The COVID-19 pandemic has tested private equity firms in ways not seen before. In the first half of 2020, private equity activity took a sudden halt as COVID-19 took hold.

30 May 22

This was not unlike sectors such as tourism, hospitality, education, real estate and retail, which were also hard hit by the pandemic.

Various mitigating measures were adopted by regulators of the different business sectors, all in a bid to stabilise their respective markets. In the financial services space, for instance, the Bank of Uganda issued a directive to financial institutions allowing for the restructuring of loans on a discretionary basis, which many financial institutions adopted, restructuring a significant portion of their loan portfolio indicating the devastating effect of COVID-19 on the economy. In the insurance sector, a moratorium on premium payment was also announced. Invariably, foreign direct investment (FDI) came to a minimum with a handful of restructurings and acquisitions of distressed assets.

As the rollout of the vaccines progresses, the economy is opening up again and businesses are beginning to stabilise, alongside private sector efforts and government policies targeted at improving access to finance to kickstart the economy. Cash flow constraints experienced by companies during COVID-19 may see many companies turn to private equity investment as a source of financing. This is because besides provision of capital, investments by private equity funds have considerable impact in terms of skills development through business development support, active management, exchange and transfer of know-how and access to a broader network. We anticipate that private equity funds will play a key role in supporting various entities across different sectors.

Regulatory Developments in the Private Equity and Venture Capital Space
The enactment of new draft regulations on private equity and venture capital funds and the ongoing stakeholder engagement by the Capital Markets Authority demonstrate the growth of private equity and the efforts to create a more favourable regulatory environment for it. The draft Capital Markets Authority (Licensing and Approval) and Regulations 2021 (the ‘’Regulations’’) seek to provide for regulation of venture capital funds established, incorporated and registered in Uganda. Applicants are required among others to fulfil both technical and financial requirements, including evidence of membership in a self-regulatory organisation with oversight over venture capital funds in Uganda as approved by the Capital Markets Authority.

The venture capital fund is required to have a board of directors with a minimum of five directors and at least a third of them independent directors. Additionally, the venture capital fund should have as its principal object the provision of risk capital to business enterprises in Uganda, and any changes to its shareholders, directors or fund manager are subject to no objection from the Capital Markets Authority.

The Capital Markets Authority (Accounting and Financial Requirements) Regulations, 2021 have also revised the net capital requirements and the minimum paid up share capital as below:

Net Capital in UGX               Minimum Capital in UGX
Fund 190 million (approx. USD53,000) 375 million (approx. USD 105,000) Manager
Venture 750 million (approx. USD210,000) 1.5 billion (approx. USD 420,000) Capital Fund
Fees in UGX
Venture Capital Funds Registration Fees – 750,000 (approx. USD210,000)
Annual Registration Fees – 1,000,000 (approx. USD280,000)
Fund Manager License Application Fees – 750,000 (approx. USD210,000)
Annual Licensing and Renewal Fees – 3,700,000 (approx. USD1,000)

The Uganda Revenue Authority is also taking steps to create a more favourable tax regulatory regime for registered venture capital funds. The Income Tax Amendment Act 2021 seeks to amend Section 54 of the Income Tax Act. It provides that there will be no gain or loss if a registered venture capital fund reinvests at least 50% of the proceeds resulting from the sale/ disposal of investment interest within the year in which the sale took place. Notwithstanding the above, the registered venture capital fund shall be entitled to a loss or gain equivalent to the percentage of reinvested proceeds. From the reading of the amendment, this incentive is only available for registered venture capital funds that are provided for under the new draft Regulations, which are yet to be passed into law.

Emerging Trends and New Sectors of Interest
Whereas some sectors such as manufacturing, technology, media, telecommunications and
healthcare were resilient during the pandemic, other sectors such as tourism, travel and hotel and
logistics may need to rethink their business models. Private equity funds are shifting their focus to
preserving the value of companies in their existing portfolios, and they are working to strengthen
existing relations with their partners and lenders.

An area likely to see renewed interest is environmental, social and governance (ESG) investing. The rapidly growing list of signatories to the United Nations supported Principles for Responsible Investment (PRI), the principal framework for investors who wish to integrate the consideration of ESG issues into their investment decision-making, is an indicator of increased awareness of ESG issues. Companies want to strike a balance between the moral values versus economic value. The Parliament of Uganda recently passed a National Climate Change Bill 2020, which gives force to the United Nations Framework Convention on Climate Change, the Kyoto Protocol and the Paris Agreement.

Another sector that has attracted investment is fintech, with financial inclusion being a key driver in this sector. This growth is being facilitated by efforts to build a more supportive regulatory framework for fintech following the gazetting of the National Payment Systems Act 2020 and the accompanying Regulations there under. The Central Bank of Uganda (BoU) has put in place a regulatory sandbox framework that allows innovative financial solutions, for example, fintech startups to be tested in live controlled environments with BoU’s oversight and subject to the necessary safeguards.

The trend towards an increasing dependence on digital tools and IT-based working models has more companies moving services and products online and more employees working from home whilst using personal mobile devices to connect to home networks, which means there is an increased investment in online and technology-based solutions. Online mobile transport companies like SafeBoda partnered with United Nations Capital Development Fund to provide an e-commerce platform that connects market vendors to customers during the COVID-19 lockdown and beyond. This digitisation has also been adopted by the government to facilitate ease of doing business in Uganda. For instance, the Companies Registry, the Immigration Department, the Revenue Authority and the Investment Authority have all adopted an online platform to cut back on in person traffic and improve efficiencies in their services to the public. An e-government procurement system is also underway. Renewable energy is one of the fastest growing sectors in Uganda.

Uganda faced significant political upheaval in January 2021, with an internet shutdown for several days during the election period. The political and social unrest surrounding the election diminished investor appetite in the country. The Government’s decision to shut down the internet in retaliation against Facebook closing the accounts of some pro-ruling party supporters left several companies counting billions of shillings in lost revenue.

Another challenge is that private equity funds do not have a special tax regime in Uganda and therefore income tax and/or dividend taxes will be assessed at the investee company level, at the fund level and again at the fund shareholder level. This creates an element of double taxation, making them tax inefficient and thereby creating a strong disincentive for investors to invest in Ugandan companies. Currently, a 30% corporate tax is payable by all corporate entities to the Uganda Revenue Authority. If a local private equity firm invests in another local firm and it is paid dividends by the company in which it invested, a withholding tax of 15% is payable on the dividends. If, however, the equity invested is in a magnitude of more than 25%, then the dividend is exempt. If a decision is made by the private equity firm to dispose of its investment in the local firm and it makes a gain on the disposal, the gain is taxed at 30%, which is a capital gains tax payable to the Uganda Revenue Authority. The 30% capital gains tax is high compared to other jurisdictions like Kenya and Mauritius, making Uganda a less favourable destination for private equity investment.

At 30%, which is a capital gains tax payable to the Uganda Revenue Authority. The 30% capital gains tax is high compared to other jurisdictions like Kenya and Mauritius, making Uganda a less favourable destination for private equity investment.

For fund managers to be able to successfully raise funds from investors, they need to demonstrate a track record of delivering good returns for their investors. The unfavourable tax regime significantly affects the rate of return to investors, making Uganda a less attractive investment destination for private equity.

Finally, while it is common place for private equity funds worldwide to set up as partnerships, in Uganda, the Capital Markets Authority Act only makes provision for private equity funds to be set up and registered as local companies. The new draft Regulations set out the criteria for registering venture capital funds as companies and not partnerships. The stakeholder recommendation to the Capital Markets Authority Act is to amend this provision to give private equity funds flexibility to set up as partnerships. Creating an option for funds to register as partnerships diversifies the structure under which private equity funds can be set up. It also limits investor liability to their fund investment.

Future Outlook
The deepening of the Ugandan capital market, coupled with economic growth, has the potential to support the development of the private equity space in Uganda.

Like all other collective investment vehicles that pool funds together, such as investment clubs, unit trusts and retirement benefits schemes, private equity and venture capital funds should not be taxed both on the investments that they make and the returns they receive and then for their existence as corporate entities. The recommendation is that the Capital Markets Authority should pronounce itself that private equity funds are a tool into which funds are individually placed, hence unifying the treatment of all similar collective investment vehicles. Understanding that they are pass-throughs, which solely pool funds to deploy into other companies, means that a more favourable tax environment is created.

Strengthening the regulatory environment will go a long way in building investor confidence in the market. This may require setting up a separate private equity and venture capital regulatory regime, providing a more favourable tax regime specifically for private equity and venture capital funds and making provisions for private equity funds to be set up as partnerships.

The lessons taught by the crisis could reshape the way funds pick their investments, manage their performance and work with portfolio companies and investors alike. There will be unprecedented scope and detail with due diligence assignments on a commercial and operational level to ascertain how the pandemic has changed businesses. Owing to the current economic environment, asset valuations have been affected, and hence there are potential opportunities for investors to purchase high-quality assets at attractive prices. The fundamental principles which drive private equity investment strategies, such as investing into high-quality assets, partnering with active and strong management teams and focused exit strategies, are expected to support private equity remaining a resilient asset class.

Funds will look for ways to preserve value, analysing strategies that worked and those that did not. Private equity funds should identify behaviours that generated high performance and apply those across their portfolios. Private equity funds can leverage their value-creating capabilities to support companies. The fundraising environment is likely to change with a continued focus on restructuring and supporting companies navigate the long-term effects of COVID-19. The ongoing regulatory developments by the Capital Markets Authority and the increased stakeholder engagements are expected to increase access to capital for Ugandan businesses and create an environment that boosts investor confidence in the country.

Should you have any questions regarding the information in this legal alert, please do not hesitate to contact Partner Fiona Nalonga Magona


This article was first published by AVCA Legal and Regulatory Bulletin.