Venture capital shifts to tech ‘disrupters’
IN an economy expected to grow by a measly 0.9% this year, venture capital backers in South Africa are shifting their attention to low-cost tech start-ups that aim to disrupt established business models.
According to a 2015 study by the Southern African Venture Capital and Private Equity Association, the number of venture capital deals completed here continues to rise, from 11 in 2012 to 43 in 2015, but the average deal size has declined.
The information and communication technology sector has doubled in deal-making since the association’s 2012 survey and now accounts for half of all transactions. There has been a shift from resource-intensive small businesses in a struggling economy to tech start-up entrepreneurs who may require as little as a laptop and a broadband connection.
Association CEO Erika van der Merwe said the potential to scale up very quickly internationally was focusing the attention of most of the R2-billion local venture capital industry.
Grotech chief investment officer Clive Butkow said the association’s finding of a 20% average compounded annual return on investment was now optimistic for traditional business models, but returns in the tech disrupter space could be more towards 30% and exits could happen in three to four years, below the industry average.
“There’s a lot of innovation in South Africa. Small guys are taking on big corporates and disrupting business models and revenue streams. The big companies can’t innovate at that pace — they’ll buy the smaller businesses once the little guys have built the disrupters, and will pay a premium.”
It is a gamble — often too risky for large institutional investors — that may pay off through the creation of the next Uber or Airbnb.
In 132 deals since 2011, venture capital investors had written off R187-million compared with R438million in profitable deals, Van der Merwe said. More than half of venture capital companies reporting data to the association had exited at least one investment since then. Average transaction value has dropped from R9.3-million between 2009 and 2012 to R7.3million between 2012 and 2015.
The average stake taken by venture capital investors is 37% and two-thirds of current investors expect to exit with two to five times their money back.
In a venture capital industry relatively small and underfunded in global terms, cheap start-ups that have the potential to snare customers globally via the internet are obviously attractive to funders.
Personal networks are the commonest way for start-ups to find venture capital backers.
Van der Merwe said there was a tax break to backing these startups. Individuals, companies and trusts can take advantage of taxdeductible investments thanks to section 12J venture capital companies legislation promulgated in 2009.
Individuals investing through registered venture capital companies can deduct the full amount of their investments from their taxable income with up to the maximum marginal rate’s 41% relief, and companies 28%.
There are 31 registered venture capital companies, although Butkow said probably half that number were active.
“The legislation has a 12-year period to 2021. We’ll have to see if it gets extended, but there have been changes to make it more attractive to investors in this asset class. The initial limit on the maximum investment has been raised to R50-million and the recoupment rule has changed — if you hold your investment for five years, the South African Revenue Service does not recoup the deferred tax.”