Foreign investment injection could propel South Africa’s VC ecosystem, 12J funds

Ask any tech startup and they’ll tell you that raising venture capital (VC) in South Africa is not easy, that said, it’s a lot easier than it was seven years ago. Back then it was next to impossible to get VC funding.

The local VC ecosystem is in its 10th year of building and while by US or Israel standards we may still be in our infancy. Yet for an industry that has had to entirely bootstrap itself we’ve done very well, but we still have a long way to go.

The US and Israel ecosystem developments were both significantly bolstered by government funding, in South Africa this has not been the case, instead investment into VCs has largely been driven by family offices and successful entrepreneurs.

Read more: ‘Government won’t match private sector in R1.5bn SME fund’

The government however has made other positive contributions to the growth of the VC industry such as the creation of the Section 12J tax incentive.

Section 12J provides a significant tax deduction incentive for private sector investors investing in registered 12J VCCs – to date more than 40 have been registered, although they not all are active. Over the past three years I’ve received funding from three of them, Kingson Capital, Grovest and Grotech.

‘Our VC’s could be investing R1-million into 10 businesses, rather than the R10-million into one business’

In my personal experience, the introduction of Section 12J VCCs and the tax incentive for investors has had a very positive impact on local VC market. There are more VCs to approach and of course more money available. Although to be clear, this doesn’t necessarily mean it’s any easier to secure capital.

The additional investment stimulated by Section 12J hasn’t lowered the bar when it comes to the deal qualifying criteria or the VC’s risk appetite. Their investors are still looking to make the big returns that this risky asset class can potentially realise, regardless of whether they are receiving a tax break or not.

The bottom line for the entrepreneurs seeking venture capital is that you still have to prove you’re the best possible bet to knock the lights out if you want to close a deal.

One 12J director recently stated that for every 400 investment opportunities they see in a year, they only fund 4 – these numbers are too low, they are far too selective.

When you consider the massive demand for venture capital it is clear that 12J alone, even if the government makes the requested improvements to it and relaxes some of the current restrictions, will only be scratching the surface of what’s needed.

One of the key reasons VC’s are being so selective and not funding many more businesses is the lack of follow-on funding available in South Africa — ie the R20-million and R50-million rounds.

As such, VCs know when they invest in a startup they will likely have to provide the next three or four rounds, not just the first one as they know there are no funders readily available to come in behind them.

Without this they are restricted to funding less businesses and forced to be selective. If we had follow-on funding  available, our VC’s could be investing R1-million into 10 businesses, rather than the R10-million into one business, as is currently the case. A big injection of foreign investment into our VC ecosystem to provide follow-on funding rounds would go a long way to solve this issue.

The government understands that our current IP change control restrictions are inhibiting foreign investments and as such announced plans to change these in the Budget speech earlier this year. Changes to our restrictive labour laws would also help attract investment.

Read more: Startups take note: an update on IP control

Thankfully South Africa is increasingly being recgonised by international investors as a place that produces quality founders, world class tech development and great innovations, we are becoming a compelling choice as an investment destination – the dollar buys a foreign investor far lot more for a lot less in South Africa.

If we get the foreign investment involvement in our VC ecosystem 12J’s could do a lot more deals which would be great news for entrepreneurs.