The number of venture capital companies (VCCs) approved by the SA Revenue Service (Sars) to take advantage of a VC tax incentive has leapt to 19, following amendments to the tax form which took effect in April.
The tax incentive was introduced in 2009 by the National Treasury under Section 12J of the Income Tax Act to spur investments in small businesses through approved VCCs.
However because of onerous criteria there was limited interest from investors. By August 2013 only a single small business had benefited from an investment under the tax regime.
New changes which took effect this year have now made the incentive more attractive for investors, by among other things allowing a higher investee asset threshold (R50 million in qualifying small businesses and R300 million in junior mining companies) and allowing a permanent investment deduction.
Little focus on start-ups
Most of the approved funds are still in the capital raising period. However while there may have been some hope that the incentive would incentivise investment in more start-ups and high-impact firms, the majority of approved VCCs are looking to invest in existing firms.
This raises the question of whether the incentive will really prove that effective, as existing small firms should be able to get finance through banks. It’s start-ups and disruptive firms that arguably battle more to get finance.
JC Bruce, who oversees two approved VCCs, said his funds would focus on existing businesses rather than on start-ups. He said the aim is to capitalise Titanium, a VCC that would invest in alternative energy, with up to R1 billion in capital and Carbide, a fund that would invest in “fair sized” companies with between R250m and R500m.
This, while Richard Asherson, a partner in Westbrooke Capital Management, said his fund would be looking for businesses than have been around for about five years or more and that had good asset base. He added that it would not focus on startups as this would involve “risky investments”.
But banks don't lend
However Neill Hobbs, head of Hobbs Sinclair which has three VCCs approved by Sars, argued however that it was difficult for even existing small firms to get bank finance.
The company has so far raised R15.5 million for its Redwood VCC fund, approved by from Sars in January.
Hobbs pointed to the fund’s first investment made in August that involved R11 million in Mastercare, a 40-year-old firm in the appliance repair sector as a case in point.
The investment follows an earlier business rescue of the firm undertaken by Hobbs, who is also a business rescue practitioner. He said the bank had been more keen on liquidating the appliance company after a troubled merger with TV repair business Early Bird.
Mastercare managing director Wesley Rabie said the investment helped save 100 jobs and countless other jobs if one included agents and spare parts suppliers.
Hobbs said his Redwood fund is also preparing to invest in a second company, in the medical sector, after the latter’s bank had refused a request for an overdraft from the firm.
Samantha Pokroy, who heads Sanari Growth Partners, said the fund is seeking capital of R200 million to help small firms to scale up.
She gave the example of some small businesses that had been in existence for 30 years, where an owner now wanted to retire but needed assistance and finance to best structure the firm for a sale that would guarantee a sizeable profit.
However Pokroy said it would ultimately depend on what value a fund manager could add to the business as to whether the incentive would have ultimately have an impact on small businesses. The provision of advice will therefore be key.
It’s already benefiting start-ups like SMEasy, a four-year-old firm with 11 employees. Four months ago the company received an undisclosed investment from Grovest to fund its accounting product.
SMEasy chief executive Darlene Menzies said having Grovest on board has helped the company gain access to new networks.
“The money was great, but what we got more than that is influence,” said Menzies
The funder is the only approved VCC that has made investments in early-stage companies. It invested R25 million in six companies in its first fund.
Grovest chief executive Jeff Miller (pictured above) surmised that most of the approved funds were aiming at later-stage investments because of how difficult it is to invest in start-ups.
“When you’re dealing with third-party money it’s very difficult… which is why funds are being cautious.”
He said the company is setting up two further funds – one aimed at the hospitality sector (which has been approved by Sars) and one at the alternative energy sector.
Yet those in the industry say the intention was never for the VC incentive to promote only investments in start-ups.
SA Venture Capital Association chairperson Erika van der Merwe said the incentive had been set up to direct investment and skills development towards small business in general – regardless of whether these were start-ups or long-existing firms.
Local SME lobby group Simodisa pushed the National Treasury to lift the threshold of investments from R20m to R50m. Yet Simodisa says in a report released earlier this year titled “Accelerating the Growth of SMEs in South Africa” that South Africa lags behind in the area of early stage angel investors.
Sars spokesperson Luther Lebelo said those VCC’s approved by Sars plan to focus on both start-ups as well as existing small businesses.
He said the provisions of the tax regime provide a vehicle for a wide range of investments and the level of risk is only limited by what the investors “are prepared to accept”.
Some in the industry – like venture capitalist and founder of Angel Hub, Brett Commaille - say a tax regime should be crafted to allow investors to also qualify for a tax break if they invest directly into a small firm. Currently the incentive is only available if one invests via a VCC.
Miller said allowing individuals to claim a tax rebate for making direct investment into small businesses, as the UK allows, is needed too.
He added that the VCC however does have the added benefit of helping to reduce an investor’s risk by grouping investors with other investors.
Yet with the incentive only now beginning to take off a large amount of time has been wasted. Investors don’t have long to get it there – the tax regime runs till June 30, 2021.
This story originally appeared in Business Day (go here for the original version). Follow Small Business Insight on Twitter at @Smallbinsight and on Facebook.
Stephen Timm is a