In recent years the SA government identified small and medium-sized entities (SMEs) as a major contributor to future economic growth. One of the main challenges to the economic growth of SMEs is access to equity finance.
To assist these sectors in terms of equity finance, in 2009, the SA government (through the SA Revenue Services or Sars) implemented a tax incentive for investors in these enterprises through a Venture Capital Company (VCC) regime known as Section 12J.
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For investors with a higher risk appetite, or who have maxed out their retirement annuity, pension fund and tax free savings account contributions, a Section 12J investment into a Sars-approved VCC is the perfect way to allocate capital in a tax free way in order to maximise your tax deduction.
When picking which Section 12J VCC to invest in, consider – the team, investment mandate, liquidity and your risk appetite
Section 12J investments are available to individuals, corporates and trusts and provide investors with a 100% deduction against taxable income in the year of investment.
As we are now in December and nearing the February tax season, the section 12J capital raising season is about to begin.
There are almost 120 Sars-accredited Section 12J VCC’s who are encouraging investment into their structures.
This can be daunting to sift through these offerings to find the right VCC to suit your risk appetite and needs before making an investment. Investors need to consider that the investment is for at least five years else Sars will recoup their tax.
Here is a guide to the most important criteria that investors should look for when investing in a VCC.
“Money follows management in the world of Venture Capital”. Your capital will be managed by a team who will be deciding on which companies to invest in, help grow the businesses and seek those returns promised through an exit.
Understanding the composition of the team is the most important criteria an investor should understand, ie the experience and track record of the fund manager.
If the VCC invests in technology companies ensure that they have experience at buying, building and exiting technology businesses.
It is important to look at the background and skills of the fund manager that ensure their skill set and experiences matches their investment mandate.
Too often I have witnessed fund managers who have never built a business before running a VCC. This is something that any investor should be wary of and should conduct a thorough due diligence on the fund manager before committing to the investment.
My advice to any investor is to speak to the entrepreneurs who the VCC have invested in to ensure they do not only provide financial capital but rather strategic capital.
All of the VCC’s that you assess should have a strong, clear and defined investment mandate. All VCC’s have a mandate which dictates how the company will invest and grow its funds.
The VCC implements a clearly defined investment strategy which dictates the manner in which to execute on the mandate.
Strategies detailed include the sectors they invest in, their investment offering to entrepreneurs and a guide to their exit strategy. Understanding the strategy will give you, as an investor, the confidence in the funds management and business building abilities.
Venture Capital is traditionally a high risk asset class with a higher return than traditional equity or unit trust investments. The investor needs to assess the trade-offs between risk and return.
Many VCC’s offer medium to lower risk offerings with some higher risk or higher return offerings — for example technology investments. Understanding one’s risk appetite will assist you when assessing and selecting a VCC to invest into.
A prudent approach is to diversify your investments and invest in a basket of low, medium and higher risk VCC’s.
An extremely important factor when choosing a Section 12J is to understand the liquidity of your shares in the fund.
If liquidity via dividends in the short term is required there are numerous VCC’s that provide this. There are other VCC’s which might not provide the predictable short term liquidity however there returns will normally be far higher.
The above criteria are a holistic guide of the areas I suggest you factor in your assessment in order to make an informed, educated and knowledgeable decision when selecting and investing in a Section 12J VCC.
I strongly recommend you always do your own due diligence and understand the risks and returns associated with venture capital and choose the correct Section 12J fund that is aligned to your risk appetite and expected returns.
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Clive Butkow is the CEO of Kalon Venture Partners, a South African Section 12J venture capital (VC) company.