An Entrepreneurial Family Scales the Peak of Nepal’s Tourism Sector

Visitors to Mount Everest and other sites around Nepal—which is home to some of the richest biodiversity in the world—contribute significantly to the country’s economy. Tourism makes up around 20 percent of foreign exchange earnings. The sector employs about 425,000 people directly and provides employment to approximately 1 million people indirectly.

So when an avalanche and an earthquake struck the country in 2014 and 2015, the consequences were felt widely. Visitor numbers dropped, slashing tourism earnings and wiping out jobs for local people.

As the industry recovers, one family of business owners is strategizing to woo tourists back to Nepal’s most popular sites. For Dawa Steven Sherpa and his younger brother Tenzing David Sherpa, who own Himalayan Chain Resorts (HCR), top-quality hospitality infrastructure is the key to long-term success.

IFC’s investment of $1.7 million supports this strategy. The financing helps HCR as it develops and leases seven new mountain lodges and expands two of its three existing lodges along the Gokyo Lakes trekking trail and the Everest Base Camp trekking trail, two popular tourist destinations in Nepal. IFC offers a grace period that is not readily available in Nepal, especially for local entrepreneurs aiming to invest in tourism infrastructure in the remote regions of the country.

IFC’s investment is complemented by an equity investment from Nepal’s first private equity fund, Business Oxygen (BO2). BO2 is part of IFC’s Global SME Ventures initiative, created to support risk capital funds in fragile, frontier, and post-conflict markets. BO2 has been funded by IFC, the United Kingdom’s Department for International Development (DFID), and the Climate Investment Funds’ Pilot Program for Climate Resilience.

Ultimately, HCR’s project will help the Nepalese government reach its goal of increasing the number of international tourist arrivals in the country from about 753,000 in 2016 to 2 million by 2020. HCR’s project is expected to create approximately 120 direct jobs, as well as temporary jobs during construction, for the local Sherpa community in the Everest region. These employment opportunities will generate economic activity, benefiting Sherpa communities including indigenous women.

All Systems Go

According to the World Travel and Tourism Council, every dollar spent on travel and tourism generates over three dollars of economic output. Over 100 million workers are employed in this industry worldwide, and tourism revenues account for more currency flows to developing countries than all aid flows from foreign donors.

IFC invests in hotels and tourism because of this strong development impact, particularly in low-income countries. At the same time, we focus on mitigating environmental risks in the sector. IFC’s Environmental and Social Performance Standards, which define clients’ responsibilities for managing environmental and social risks, were critical to the HCR expansion. During the project, IFC helped the company create plans for biodiversity management, waste management, occupational health and safety, and emergency response and preparedness among other areas.

This approach aligned with the vision of HCR’s founders to create a lasting, positive impact. “IFC has been an incredible support in helping us achieve the dream of my family, to provide high standards of hospitality in one of the most extreme environments, the Mount Everest region,” says Dawa Steven Sherpa. “From helping us develop our administrative and accounting processes to introducing strategic opportunities and global best practices, IFC has been an invaluable partner on this journey.”

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‘Govt officials tend to act as regulators rather than facilitators’

Globally, budding companies that have failed to secure much-needed growth capital from sources like banks have turned to private equity funds. This trend has also made inroads into Nepal but at a much smaller scale. Private equity funds generally invest in firms that are looking for capital to grow. The investment is made in the form of equity, meaning the fund acquires shares in companies, which are offloaded after certain years. Private equity funds here have relieved companies, relying on bank credit to expand their business, from the burden of cobbling assets that need to be pledged as collateral and periodic debt servicing. Rupak D Sharma of The Himalayan Times met Siddhant Raj Pandey, chairman and CEO of Business Oxygen (BO2), Nepal’s first private equity fund, to discuss the prospects of alternative investment like private equity in Nepal and challenges faced by these funds to grow. Excerpts:

It’s been almost three years since BO2 formally launched its operation. How has the experience been?

The whole concept of private equity is very new to the market. We are, therefore, spending a lot of time generating awareness among both investees and regulators, including the bureaucracy. The whole process has been challenging, but rewarding as well. We didn’t know there was so much of scope as well as demand in this segment. Currently, our investment is focused on small and medium enterprises, and we are injecting anywhere between $100,000 to $2 million in each company with average investment hovering around $350,000 per company. Private equity is a hand-holding mechanism and the investment we make is not in the form of loan but equity. This means we share the risk with entrepreneurs and also provide value addition through technical assistance. This has enabled us to introduce international best practices in companies that we have invested in. We also make sure our partner companies are complying with all the laws of the land and do not maintain two account books to evade taxes.

Over the years, BO2 has invested in six companies ranging from restaurants and a resort to firms engaged in manufacturing and renewable energy. How are they performing?

In the last three years, we’ve scanned over 3,000 companies, out of which we have invested in six. Some of these companies are doing extremely well and some are in growth stage. Of course, there will be ups and downs and some companies need intervention. But majority of our companies are doing well and their performance is in line with our financial forecasting. We are currently conducting ‘active assessment’ of eight more companies. We will soon be closing a couple of deals that are in the final stage. So, by the end of 2018, we should have about 12 companies under us. In 2019, we will be adding another 10 companies. And mind you, 50 per cent of our investment must be outside Kathmandu valley.

But not all companies you invest in succeed, isn’t it?

Yes, odds are very high. That’s why we have to assess companies carefully because we do not ask them to back the investment we make with collateral. So, we look for companies that have been around for a couple of years. These companies should also have enterprise value, a positive balance sheet and demonstrate that they are in need of capital to expand business. In post-conflict nations like Nepal, certain components of private equity resemble blended finance as well. And blended finance means impact investment because it creates a win-win situation for both investors and communities that we work in.

So, how do you assess the companies?

We look at four aspects: Financial, economic, social and environment. The financial part focuses on a company’s balance sheet and profitability. The economic part deals with the number of jobs created by the company and taxes paid to the government. Under the social component, we make sure there is no participation of child labour; check the number of women employees; and see whether the workforce is inclusive. Under environment component, we look at climate-friendly initiatives taken by companies and ways we can help them become climate-friendly. So, these are values that we add once we invest in a company.

In the future, what types of companies are you planning to rope in?

We’re sector agnostic. We have investment in agribusiness, manufacturing, renewable energy, hospitality and tourism. We are looking at companies that have enormous potential to grow in terms of profitability and can create positive impact in the society and environment. Financial sustainability is an integral part of our selection process, meaning companies must show that they can generate returns. For any venture to be sustainable, it has to be commercial. So, companies should not think we are here to offer grants. This, however, should not mean we frequently interfere in operational matters of companies that we invest in. We don’t do that. But we do make sure the company meets its targets, does not deviate from its goal and follows what we have agreed upon.

There is growing criticism globally that private equity funds look for short-term profit because they have to make an exit after some years, which tends to hit long-term performance of companies. What is your take on this school of thought?

Private equity funds are not charity organisations. We inject money in a company seeking returns; and companies accept our investment because they are looking for capital to grow. BO2 is a 10-year fund and our investment in a company generally lasts for five to seven years after which we make an exit. Before making investment, we set a target of taking the company to a certain level and companies should meet those projections by the time we leave. We make these things very clear when we enter into agreement with companies. Entrepreneurs should understand that private equity funds enter companies as shareholders, meaning we share profit and loss based on their performance. We are unlike banks that initially ask for collateral and make borrowers pay interest on a quarterly basis. Quarterly interest payment puts a huge drain on balance sheets of companies that have just started growing. These things should be taken into account as well.

But BO2 also calls itself impact investor. Is there any difference between this particular private equity fund and other general private equity funds?

What we do is put systems, structures and frameworks in place as soon as we invest in a company. If companies follow these systems and processes, their long-term success is guaranteed. But we do not support companies once we make an exit. The idea of BO2 is not to hang around with one or two companies, but work with as many companies as possible in order to develop an entrepreneurial base in the country and encourage companies to follow global best practices, including that of good governance.

What is it like for private equity funds to operate in Nepal?

In countries like Nepal, where staff turnover is high in government offices, we have to continuously familiarise every new staff, who has been transferred, with the concept of private equity. The problem with government officials is that they tend to act as regulators rather than facilitators. This mentality has to change. But the situation is getting better. We are currently helping the Securities Board of Nepal (SEBON) – the securities market regulator – to draft a regulation on alternative investment fund, which includes private equity, venture capital and angel investors. We are happy the budget of this fiscal year has announced to support alternative investment. This shows there is political will to promote private equity and we are very happy that the Ministry of Finance is very proactive on this front.

What kind of provisions do you want to see in that regulation?

Right now, private equity funds are incorporated as private companies under the Companies Act. Normally, private equity funds do not operate that way. That’s why we are asking the government to establish a separate body to regulate us. Currently, we are regulated by multiple government agencies, such as the Company Registrar’s Office because we are a private company and the central bank because we are attracting foreign direct investment. We also need a separate governing body because some of the existing provisions can impede growth in alternative investment sector. For example, there are very stringent rules on blacklisting of credit defaulters in Nepal. The central bank says board directors and anyone who has 15 per cent or more equity in a company can be blacklisted if their companies have defaulted on loan payments. Also, all the companies associated with those blacklisted firms will also be blacklisted. This kind of provision will make it impossible for private equity funds to operate because a private equity fund invests in many companies at one time and mistake made by one company should not punish the entire fund.

Is SEBON willing to address these concerns through the new regulation on alternative investment fund?

SEBON is very proactive on this issue. It has held several rounds of meetings with various stakeholders, including private equity players in the market. They are in the final phase of drafting the regulation. But we have told them that if the new regulation is going to create another layer of regulation, then we’d be better off with what we currently have. So, the new regulation should facilitate alternative investment and encourage FDI inflow. Private equity provides access to finance and can complement economic growth in many ways. If we frame sound rules and regulations and create a favourable environment for alternative investment funds, we can attract millions of dollars in foreign direct investment.

Most of the private equity funds here are being operated by international development financial institutions. What are the chances of domestic contractual savings institutions and the private sector supporting these funds in the coming days, like in many other countries?

Most of the private equity funds are operated by development financial institutions in post-conflict nations like Nepal. This is because high net worth individuals, pension funds and wealth management companies do not have appetite for risks. So, someone has to break the ice and development financial institutions are taking that risk to penetrate these markets by putting their money. These initiatives generally lead to changes in regulations and establishment of separate bodies to govern the sector. Once the sector starts taking off and wealth managers start seeing good returns from these investments, more parties will step in, which opens up a whole new investment avenue.

Globally, pension funds and sovereign wealth funds have started bypassing private equity funds to make direct investment in companies with good prospects. Nepali contractual savings institutions and Nepali Army’s Welfare Fund, which sit atop piles of cash, may also follow suit. Won’t this affect private equity funds?

No, I don’t think so, because someone needs to manage the fund for them. The cost of managing the fund will be huge for them. If you give two to three per cent of the investment to a fund manager, they can easily manage that fund. So, that’s not going to be a threat for us.

A version of this article appears in print on September 11, 2018 of The Himalayan Times.