The Nepali financial market is highly dominated by banks and financial institutions (BFIs); it mobilizes almost 86.6% of financial assets in the financial system. Due to limited financing options, businesses, especially small and medium enterprises (SMEs), which constitute almost 85% of businesses in Nepal, mostly rely on financing from traditional financial institutions. Nonetheless, accessing finance from these institutions is a major challenge as it requires adequate collaterals and interest rates are generally high. As per the study conducted by the UKAID Sakchyam Access to Finance Programme in 2018/19, the SME financing gap in Nepal is estimated to be about 15% of the national GDP at USD 3.9 billion (NPR 438 billion).
Globally, alternative investment funds such as private equity (PE), venture capital (VC), infrastructure funds, real estate funds, hedge funds, etc. have emerged as an alternative asset class — a valuable partner and strong source of long-term risk capital for competitive, scalable, innovative, transformative, and growth-oriented businesses, especially SMEs, to diversify their funding base. As per a McKinsey study, the global private market assets under management totaled USD 13.1 trillion (NPR 1,738 trillion) as of June 2023. Likewise, as per Preqin’s ‘Future of Alternatives 2028’ report, global alternative assets under management (AUM) are expected to reach USD 24.5 trillion (NPR 3,250 trillion) by the end of 2028. Apart from financing, these alternative investment funds, such as PE and VC funds, tend to take a “capital plus” approach, wherein they provide a variety of technical support to businesses to enhance operations; build management capacity and market linkages; and improve governance and growth. This additional technical support plays a pivotal role in the growth of businesses, particularly SMEs, which lack such skills, knowledge, and networks.
Although Business Oxygen (BO2), Nepal’s first private equity fund, was launched in 2012, Nepal only got a Specialized Investment Fund (SIF) regulation in 2019, issued by the Securities Board of Nepal (SEBON). The entry of various funds provides an alternative mechanism for SMEs that might struggle to access finance from traditional financial institutions and is expected to play a major role in fulfilling the existing SME financing gap. And while the alternative investment market in Nepal is still at a nascent stage, some of the trends and developments that provide evidence and opportunities for the growth of alternative investment mechanisms in Nepal are outlined below:
Funds with Foreign Direct Investments (FDI) Paving the Way
Both offshore and onshore foreign direct investment (FDI) funds have played a key role in developing the alternative funds market in Nepal and attracting foreign investments. Business Oxygen (BO2), Nepal’s first SME Venture Fund, has invested in 16 SMEs, and has already successfully exited from five investments. Likewise, Dolma Impact Fund, an offshore fund which is the largest PE fund in Nepal, has raised more than USD 100 million (NPR 13.26 billion) via its two funds. Both of these funds have primarily sourced their funding from development financial institutions (DFIs). Likewise, One to Watch has been able to significantly attract funds from private investors from Netherlands.
These funds with FDI have played a key role in developing both the legal and business environment for alternative investment funds and attracting foreign investments in the form of private equity. Moreover, these funds have been instrumental in adopting international best practices such as environmental, social, and governance (ESG) factors in investment decisions and due diligence practices, amongst others.
More than USD 66 million (NPR 8.76 billion) Already Mobilized by PE-VC Funds
As per the market snapshot report published by the Nepal Private Equity Association (NPEA), Nepali PE-VC funds have mobilized around USD 66 million (NPR 8.76 billion) between 2012 and 2022, across 15 different sectors. Amongst which, 25% was mobilized by offshore FDI funds, 12.5% by onshore FDI funds, and 62.5% by local funds. These figures do not include investments from SIF-registered funds, as they have not made any investments as of 2022. In terms of instruments, 70.8% of investments have been made through equity, while the remaining 29.2% are through hybrid instruments. Likewise, in terms of the number of investments or deals, a total of 72 investments were made, out of which information and technology (IT) received the highest number of investments at 17, followed by renewable energy at 13, and agribusiness at 12.
More than 15 PE-VC Funds in Operation
Like any other growth trend in Nepal, the alternative investment fund market is currently witnessing the foray of new fund managers and funds. As of mid-March 2024, SEBON, under the SIF regulation, has already provided the fund manager’s license to more than a dozen fund management companies, and has registered eight funds. Moreover, there are a couple other fund managers and funds in the pipeline awaiting SEBON’s approvals. Notably, most of the funds registered with SEBON are promoted by financial institutions such as commercial banks and insurance companies. Among the registered funds, Avasar Equity has already raised NPR 5 billion (USD 37.68 million) under its first PE fund, i.e., the Avasar Equity Diversified Fund, and has started to deploy the funds. With these funds in the pipeline, SIF funds are estimated to raise and deploy between NPR 30 to 40 billion (USD 225.09 million to 300.12 million) in the next few years.
Development of an Ecosystem
The Nepal Private Equity Association (NPEA) and Invest for Impact Nepal (IIN) are some of the key actors that are working towards developing a strong ecosystem to support the development of alternative investment funds in Nepal and promote access to finance for SMEs. Currently, NEPA has 18 regular and seven associate members and is actively involved in providing training and support, policy advocacy and lobbying, research, and networking. Likewise, Invest for Impact Nepal is a collaborative platform established by British International Investment (BII), the Dutch Entrepreneurial Development Bank (FMO), and the Swiss Agency for Development Cooperation (SDC), that has been complementing existing efforts to attract Development Financial Institution (DFI) investment in order to support private sector growth. Similarly, there are numerous well-established accelerators, incubators, law firms, and consulting firms required for the growth of the industry.
Opportunity to Mobilize Foreign Investments
Nepal offers ample investment opportunities in both greenfield and brownfield projects in high-potential sectors such as the energy, tourism, information technology, infrastructure, education, healthcare, and agriculture sector. Thus, alternative funds provide an opportunity to mobilize foreign investments in the form of private equity and particularly attract funding from DFIs. The ability to attract and involve DFIs provides a strong basis to attract foreign investment from other foreign commercial capital providers. Moreover, the SIF regulation allows investment from multilateral or bilateral international institutional investors, foreign nationals or firms, companies or foreign institutional investors, foreign registered funds, fund managers, and other types of institutional entities.
Few Successful Exits and Confidence-Inducing Capital Market
Having clear exit options is crucial for the development of the alternative investment fund market. Fortunately, the Nepali market has already witnessed some successful exits in the recent past. As per the NPEA market snapshot report, a combined total of 17 full or partial exits have occurred, out of which 58.8% were full exits and 41.2% were partial exits. Moreover, the capital market provides the necessary depth required for such successful exits through initial public offerings (IPOs) since, as per SIF regulation, the lock-in period for SIF-regulated funds is only one year, which provides a substantial exit incentive for SIF-regulated PE-VC funds.
Reforms in Regulations
The current SIF regulation has been amended once, and as the market evolves, there is a need to amend various regulations in order to support full functioning as per the capacity of both local and international funds. To develop a favorable regulatory environment, various policy dialogues are currently ongoing, and some regulatory changes are required to accommodate the efficient operations of these funds and be able to route and attract foreign capital. Some of the areas of improvement are: tax pass-through for alternative funds; resolving the risk of blacklisting for local funds; and exemption from change-of-control provisions for PE-VC funds under Section 7 of the Income Tax Act.
The role of attracting foreign investments is crucial for stimulating growth and employment opportunities. Despite the significance of FDIs in the Nepali economy, Nepal has not been able to attract the desired level of foreign investment due to various market barriers, primarily an unstable policy and political environment. Positively, the recent developments in the alternative investment fund landscape offer a platform to attract foreign capital via these alternative funds. However, it is imperative to create an enabling environment by making the required timely reforms in the current regulatory and legal framework without any further delay.
Rojesh Bhakta Shrestha is a senior consultant at beed. He has over 15 years of professional experience in a variety of settings and programmes, with strong expertise and experience in areas such as fund structuring, investment management, banking and capital markets, and financial and management advisory.
