VENTURE capitalists are calling for the National Treasury to overhaul a tax incentive aimed at boosting venture capital investments in small businesses, amid growing disillusion over the incentive’s effectiveness.
Despite coming into effect in July last year, not a single investment has been made under the incentive, provided for by section 12J of the Income Tax Act.
The incentive allows individuals and listed companies to deduct up to R750,000 a year if they invest in venture capital companies which in turn invest in certain kinds of small enterprises.
But the incentive has been criticised by tax consultants and venture capital fund managers and consultants, as being too onerous, particularly as unlisted companies and trusts are excluded from taking advantage of the incentive.
A further disincentive is that investors are not able to exercise any control in the small business the qualifying VC fund invests in.
Venture capitalists that want to take advantage of the incentive have to register with the South African Revenue Service (Sars) as a venture capital company (VCC). Only one company Olivewood has registered as a VCC with Sars.
Said Sars spokesperson Adrian Lackay: “We’ve had a number of enquiries, but many guys indicated that they would struggle to qualify”.
Olivewood chief executive James Allan said he had registered the vehicle as a venture capital company last year, with the aim of focusing on investing in small mining firms, but added that the fund had not made any investments yet.
“We raised some money and then returned it to investors because there were major drawbacks,” said Allan.
He said principle among these was that when investors chose to sell shares Sars would, in one year, recoup the full amount of an investor’s deduction and apply Capital Gains Tax (CGT) to any profits made from selling of the shares.
In a statement at the launch of the fund in September last year, Allan said the company hoped to raise R1 billion and that a number of listed companies and individuals had been approached.
Guy Harris, a business advisor who is setting up a venture capital fund in the Garden Route area, is spearheading a group looking to lobby the National Treasury to overhaul the tax incentive.
A workshop has been planned for June 24 in Johannesburg and a number of venture capital consultants and fund managers are expected to attend, as well as the South African Institute of Chartered Accountants (Saica), Wits University’s Centre for Entrepreneurship.
Harris said became concerned after discovering how onerous the incentive was when he began setting up his fund recently.
An effective and far-reaching tax incentive for those that invest in small enterprises could go some way to helping South Africa tackle its high failure rate for start-ups.
The failure rate for start-ups is worryingly high. The 2009 Global Entrepreneurship Monitor (Gem) report released last month has called for more to be done to support entrepreneurs starting out.
The report revealed that the extent of the problem, in that while one in 28 South Africans is involved in setting up a business, just one in 40 are running a business which is less than three-and-a-half-years old.
On top of this a 2006 report by FinMark Trust highlighted the case of venture capital incentives in the UK, where businesses that had received venture capital injections grew 32% per year over five years, compared to those that had not received equity investments, which grew by less than 1.5%.
JP Fourie, chairperson of the SA Venture Capital Association (Savca) said venture capital investments in start-ups and early stage businesses made up just six percent of the R10bn that as of the end of last year was made in private equity investments.
He listed six funds in South Africa that focused on early-stage and seed fund investments, namely: The Innovation Fund, The Industrial Development Corporation’s business venture capital unit, Invenfin, Trium Investments and 4Di Capital.
Brett Commaille, chief executive of Invenfin, Remgro’s R50m venture capital fund, said South Africa’s venture capital tax incentive had to be better thought out and mirror those that had worked well in other countries.
The fund has so far made five investments and had received in all about 500 applications for funding. It was looking to make about two or three more investments before it closed, he said. However the quality of applications had begun to pick up again, he said.
Commaille said entrepreneurs applying for venture capital funding needed to do their homework.
The fund turned down a lot of applications for funding from entrepreneurs for ideas that were essentially “also-rans and duplicates”.
“People tend to have blinkers on and evaluate their market incorrectly,” said Commaille, who added that there was a belief from entrepreneurs that even with ideas that were near similar to ones already in the market that “nobody does it like I do”.
While they needed to be realistic about projections in their business plan, they also needed to think big about the up scalability of their idea on a global level.
He said last year had seen a drop off in the quality of applications the fund received, compared with the year before, when it was launched.
This article appeared in Business Day on 15 June 2010.
Stephen Timm is a