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The world of startups is a risky choice for an investor. But there is a clever way you can reduce that risk, and that is by investing in a government-sanctioned Section 12J fund.
The tech industry often laments that government can do more to support small business. Yes, it can do more, but here is an example where it is making a difference.
Section 12J funds have been around for the past 10 years but have only gained traction in the startup world recently. The attractive part about these funds are that they are 100% tax deductible should one hold the investment for five years or longer.
Therefore, if a taxpayer is an individual or a trust with a marginal tax rate of 45%, the taxpayer can invest R1-million and will only pay R550 000 (that is R1 million minus tax of R450 000) for the investment.
In simple terms it means your startup investment comes in at about half the price. For companies that invest, the principle is the same, but the calculation looks different because companies are taxed at 28%.
If you are in the top tax bracket, it’s an attractive option for investors with higher risk appetites, especially those who have already maxed out their retirement annuity, pension fund and tax-free savings account contributions.
Given the country’s priority on small business and job creation, it’s simply a no-brainer that Section 12J should continue, be improved, and be intensified
There is a catch though. When you realise the investment after five years, the base for the capital gain will be zero due to the initial tax benefit received. Effectively the government will recoup some of its tax when you exit the fund, but still, the overall benefit is there.
CEO of Kalon Venture Partners Clive Butkow says that government introduced Section 12Js to solve the key issue that all small and medium-sized businesses have: access to equity finance.
Kalon is one of the few dedicated tech and startup Section 12J Venture Capital Companies (VCCs) out of the 130 or so that have now been registered.
When Kalon registered as a Section 12J, it was fund number 30. Just three years later 100 more funds rushed online – a sign that investors are waking up to this opportunity. The majority of funds look at areas such as mining, hospitality, renewable energy, student accommodation, moveable assets, and others.
‘Investing in disruptive tech’
Butkow’s VCC invests exclusively in “disruptive digital technology” and claims to have raised in excess of R100-million. He says his fund has so far invested in four tech companies, with additional deals in the pipeline.
“The VCC is intended to be a marketing vehicle that will attract retail investors. It has the benefit of bringing together fund managers concentrating investment expertise in favour of the small business sector,” he says.
Kalon caters for both the small investor with a minimum investment amount of R110 000 but also includes big-money investors too.
Three of Kalon’s investments involve an EFT payments platform, a loyalty programme and an artificial intelligence (AI) chatbot.
I-Pay is its EFT payments platform where consumers can use EFT rather than a credit card when making purchases online or at the point of sale. Butkow says these transactions are cheaper and more secure than credit cards, and enables consumers who do not have a credit card to transact online.
Their AI play, FinChatBot, is chatbot that helps companies reduce customer acquisition costs through a conversational bot. The company also enables companies to reduce the size of their call centres for certain transactions.
On the loyalty side, Butkow claims that SnapnSave is “South Africa’s number one cash-back shopping app”. The app gives shoppers money back on everyday items they buy.
SnapnSave does not require integration to the retailers’ point of sale and allows consumers to purchase discounted products in any retail store, snap their till slip and receive money back in their bank accounts.
Good start, but state can do more
Section 12Js are a good start, but government can do much more if it wants to become part of the tech and startup wave that is gripping the world. A good start would be to create a fund that caters particularly towards tech startups.
Butkow says that Section 12J’s tech-focused VCCs have certain limitations, such as the time horizon to investment.
He says that typically a tech fund invests in about “one out of every 100 companies” and needs longer than the Section 12J-legislated three years to deploy all its capital responsibly.
There is also confusion over whether fintech and insurtech companies are seen as qualifying companies because S12Js specifically exclude “financial service, insurance and banking companies”. Butkow argues that these startups are tech companies and not financial services companies.
Government could get more creative and use the Section 12J or a variant to start attracting sorely needed tech talent into the country.
For example, many countries allow residency or citizenship based on the startup investments they make.
In 2021 the S12J regime comes to an end. The government will then assess if it has achieved its objective of creating jobs or not.
Given the country’s priority on small business and job creation, it’s simply a no-brainer that Section 12J should continue, be improved, and be intensified.
More on Section 12J funds
What investors should look for in a Section 12J VC company [Opinion]
State must close door on those that misuse VC tax incentive [Opinion]
Savca raises concern over governance issues in Section 12J VC tax incentive
Venture capitalists welcome Section 12J proposals but call for more changes
Investors clamouring for 12J VC incentive following tax hike – fund managers
Can 12J VC tax incentive create the jobs South Africa badly needs?
Foreign investment injection could propel South Africa’s VC ecosystem, 12J funds
More from Matthew Buckland
How corporates are jumping to work with tech startups [Opinion]
Your pitch deck is your business story, but don’t let it baffle investors [Opinion]
How Naspers could help find SA’s next great tech startups [Opinion]
Pick a sector, add internet and your firm could be worth millions [Opinion]
Time for startups to get over myth of the ‘one big idea’ and just get going [Opinion]
What really is the secret to getting a VC deal? [Opinion]
SA’s startup ecosystem offers a positive vision of country’s future [Opinion]
Indonesian unicorn shows Silicon Valley model can’t beat going local [Opinion]
What’s the secret ingredient that makes entrepreneurs successful? [Opinion]
Matthew Buckland is an investor, entrepreneur, founder of Ventureburn.com. He is an investor in an S12J fund, not mentioned in this article. This column was first published in Business Day. See the original version here.
Featured image: Kalon Venture Partners chief executive Clive Butkow (left) and SnapnSave CEO Mark Bradshaw (right) pictured during a funding deal signed between Kalon and SnapnSave in August last year. (Supplied)