* Investors pile into Africa for better returns
* Funds need to add value to open up family firms
* Experienced managers in short supply in Africa
By Duncan Miriri
NAIROBI, March 6 (Reuters) - Kenyan entrepreneur Ayisi Makatiani scrapped his first effort to launch a private equity fund 10 years ago because his pitch to invest in Africa couldn't raise enough cash to make it work.
Fast forward a decade and he is now managing partner of Fanisi Capital, a $50 million fund that has investments across east Africa in agri-business, healthcare, retail and education. A second $100 million fund is on the way.
"The returns in Europe and the rest of the world have been low so the only place where you get good risk-adjusted returns is Africa," U.S.-educated Makatiani, 47, said from a swanky office block on Nairobi's upmarket Riverside Drive, where other new financial ventures have set up a regional base.
Their expansion marks a turnaround in attitudes to Africa, but masks many of the emerging challenges for both new and more experienced private equity firms on the continent.
Private equity is still a relatively new financial vehicle on Africa's landscape and challenges include offering enough added value to encourage family firms to open up to external financing, finding local managers with the skills to see a project from investment to exit and winning over African pension funds and other local funding sources to create a more indigenous industry.
"If it is only the money you need, there are other places you can get that," said Michael Turner, Kenya managing director for emerging markets specialist Actis Capital. "Private equity is about value added."
The numbers suggest raising cash is no longer the biggest challenge in Sub-Saharan Africa - a region with economic growth rates that are rivalled only by Asia.
Sub-Saharan Africa drew $1.6 billion of private equity investment in 2013, with east Africa - on the brink of an oil and gas bonanza - seeing the biggest rise in deal activity, data from the Emerging Markets Private Equity Association shows.
A bigger objective is how to invest that cash successfully. That is where global firms like London-based emerging markets private equity firm Actis, with $6 billion under management, may have an edge over local, smaller rivals.
They can draw on a broader pool of experience to identify attractive sectors and steer a target through a turnaround or expansion.
Describing his most recent investment in AutoXpress in Kenya, Turner points out that it was his South African colleagues who prompted him to scout for a tyre firm because they saw growth in that sector in their market. And it was an Actis specialist from Brazil with experience running a tyre firm who helped "seal the deal" by explaining the potential to the family owners.
AutoXpress had spurned other private equity approaches but Actis secured a 36 percent stake. Turner now sits on the board, but said such a move was a big leap for any family firm. "It is like opening up your house to a stranger," he said.
Many firms that have surfed Africa's fast growth began as a family trade. They range from retailers that have expanded from corner stores to supermarket chains, such as Kenya's Naivas or Nakumatt, to manufacturers that have grown out of workshops such as Interconsumer Products, which was snapped up by cosmetics giant L'Oreal last year.
Private equity can bring a fresh perspective to help the family expand or find an exit. But it doesn't always work out.
Kamal Budhabati, who heads Kenyan software developer Craft Silicon, sought financing to expand. He secured $3 million from a local private equity firm. Within three years of that deal, he had bought back the investor's stake as their views collided.
"For us the visions were not matching. They had a short-term goal, we had a long-term goal," Budhabati said, speaking at his Nairobi office complex, which with its green lawns and a basketball court would look at home in Silicon Valley.
"The venture capitalists who want to put money into software businesses, they must understand that these are long-term businesses," he said.
The lack of experience among local private equity firms means foreign firms continue to dominate the industry in Africa.
"One of the challenges that many (local private equity) fund managers face is the short supply of management talent," said Kevin Njiraini, investment officer for private equity at the International Finance Corporation (IFC), the World Bank's private sector arm.
A typical cycle in private equity runs over 10 years. The first three to four years are spent seeking out investments and the next three to four are spent growing them. The final period involves finding an exit, such as a strategic buyer.
In fast-growing Africa the kind of experience required over the cycle can be lacking. The IFC is using its funding to give new private equity managers an early leg up and accelerate the learning process.
Its private equity investments include backing Nairobi-based and Mauritius-listed Catalyst Principal Partners.
Development institutions, such as the IFC, accounted for about 70 percent of funds raised for Principal Partners' first $125 million fund launched in 2012. The rest came from individuals, insurance firms and other sources. The fund is being invested across east Africa.
The longer-term objective for African private equity managers is to draw in more local sources of funding, such as from pension funds, who might also prefer locally registered companies operating in the local currency.
For now, such funds are cautious about private equity, partly because they are unfamiliar with the concept.
"There are challenges of understanding how private equity works and the risks involved, so that has tended to keep would-be investors away," said Kenneth Muchina, director of fundraising at Nairobi-based Fusion Investment Management.