Landmark year for VCCs

After some tweaks to the venture capital regime in 2018, the industry is set to finally have its intended economic impact investing in SMEs, writes Pedro van Gaalen

“Funds flowed into VCCs as investors looked to realise favourable returns and reduce their tax liability in a volatile local economy

In an effort to boost equity funding for SMEs, the government introduced section 12J to the Income Tax Act.

“SMEs are the lifeblood of the economy. They stimulate growth and are the most prolific employers on a rand-for-rand basis,” says James Twidale, director and portfolio manager at Virtuosity Capital. “Offering an incentive to help boost this sector is fantastic for both the economy and investors.”

Since 2009, retail investors, trusts and companies can deduct from their taxable income the full amount invested via a venture capital company (VCC) that is registered with the SA Revenue Service (Sars). The invested amount will only attract capital gains or dividends tax once returns are realised.

The VCC, which must be a resident of SA, then manages the fund and makes investments in qualifying SMEs. “After a slow start, the number of Sars-approved VCCs increased significantly in 2015 following minor legislative amendments that made these investments more attractive to investors and investment managers,” says Twidale.

Funds flowed into VCCs as investors looked to realise favourable returns and reduce their tax liability in a volatile local economy. Another spike followed the announcement in February 2017 of a 45% income tax bracket for SA’s highest earners, as taxpayers sought ways to more efficiently structure their tax.

“These drivers spurred investor interest and fuelled incredible growth in VCCs. About R3bn has since flowed into VCCs, with 2018 proving to be a prolific year,” says Jonty Sacks, a director at Jaltech. The sector is on track to realise R1.5bn in inflows for the current financial year, he says.

However, instead of funding early-stage small businesses, certain VCCs that have raised funds have failed to deploy capital in qualifying companies.

“Of the VCC funds registered with Sars, only about 40 are active,” says Sacks. These VCCs generally account for the roughly R600m invested in qualifying companies to date from the R3bn the industry has raised.

The National Treasury subsequently raised concerns around the apparent failure of VCCs to deploy funds in qualifying investments. Opaque fund structures due to a lack of information about underlying investments and the objectives and strategy of the VCC have also been cited as areas that require regulators’ attention.

To provide clarity, Sars released a draft guide in June 2018 to provide retail investors with general guidance on investing in VCCs.

Twidale welcomes this, but suggests that retail investors should still seek advice when investing in VCC opportunities.

In an attempt to curb industry abuse, the Treasury tabled the draft Taxation Laws Amendment Bill this year, which proposed various industry changes. However, these broad amendments meant certain compliant funds would have been penalised.

As a consequence of industry-wide lobbying, a collaborative process that included hearings by the standing committee on finance in parliament, public comment and industry participation, a final amended bill was released in October.

Grovest CEO Jeff Miller is confident that this will spur significant growth in the market and increase industry participation. “By rooting out the parties that were abusing the system and not acting in the spirit of section 12J, more funds will also flow into SMEs. As such, these structures will start to have their intended economic impact.”

Twidale says: “We are pleased to have clearer legislation that closes the loopholes.” He believes the amendments, which come into effect in January, will provide greater certainty and clarity, and therefore more robust investment opportunities for investors.

And the resultant growth is already evident, with approved VCCs increasing from 116 in June to 135 as of November 1, according to the Sars website. Sacks says a flurry of registrations occurred ahead of the start of capital-raising season in November. “And with less than three years left until the sunset clause comes into effect on June 30 2021, and a maximum of 36 months to deploy capital, 2018 is proving to be a landmark year for section 12J VCCs.”

Picture: 123RF — TASHATUVANGO