In an effort to grow the moribund start-up and small business sector in South Africa, the first operational venture capital fund incorporated under section 12J of the Income Tax Act begins to raise capital on Monday.
Venture capital funds have grown to become a successful multimillion-pound industry in the UK as high-income earners look to reduce their tax bills and a similar result is expected in South Africa. South Africa lost 440,000 small businesses in the five years to 2012, with start-up activity hitting a record low despite government ambitions to create millions of jobs.
The recent Global Entrepreneurship Monitor showed total early-stage entrepreneurial activity in SA has dropped to the lowest in four years.
While the idea of offering incentives to investors who provide venture capital to small companies was first mooted by the finance minister in 2008, it did not take off. Improved incentives were announced two years ago, and the idea is starting to catch on.
It took a year to lay the groundwork and get approval, but Grovest Venture Capital Company hopes to grow this sector in the same way as unit trusts grew from humble beginnings to now boast more than a R1-trillion under management.
The main benefit of this asset class is that investors can get up to 40% tax relief, while more attractive investment caps of 20% of investments will apply. Only R750,000 annual deductions were allowed before. Grovest will focus on high-growth firms in the tech and mobile industries as it starts raising R100m to be invested in some 15 to 20 underlying businesses.
“These startup businesses need capital, but the banks have not been interested.
“It is extremely sad as every journey starts with the first step, but entrepreneurship in South Africa is at an all-time low,” says Grovest CEO Jeff Miller.
Investors can invest from a minimum of R100,000 up to 20% of the fund and investments will be matched with the tax year to ensure investors qualify for the annual deduction.
It means if an individual invests R100,000, and is paying tax at the maximum threshold, he or she will receive income tax relief of R40,000, making the net cost of the investment only R60,000. The tax benefits apply to trust and companies alike.
Costs include a set-up fee of 2% to cover all costs, such as legal and compliance, a 2.5% management fee per annum on the capital under management, and a 20% upside charge after capital is returned. Mr Miller is keen for pension funds to get involved in the new asset class.
New rules allow pension funds to invest up to 10% in this asset class, but are still woefully underweight private equity holdings relative to developed markets. “We would love a pension fund to give us some of this money (the 10%) as it offers exposure to a different asset class, but also helps by assisting the economy to finance small, medium and start-up companies with proper management and in a controlled environment,” he said.
“It offers a platform — the funding and management — to express the talent in South Africa. Companies can plug into a network. We’re not just lazy capital — we sit on the board and attend management meetings and work with entrepreneurs,” Mr Miller said.
He calls himself a “serial entrepreneur, with one of his previous ventures Brandcorp — the luggage, handbag and tool business — going all the way to the main board of the JSE before being bought. The Grovest team includes other industry heavyweights like former partner of Grant Thornton Malcolm Segal. Nonexecutive director of ADvTECH Jeffrey Livingstone is also on the team.
Erika van der Merwe, CEO of the South African Venture Capital and Private Equity Association, says it is encouraging to see the momentum in South African venture capital, with support for fledgling entrepreneurs coming from committed investors and seasoned business people willing to share their knowledge. “Every year we see new research on the South African entrepreneurial and SME space, most of which confirms the view that the sector desperately needs savvy mentoring, viable networks, intelligent funding and a supportive policy environment,” she says.