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The outlook for the South African economy may be grim. The Reserve Bank forecasts that the economy will grow at just 0.5% this year. Yet the one thing that looks hot right now is the tech startup sector.
While the number of investors taking advantage of a new tax incentive has picked up of late, a whole list of SA startups have recently been acquired by foreign companies, bringing healthy returns to investors.
And you don’t have to be a super high-net-worth individual to start angel investing, says Keet van Zyl (pictured above), Knife Capital co-founder and partner.
‘If an angel investor pools their money with other investors they can make an impact, even with a few thousand rand’
“As long as you pool your money with other investors to make an impact, it can be a few thousand rand at a time. But we find that the more serious angels don’t invest less than R100 000 at a time at the bottom end,” says Van Zyl.
Together with Brett Commaille, Van Zyl founded angel investment network Angel Hub in 2011 (in 2014 it became venture capital fund Angel Hub Ventures after an injection of capital from former FNB executive Michael Jordaan and Kevin Harris).
‘Invest five to 10% of portfolio’
Van Zyl says while it depends on one’s individual risk appetite, it is generally accepted that one should invest about five percent to 10% of one’s overall investment portfolio in an alternative asset class, in which angel investing falls. Then you need to be patient, as it can typically take between three and six years to exit a startup in SA, he says.
Being an entrepreneur who has exited their business, and now has some capital on hand to invest, does help. But you can also be a professional looking to diversify your investment portfolio.
The key is to focus on an area or industry where you have experience and networks, giving you the opportunity to add more value to the investment over and above the money.
And while it’s a good idea to put your money into various investments, Van Zyl says there is no “magic formula” on how many investments to make to ensure that your angel investing portfolio is diverse enough.
“If one invests in really early-stage startups at seed level, statistics show that only one in 10 really succeeds, so then you would be gambling a bit to invest in less than 10.
“But if one invests in a slightly later stage where startups have some traction, the failure rate is lower and you can invest in as little as one company where you really back the team to continue their execution,” he says.
For the most part it’s a good idea to team up with other angel investors when looking to invest. “Many angels invest together to better spread the risk and increase the networks that can assist with startup success,” says Van Zyl.
If you’re investing with others in an angel group or as a co-investor, you should however put legal arrangements in place to ensure collective voting that strengthens minority protections, and agree on other elements of control like board seats, he says.
Those interested in learning more about angel investing, he says, should follow some of the right people and early-stage investors on Twitter, invest via crowdfunding platforms, attend some local startup events (particularly those hosted by the SA Business Angel Network (SABAN), Startup Grind, SiMODiSA Startup Thursday) and follow some blogs like Brad Feld’s www.feld.com.
Don’t forget tax implications
Angel investors can also take advantage of the 12J venture capital (VC) tax incentive. Van Zyl points out that individuals, companies and trusts (any SA taxpayer) investing through approved section 12J venture capital companies (like KNF Ventures) can deduct the full amount of their investment from taxable income in the tax year that the investment is made.
TaxTim director and tax expert Marc Sevitz says individuals, companies and trusts will be liable to pay Capital Gains Tax (CGT) on any profits made.
Individuals don’t have to pay tax on the first R40 000 in profit they make. Thereafter 40% of any gain on top of this is liable to being taxed, says Sevitz. It means individuals pay an effective CGT rate of 18%, but as they are taxed according to a sliding scale, the gain could be as little as zero rand assuming no further income.
However, if you record a net loss from investments in one year, one is able to offset this loss against what you owe on a gain in another year, he says.
Trusts and companies are liable to having 80% of profits taxed (which are taxed at 28% and 45% per R1 in income respectively), which means that the net CGT rate is 36% and for companies 22.4%.
Do due diligence
Commaille, today the director of Angel Hub Ventures, cautions that angel investing, particularly in South Africa, is a long game.
“If you go it alone or with friends (not through a 12J fund), remember you are likely going to have to follow-on (provide more money to the same company) so you need to have additional amounts available and factor that into your investment commitment,” he says.
He advises that investors never become too attached to any idea which could prevent them from making regular, honest evaluations on where the company is going.
“If the company is achieving its goals, support it further. If not, think very carefully before throwing more money at it. Are you delaying the inevitable end or are you helping it through a legitimate unexpected setback that does not damage the company’s prospects?”
When doing a due diligence on a company one plans to invest in, there are certain warning lights one should look out. These he says are that:
- Your funding does not give them enough runway to get to the next round or to break even.
- There are clear signs that they are poor at managing cash flow.
- Too much of the fundraising round goes to founder salaries.
- The business model does not lend itself to scaling up.
- There are too many competitors or the market is too crowded, with no clear and significant differentiation.
- The founder has bad or questionable ethics.
Conversely, the following are positive signs:
- Founders who have a deep industry experience.
- There has been interest from strategic acquirers.
- The presence of quality customers. Even better is if some of them have funded additional development.
- Founders are frugal or thrifty spenders.
- Founders are coachable and there’s a good fit.
- There is a positive opinion on any intellectual property (IP) and its protection.
Investors should never neglect the importance of proper due diligence, says Knife Capital co-founder Andrea Bohmert.
“We have seen many angel investment deals fail and very often it comes down to investors not doing a proper due diligence (DD) and as a result being surprised when things don’t go as expected. A proper DD takes time and covers a lot of areas. In the long term it never pays to do this superficially or not at all.
“Importantly, investing is easy but investing at the right terms, ensuring that the money gets allocated where it should, post investment management and the realisation of returns are the tricky parts,” she says.
But perhaps key is the ability to empathise with entrepreneurs. Says Bohmert: “If you don’t appreciate the opportunities and challenges of entrepreneurship, you shouldn’t be an angel investor”.
Featured image: Knife Capital co-founder and partner Keet van Zyl (Supplied)