In April 2024, we set off for the Himalayan nation of Nepal to learn about its PEVC ecosystem. While in the capital of Kathmandu, we met with five of Nepal’s largest PEVC funds in addition to attending the 3rd Annual Nepal Investment Summit. It has been a while since a report on the Nepal PEVC ecosystem was published, so we are excited to bring you these differentiated insights.
In this post, we detail our key findings with focus on: formation and overview of the PEVC ecosystem, key industries, sourcing tactics, valuation methodology, exits, cultural considerations, case studies, challenges and opportunities, and an overview of the 2024 Nepal Investment Summit.
This post relies heavily on information obtained in meetings with investors as well as Nepal Private Equity Association (NPEA) reports. We would like to thank the many investors who took time to talk to us, including fund managers at Aadyhyanta Fund Management, Avasar Equity, Business Oxygen, Dolma Advisors (Dolma), and True North Associates (True North) about their views and experiences.
We hope you enjoy!
Introduction
On our way to our first meeting, we were paralyzed in an endless stream of traffic directed by cops pointing and shouting from metal pedestals in the road in lieu of traditional traffic lights. Kathmandu was filled with a thick cloud of smog as we snaked our way past stupas and markets full of livestock to meet with Nepal's top private equity investors. Our driver, lacking the ability to read directions from a GPS, dumped us off as close to the office as he could. We were left with a lengthy walk through a neighborhood perched in the foothills of the Himalayas, accompanied by a vocal rooster and a curious monkey. We arrived at a house converted to a business. We were not in Manhattan anymore.
Private equity is still in its infancy in Nepal. The industry is barely a decade old, and deal sizes rarely exceed the size of a bill for an industry report from McKinsey or Bain. Investment bankers are virtually non-existent and auditors lack adequate training to service the small, but growing number of sponsors in the region.
How could private equity or venture capital thrive in this environment? In our first edition of Trekking for Alpha, we explore the PEVC industry in Nepal and explain why Kathmandu's investors are trailblazers giving it their all to put the country on the map as an emerging market to watch for alternative asset investment. Below, we cover the following topics:
1. Nepal's Private Equity Industry
2. Challenges Faced by Kathmandu's Sponsors
3. The Future of Nepal's PEVC Industry
After several weeks on the ground in Nepal, it was time to have our last momos and head to our next frontier. Our time on the ground revealed to us that there are interesting opportunities in Nepal for impact-oriented investors. Specific sectors, like hydro, are poised to generate positive returns while making a difference. The PEVC ecosystem is positioned to support much needed development in the country. We also believe that there are many strong local investors to invest alongside and we are excited by the work the Nepal Private Equity Association (NPEA) and others are doing to build a dynamic and healthy PEVC ecosystem. Let's dive in!
History and Overview of the Industry
Nepal’s private equity industry started forming a decade ago as the nation emerged from years of political turmoil. In 2014, the IFC helped establish funds as part of its SME Ventures program. Business Oxygen and Dolma, each of whom we met with in Kathmandu, are early funds formed with IFC support. These funds were founded to both provide an alternative capital source to SMEs beyond bank debt, which tends to be expensive and inaccessible to many business types, and to offer resources and expertise to help businesses grow. Business Oxygen and Dolma, among other early market participants, pioneered the industry and laid the groundwork for the ecosystem that exists today.
Meeting at Dolma. Meeting at Business Oxygen.
In 2019, the Securities Board of Nepal (SEBON) established regulations for the industry - Specialized Investment Fund Rules. As of 2023, sixteen funds have formed in Nepal which, according to investors we spoke with, makes the space a bit crowded given the size of the market. PEVC investing occurs primarily through minority stake equity investments sometimes supplemented by hybrid / preferred instruments. Debt is not a capital source normally deployed by funds due to severe blacklisting regulations (discussed later in this report).
Funds in Nepal presently do not have specific sector mandates as they find the opportunity set of investible companies today to be too limited. Investors noted optimism around industry specialization in the future though. For example, Dolma is exploring a $300 million climate-focused fund.
Fund managers take a very hands-on role with their portfolio companies. This is in part a byproduct of brain drain as investors struggle to find adequate talent to manage port cos. Funds tend to provide support through a board observer role versus as a direct board member due to the aforementioned blacklisting regulations.
In many respects, Nepalese funds look very similar to their counterparts in developed markets. Many managers have implemented industry norms with respect to fee structure, fund life, investment hold period (5-7 years), the list goes on. Investors do not feel a need to reinvent the wheel and want conformity for foreign LPs. Some funds have adapted these norms to better fit local market conditions. For example, one manager called all committed capital up front due to uncertainty around future liquidity from LPs. Other funds have different fee structures to account for smaller AUMs.
Nepalese funds’ foreign LP base has almost exclusively been development financial institutions (DFIs) including the IMF, British International Investment (BII), FMO, Japan International Cooperation Agency (JICA), among others. There is optimism that ESG investing will become more development-focused resulting in endowments and philanthropic-minded HNWIs writing checks to Nepalese PEVC funds. Funds with foreign investors are exposed to additional regulations including minimum investment hurdles and a restricted industry list.
Domestic capital comes from local banks and, to a lesser degree, from HNWIs. Fund managers are hopeful that a future source of domestic capital will be insurance companies. The insurance industry in Nepal is growing fast and companies are looking for higher yield investment opportunities for their capital.
For reference, we provide key facts on Nepal in Appendix A.
Industries
To date, 46% of capital has been deployed into renewable energy (reflects data from 8 funds from 2012 – 2022) and the sector dominates conversation around future investment opportunities. This is a byproduct of i) prior demonstrated investment success in this sector (there has been limited demonstrated success outside of this sector), ii) plentiful hydro supply from the Himalayan-fed rivers, and iii) the focus of foreign development organizations on sustainability and ESG initiatives.
Nepal relies on its hydropower as a domestic energy source and exports it. In January 2024, India signed an agreement with Nepal to receive 10GW of hydroelectricity over the next decade. This trumps the 2.6GW produced today. Exact figures on Nepal’s true hydropower potential are up for debate with more conservative estimates putting it around 20-fold of current production levels and more lofty estimates at 40-fold.
Both India and China invest in hydro infrastructure in Nepal making the industry an outlet for geopolitical turmoil. In 2018, India amended its energy policy to prohibit purchase of power produced with investment from nations with which it does not have a "bilateral agreement on power sector cooperation". This policy change prohibits India from purchasing power produced in facilities constructed with investment from China. Since this policy change, Nepal has removed China from multiple power projects in the country.
The information and communications technology (ICT) sector is also touted as Nepal’s future. Given the ease of export of digital services, the ICT sector provides an opportunity for businesses to scale outside of landlocked Nepal. As India becomes more expensive as a cost center, Nepal stands as a cheaper alternative for businesses worldwide. Despite this optimism, it is worth noting that investors here have concerns around education levels, language skills, and infrastructure needed to fuel this sector’s growth.
Examples of Nepalese successes in the ICT sector include CloudFactory, a managed workforce solutions provider for AI, and Fusemachines, an AI products and solutions provider. Both companies have attracted U.S.-based investor interest with CloudFactory receiving funding from FTV Capital, a US-based growth equity investment firm, and Fusemachines on path for Nasdaq listing via a $200 million SPAC deal.
There is brewing investor sentiment that agriculture will become a more relevant sector for PEVC investors. Agriculture represents ~27% of the country’s GDP and employs over 50% of the population. Nepal has impressive biodiversity and has potential as a producer of high-value, niche products including herbal supplements. Agriculture in Nepal is highly underdeveloped which creates low-hanging fruit. During our travels around the country, we felt as if we could still be in the year 1300 as farming tactics seemed so primitive.
Agriculture could greatly benefit from additional financing solutions, technology, and products with rewards being both monetary and humanitarian. One investor we spoke with believes that if agriculture companies can successfully IPO on the Nepal Stock Exchange (NEPSE), more agriculture-specific financing options and investment in the sector will follow. It is worth noting that funds with foreign investment are restricted from investing in various sub-sectors of the agriculture industry although this regulation has recently been loosened.
Tourism is also touted as an attractive investment sector thanks to the nation’s breathtaking Himalayas and rich culture. Today, tourism makes up ~7% of Nepal’s GDP which is a lower percentage versus neighboring nations such as Sri Lanka. While we believe there is room for growth in this sector - infrastructure, extreme fragmentation, and lack of differentiation (many hotel owners asked us why we picked their hotel as they expressed difficulties creating differentiation despite having superior offerings) are pain points.
With respect to infrastructure, nearly all roads, even roads connecting vital tourism hubs, are in very poor condition. For example, it took us seven hours to drive the 200 km between Pokhara and Kathmandu. The ride was painfully bumpy and included a shocking moment when we got sprayed in the face through an open window by a truck dispersing water to settle dust on the dirt road. Also to note, we were forced to make the harrowing drive due to multi-day flight cancellations at Pokhara International Airport caused by pollution and weak aviation infrastructure.
The government is acutely aware of the infrastructure challenges and is making improvements. Multiple government initiatives focused on infrastructure are underway including the Chitwan-Rampur-Pokhara Expressway that will reduce commute times between Pokhara and Chitwan National Park. Pokhara to Kathmandu road improvement projects are also in the works. The grid has also been hardened significantly over the past decade. Better infrastructure makes Nepal a more attractive tourist destination and unlocks opportunities for investors.
Sourcing
Given the limited M&A advisory resources in Nepal, sourcing requires a heavy dose of hustle and is nearly all proprietary. Sourcing has historically relied on “grape vine stuff” - leveraging fund employees’ and LPs’ networks. Funds also run accelerator programs targeting a specific investment focus (i.e., an accelerator program for agritech companies offering mentorship and industry connections) and provide business advisory services. These high-effort tactics build the funds’ reputations as value add. Additionally, the NPEA hosts pitch events where local entrepreneurs and business owners present to investors. Despite the lack of banked processes, investors expressed that they still have a low selectivity rate of 1-2% (opportunities seen to actual investment).
There is general consensus that sourcing has been getting easier. One investor expressed optimism that an investment banking mechanism for sourcing is starting to develop.
Valuation
The nascency of the market brings challenges to valuation methodology as well. With limited M&A activity and a sparse public comps universe (listed companies are mainly in two sectors - financial services and hydropower), comps are few and far between. Additionally, there is no reliable, centralized data source. Some funds have taken to applying a steep discount to Indian comps. Many investors rely heavily on credit agencies and “ground intelligence” to assist with valuations.
In several meetings, investors expressed concern about valuation distortion driven by development fund capital as cash infusions from external development funds may artificially drive up valuations creating a bubble. They fear that this could set the PEVC industry up for long-term failure.
PE investors educate business owners on valuation so that term sheet negotiations can take place. We heard from market participants that DCF valuation methodology was taught to entrepreneurs; however, their valuation expectations “got crazy”. Some in the investment community are now directing entrepreneurs to market their businesses as “profitable or having line of sight to profitability” with an emphasis on path to exit rather than ‘harp’ on the concept of valuation.
Exits
According to the NPEA, investment exits started occurring in 2019. From 2019-2022, there were ten full and seven partial exits (reflects data from 8 funds from 2012 – 2022). The main exit path to date has been management buyback. There have also been a few sales to sponsors (including the partial exit of CloudFactory), sales to strategics, and IPOs (mainly hydropower companies). Interestingly, unlike in developed markets where strategic sales often command the highest premium, strategic sales in Nepal have mainly happened in distressed scenarios and / or at a discount. Managers are highly focused on exits and often include exit expectations in term sheets.
Fund managers have varying views as to how the exit environment will evolve. Several managers are planning to exit 100% of their companies via public listing. Others suspect that the IPO market will have a temporary moment in the sun and then fizzle out. As the PEVC ecosystem develops, sales to domestic sponsors becomes possible.
IPO exits occur through the Nepal Stock Exchange (NEPSE), which was founded in 1994. There are approximately 250 listed companies with a market capitalization of ~ $26 billion (as of January 2024). Like many exchanges in developing markets, NEPSE faces high levels of concentration and low liquidity. The companies listed are mainly financial institutions (commercial banks, insurance, etc.) with hydro projects entering the NEPSE more recently. There are also a few hotels and manufacturing and trade companies listed. Investors expressed optimism that soon other sectors including real estate and agriculture businesses will list on the NEPSE.
As a sign of increasing sophistication in the market, companies started listing using the book-building method. The first company to do this was Sarbottam Cement in 2023 (more about the IPO can be read here). Historically, there was a three-year lock-up period for pre-IPO investors. In 2023, this lock-up period was shortened to one year for PEVC investors and other funds registered with SEBON.
Case Studies: Kathmandu Coffee and Foodmandu
In addition to successes in the hydropower and ICT spaces, there have been attractive exits in the consumer sector. These include Kathmandu Coffee, a provider of coffee products and services across the coffee value chain, and Foodmandu, a homegrown food delivery app similar to Uber Eats. Both companies delivered positive results for their investors and benefited from the support of the PEVC ecosystem.
Kathmandu Coffee
In May 2024, True North, a Kathmandu Valley-based investment firm, announced the full exit of Kathmandu Coffee for ~21% IRR / 2x MOIC through a sale to a strategic. During True North’s investment period, revenue doubled driven by new business lines including high-end coffee retail outlets in the Kathmandu Valley and branded coffee concentrates. In addition to demonstrating opportunities in the consumer space, this investment also exhibits the potential of upscaling agri-value chains.
True North acquired their stake in Kathmandu Coffee in December 2020.
Foodmandu
Foodmandu was one of the earliest companies to tap into Nepal’s PEVC ecosystem. In 2016, facing challenges from the 2015 earthquake and six-month trade embargo with India, Foodmandu was struggling. The cashflow profile of the business in conjunction with its asset-light model limited access to traditional bank financing. True North, appreciative of the growth potential and disruptive business model, took a bet on the company and led the Series A round.
Foodmandu not only received vital capital from True North, but also instrumental managerial support. Nidhaan Shrestha, Investment Director at True North, took a two-year secondment from True North to run Foodmandu. Under his leadership, Foodmandu raised a successful Series B (led by Team Ventures in 2020) and grew significantly. True North even acted as banker for the company during this investment round.
Capital and operational improvements provided by the Nepalese PEVC ecosystem supported Foodmandu’s growth to 365 employees and its expansion to Pokhara and Chitwan. Even as a tourist, the scale of Foodmandu is apparent. We saw Foodmandu delivery drivers, armed with yellow insulated bags stuffed with everything from momos to pizzas, in every nook and cranny across Kathmandu and Pokhara. To date, Foodmandu has completed three exits distributing capital to the founders and two PEVC funds. Exact returns figures have not been reported publicly, however, we met with the funds which received liquidity and both seemed satisfied with the outcome of their investment.
Culture
Nepalese investors pointed out cultural considerations that must be navigated. According to our meetings, Nepalese people generally avoid conflict and pile on niceties in social settings which can impede business performance. We were told that a typical board meeting consists of all parties going around the table complimenting each other and the state of the company while avoiding corporate issues. We saw this attitude at the Nepal Investment Summit (further described below) too. There were numerous 10+ person panel discussions where formal greetings, compliments, and gratitude eclipsed substantial discussion. PEVC firms add meaningful value by countering this tendency, acting as a third-party to facilitate difficult discussions and ultimately implement solutions.
Nepalese business owners also often have complacency around scale and skepticism of non-bank financing. On the scale point, it is common for successful SMEs to be family-owned businesses grown to a point where the owners can sustain a comfortable lifestyle. This creates a desire to maintain the business as is. Often, owners are not excited about PEVC funds’ transformative visions but view these as unnecessary, burdensome, or suspicious. This trait coincides with skepticism around non-bank financing. Lack of education on the PEVC space is a contributing factor to this.
For these reasons, PEVC fund managers must build a reputation amongst the business community as trustworthy, responsible, reliable, and stable sources of capital first and foremost. They then must convince businesses that they can catalyze growth in an attractive way. PEVC fund managers we spoke with understand this dynamic and go the extra mile to create and protect the reputation of the industry - a prime example being True North’s supportive shepherding of Foodmandu.
Core Challenges
Investing in Nepal is not for the faint of heart. Black swan events - the 2015 earthquake, unexpected government turmoil, and the 2015 India blockade, to name a few - do not feel as rare here. On top of this, Nepal faces the hurdles classically witnessed in other least-developed markets. We explore these challenges and more in greater detail below:
Nascency of the PEVC industry: The nascency of the investment ecosystem creates numerous hurdles including: business owners’ lack of familiarity with the space, limited exit opportunities to other sponsors, lack of banked processes, few to no auditors and consultancies with PEVC capabilities, uncertain regulatory environment, a limited track record of success, and more.
Small TAM and even smaller SAM: At slightly over 30 million, Nepal has a small population. Realistically, the SAM is significantly smaller as ~75% of the population is rural and ~20% of the population is without road access. Additionally, the geography makes external expansion challenging.
Blacklisting: Defaults can result in the blacklisting of individual investors, management, and board members. Blacklisting is a freeze on bank accounts and prevents those listed from withdrawing money. The extreme repercussions of blacklisting limit the use of leverage on investments and investors’ willingness to take formal board seats.
Example: If you are a board member and the business defaults, your personal bank account could get frozen. Talk about skin in the game!
Regulatory challenges: Nepalese investors face a myriad of regulatory and legal challenges. We will not pretend to be an expert on these and we encourage you to review the U.S. State Department’s 2023 Investment Climate Statements: Nepal report linked here.
One of the worst examples we heard on this front is that buyers, versus the sellers, are responsible for paying the capital gains tax
High reliance on India: ~64% of Nepal’s imports are from India, creating dependency and concentration risk. This was an issue in late 2015 when India imposed an unofficial blockade on Nepal. This led to crippling shortages, a humanitarian crisis, and a very weak business environment. While unlikely to occur again, this remains a risk due to the continued high dependency.
As noted, India’s control over the market also intensifies tension with China - the other major capital source in the region.
Deeper death valley: Due to the limited number of VC investors, raising consecutive rounds of capital is more challenging. This makes strong cash management tactics and line of sight to profitability more important.
No sovereign credit rating: Foreign investors currently lack this basic reference indicator. Ahead of the 2024 Nepal Investment Summit, Nepal announced it has initiated its sovereign credit rating process.
Chinese infrastructure loans: Several large infrastructure projects, including the Pokhara International Airport, were funded via Chinese financing packages. Project overspending in conjunction with weaker than projected financial performance puts some projects into default risk territory. Loan defaults could shift ownership of critical assets to Chinese organizations. There are also questions around construction quality which may lead to accidents, closures, and inefficiencies. Additionally, Indian companies may be unwilling to utilize some of this infrastructure.
Brain drain: As is typical in developing nations, most top talent leaves. This makes it much harder for PEVC investors to find qualified talent to run port cos.
Investors counter this by taking a very hands-on role in management
FX risk: Classic risk in a market of this nature, so we will not opine. Note that the Nepalese Rupee is pegged to the Indian Rupee.
Hold period: Beyond the classic challenges around exits in a market of this nature, high percentage of minority stakes drags duration.
Natural disasters: Nepal is at risk for severe earthquakes, flooding, and droughts. Weak infrastructure makes the nation even more exposed.
For example, the April 2015 Nepal Earthquake caused an economic impact totaling ~50% of the nation’s GDP.
Weak infrastructure: Although improving, infrastructure on the whole is in poor shape. Roads are in excessively tattered condition. Few traffic lights exist across the country. There are still very frequent rolling black outs which we witnessed nightly in Kathmandu. Ground stops and flight cancellations are plentiful due to extreme weather, challenging terrain, and pollution.
Pollution in Pokhara, Nepal which led to ground stops at Dining by smartphone light due to a rolling blackout in
Pokhara International Airport. April 2024. Kathmandu, Nepal. April 2024.
Opportunities
While burdened with many hurdles, investors in Nepal are optimistic that geopolitical opportunities, an improving regulatory environment, human resource advantages, and increasing discretionary income create a strong bedrock for a fertile investment environment. Opportunities are not only monetary. Importantly, successful investments help with the development of the country.
Geopolitical opportunities: Sitting between India and China, Nepal straddles the two largest markets by population. Increasing geopolitical tensions between the two giants, especially around import / export restrictions, is creating new opportunities.
One interesting tidbit we learned from a conversation with a local business owner is how Nepal may benefit from India’s greater BIS (Bureau of Indian Standards) certification restrictions against China. Some in Nepal see this as an opportunity to replace Chinese suppliers.
Interesting article on the topic here.
Improving regulatory environment and increased focus on FDI by the government: Many in Nepal believe that the government has finally woken up to the importance of attracting FDI and creating a healthy PEVC ecosystem and is making progress on creating business-friendly regulations. These actions include tax incentives, improving the ease of doing business and making investments, and creating regulation / framework around alternative asset classes.
Human resource advantages: Nepal has a young population with 57% of the population working age (which they define as 15-59 years old). Additionally, the cost of labor is lower than peers’.
Increasing discretionary spending: Looming graduation from Least Developed Country status in conjunction with high remittance rates (officially ~30% of GDP with unofficial estimates up to 50%+) provide some investors with hope that discretionary spending is rising.
Improving infrastructure: Infrastructure investment is a key focus of the government. Recent upgrades include several road, hydropower and solar projects, a more functional grid, and airport openings.
Meaningful money / development: Access to capital and expertise from fund managers supports the growth and success of SMEs - creating quality jobs, encouraging implementation of international best practices, and facilitating infrastructure improvements. This can help stem systemic poverty in nations like Nepal by increasing access to education, etc.
Introduction of green bonds: Dolma is working with the World Bank to issue international green bonds. These will focus on the renewables sector and introduce institutional investors to Nepal. The bonds may be backed by risk insurance from the World Bank’s Multilateral Investment Guarantee Agency.
2024 Nepal Investment Summit Overview
Arriving at the 3rd Annual Nepal Investment Summit felt more like pulling up to a UN meeting versus at a traditional investment conference. Upon stepping out of the car, we were greeted by a crowd clad in dhaka topis, thobes and ghutras, and saris. The start of the conference did not stray from the UN vibes as much of the first day was packed with speeches from government officials (including Prime Minister Pushpa Kamal Dahal), representatives from the World Bank and IMF, and diplomats. After the international niceties, the programming consisted of panels on everything from manufacturing, tourism, and infrastructure to the ease of doing business in Nepal with top domestic investors leading many of these discussions.
Jennifer and Michelle attending the 2024 summit. Headline of Nepalese newspaper highlighting summit.
While the conference was very interesting, substance was limited as many of the panels had 10-15 speakers leaving each participant with three to five minutes to speak. Additionally, many of the panelists apparently intended to discuss identical concepts (hydro, hydro, hydro) which left nearly all of the panelists slated to speak towards the back half of the sessions conceding that their content “had already been covered”.
See below for our key takeaways from the Summit:
Renewable energy reigns king: As we had heard in our investor meetings, the core investment focus in Nepal is renewable energy. This was the near singular focus of the conference. Nearly every panelist, no matter the session, dedicated significant time to this topic. Lots of hydro opportunities were advertised throughout the conference.
Growing investment ecosystem: The number of active funds, investments, total amount invested, and number of sectors invested in are all on the rise.
Battle of the super powers: Sandwiched between China and India, Nepal is in one of the most intriguing geopolitical positions. This dynamic was on full display at the Summit as China, the United States, and India all had considerable presence and the tension was immediately palpable. The Chinese delegation, clearly pulling antics, was “required to open the conference due to a flight conflict”. Over half of the two-hour Welcome Ceremony was allotted to Western, Chinese, and Indian delegations trying to win over hearts and minds.
As noted above, ~64% of Nepal’s imports come from India. It will be interesting to see how Nepal’s New Left alliance government navigates the China versus India question.
Emergence into lower middle-income status: Given economic progress, including a reduction in the poverty rate by 25% since 2011, Nepal is expected to emerge from least developed country to lower middle-income status in 2026. This, in conjunction with the high remittance rate, gave some panelists hope that disposable income and the economic opportunities that come alongside that are on the rise.
Link to conference materials: Conference materials can be viewed here
On the surface, the conference demonstrates government interest in building out a stronger investment ecosystem. However, it is important to note that the new government is left-leaning, therefore, they may be less pro-business and pro-investor in practice. Additionally, many of the reforms and policy implementations are reliant on lower-level government bureaucrats who we have heard are less business-friendly (due to communist leanings) than their counterparts at the top. This could stall meaningful change, but the conference concluded on an extremely optimistic note.
Conclusion
Trekking, literally in the case of Nepal, for Alpha in one of the world’s most undeveloped PEVC ecosystems was an adventure of a lifetime. We encourage development-, green-, and philanthropic- minded investors to dig deeper into opportunities in this beautiful nation. By investing alongside the right local partner, there are opportunities to make a difference and gain some returns along the way.
Appendix A – Nepal Fast Facts
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