisition, they will already be a long way behind those that were not afraid to invest early and aggressively.

So, next time someone pitches you on a great company in a struggling economy, do not get caught up in the barriers to investment. Instead, focus on the rich opportunities and how you can grab hold of them before anyone else does. 

Because ultimately, there is risk in every investment, no matter which economy it operates in.

But the biggest risk does not come from backing a company that does not make it. Instead, it comes from choosing not to invest in a region that is bursting with possibility. Yes, there are risks but they are known and can be managed.

That is especially true if you make follow-on investments from investors who have grown and helped build up those companies to the point where they are ready for a clean exit to someone who can help drive the next phase of growth.  

Martin Soderberg is partner at Spear Capital