Widen benefits for venture capital
• Stimulate the appetite for impact investing by encouraging S12J funds
The new political era under President Cyril Ramaphosa has unlocked optimism for SA and the region. Business confidence is up, and the first quarter of 2018 has seen renewed investor interest.
But, as identified by analysts at a recent panel discussion at the UCT Graduate School of Business, Ramaphosa is faced with the daunting task of “doing growth differently”.
With widening inequality and growing social anger over land and economic exclusion, SA urgently needs to find a route to more inclusive growth. Growing the investing for impact segment, where the primary aim of the investment is generating measurable and beneficial social or environmental impact along with financial returns, is one way to achieve this.
SA is already a regional leader in impact deal flow terms and to date accounts for $4.9bn, or about 74%, of impact capital not from development finance institutions in Southern Africa. But impact flows constitute only 3% of SA’s total financial assets.
An important piece of legislation, section 12J of the Income Tax Act, could hold the key to growing this share.
Section 12J funds were introduced by the South African Revenue Service (SARS) in 2009 under an innovative scheme to stimulate impact investment. It offers venture capital company investors an upfront 100% tax deduction on their capital, provided the companies comply with specific regulations. Though uptake was initially slow, there has been greater engagement with these structures over the past three years.
There are about 90 venture capital companies registered with SARS and it is hoped growing investor appetite for them will see more movement towards impact investment. The companies’ investments have gone towards funding start-up costs and for expansion of businesses, creating employment and launching new apps and other innovative technology.
Metta Capital, a new fund of funds, was created to raise R200m for investment in logistics, mining, hospitality, retail, energy and telecommunications. Grovest has invested in the agriculture, technology, fintech and hospitality sectors. Growth Grid helped to launch health technology start-ups like RecoMed, which has teamed up with Discovery on an online booking platform that enables more efficient bookings with healthcare providers and improves patients’ experience.
These companies appear to be making inroads with regards to social development, job creation and the promotion of entrepreneurship.
If they are scaled, S12J funds could be a potent tool for broadening social and environmental impact initiatives, but practitioners say that to do this adjustments to the legislation are required.
The S12J regime was initially approved for a 12-year period and is subject to a sunset clause exercisable in mid-2021, so it is timely to consider now how it could be adjusted to capitalise on market optimism and bring more investment to SA.
This would not be the first time the legislation has been revisited. The regime initially set a maximum R20m investee book value and recouped tax on disposal of venture capital companies shares. Changes in 2015 mean venture capital companies are subject to limits of R500m for mining and R50m for other investees. There is no tax recoupment provided investors hold shares for at least five years.
These amendments (potentially coupled with recent increases in the marginal rate for the top individual income tax bracket) appear to have had a profound effect on uptake. About 90% of approved venture capital companies listed by SARS have only been accredited after 2015 and close to 50% were approved in 2017.
This recent uptick reads like a triumph of responsive policy. But practitioners still harbour concerns about the regime’s longevity in the light of flagging tax revenues and its accessibility and ease of use.
Material concerns include that venture capital companies are subjected to double tax (through capital gains tax when selling their venture capital companies shares) and applicants require a Financial Services Board licence and corporate registration endorsements from the Companies and Intellectual Property Commission, which can be hard to obtain and prolong the approval process.
Less onerous requirements and improved access to foreign capital could help ensure that the SJ12 funds continue to flourish. In addition to the regime’s renewal, some practitioners are calling on SARS to increase the tax deduction to a level above 100% of the investment amount and eliminate all terminal capital gains consequences.
Industry leaders indicate that a greater uptake of the venture capital companies could take place if provisions were made to enable shares in mid-sized, impact-theme focused funds — provided they satisfy periodic impact reporting requirements.
“Extending the scope of venture capital companies’ tax benefits would unlock a valuable source of growth capital for these entities and encourage more social entrepreneurs with innovative solutions to address national priority challenges,” says Mark van Wyk, head of unlisted investments at Mergence Investment Managers.
“Implementing a revised incentive should enable impact businesses to attain the scale required to attract institutional investments — thus enhancing their long-term sustainability and impact.”
There are enabling mechanisms for impact capital raising and accountability. The Impact Exchange, a Stock Exchange of Mauritius board dedicated to listings by impact entities, imposes reporting requirements for establishing and maintaining listings. Coupled with Mauritius’s favourable tax regime, the exchange is proving a lightning rod for international impact investors, who account for more than 35% of daily turnover. Future revisions to section 12J could adopt similar principles.
A generally upbeat market and growing interest in impact investment makes now an opportune time for efforts to attract impact investment capital. Streamlining S12J and establishing impact investment dispensations and accountability measures holds significant promise for catalysing domestic impact capital flows.
But stakeholders must continue to engage on these issues and leverage platforms such as the Southern African Venture Capital and Private Equity Association, SiMODiSA and Impact Investing SA to shape the regime’s evolution.
Panulo is a senior analyst at the Bertha Centre for Social Innovation and Entrepreneurship, a specialised centre at the UCT Graduate School of Business.