SA COULD create thousands of jobs by boosting investment in high-growth startups through a state venture capital fund that co-invests in private venture capital funds.
From the US to Israel and several emerging economies, governments have been involved in setting up a fund-of-funds to invest in startup companies that show potential.
Last month India became the latest emerging economy to enter this market with the launch of a 20-billion rupee ($301m) fund administered by the Small Industries Development Bank of India.
The Chinese government announced earlier this month that part of a new 60-billion yuan ($9.40bn) fund for small businesses would be used to back startups.
The fund-of-funds model is based on the success of Israel’s Yozma initiative in the 1990s in stimulating a venture capital industry in the country. It involves a government either matching the investments private venture capitalists make in startups, or typically investing at a ratio of R1 for every R2 the fund commits to new businesses.
SA is behind the curve. National Advisory Council on Innovation council member Claire Busetti says venture capital in SA lacks government support.
Writing in a Southern African Venture Capital Association publication, Busetti contrasts SA with several developed and emerging economies where governments provide support for venture capital.
“In these various jurisdictions, the public sector has set up and funded private sector-managed venture capital programmes, as there is appreciation for the importance of facilitating innovation and the growth of new small businesses, which in turn enhance economic growth and provide employment,” she writes.
The South African government’s only fund-of-funds was abandoned by the Industrial Development Corporation (IDC) in 2007 in favour of direct investments in businesses and in 2013, the Technology Innovation Agency scrapped an idea to launch a R100m fund-of-funds.
The development agency’s fund was launched in 1999 when it took 40%-50% stakes in nine funds with foreign development finance institutions, pension funds and corporates, says Christo Fourie, the head of the IDC’s new industries unit. Two of the funds are still operating.
THE agency’s commitment to the nine funds reached about R600m, with funding support from the Eskom Pension and Provident Fund, Development Bank of SA and international development finance institutions, taking the institutional investment up to about R1.7bn.
Of the nine funds, two performed quite well, two did quite poorly and some had mixed outcomes.
Fourie says the IDC decided to bring the venture capital investments on to its balance sheet to ensure that the funder has more control and so that it is able to better meet certain of its developmental objectives.
Since 2007 the IDC has invested R750m in 39 companies, but the government plans to increase its investment in startup companies and early-stage products, believing that the private sector is too risk averse.
Small business lobby group Simodisa is rallying for improved government support for high-growth firms. The organisation, established to bring the government and private sector together to catalyse entrepreneurship and increase the number of startups, argues that in SA, small businesses employ 60% of the workforce and contribute about 34% of the gross domestic product.
“But SA has one of the highest SME (small and medium enterprise) failure rates in the world, which is indicative of the harsh environment in which SMEs operate in the country,” Simodisa says in a position paper, Policy Recommendations for Enhancing the Start-up/SME Ecosystem in SA.
“With poor economics and an unsupportive policy environment, private sector investors are deterred from investing in startups and high-growth enterprises in SA. Consequently, there is a very concerning gap in funding for South African businesses, which has also resulted in a substantial lack in skills to effectively deploy the little funding that does exist in the ecosystem.”
SIMODISA argues that the government cannot afford to ignore the barriers that cripple the growth of small businesses. Tackling and overcoming these roadblocks is imperative if the objectives outlined in the National Development Plan are to be achieved, and crucial in radically transforming the lives of South Africans and the economy.
It says that to achieve this the state must create incentives for private sector investment in SMEs.
“Not only will this address the funding gap, it will attract private sector financial management skills to the country, and increase SA’s competitiveness in the global markets,” the Simodisa paper reads.
“In addition, significant foundational input is required for the South African SME sector to fully mature and realise its potential. It is important that government adopts an industry-building approach, as significant foundational aspects of the sector still need to be built or are currently dysfunctional.
It says suitably qualified funds don’t exist in the numbers needed to fill the funding gap, and developing such funds in the country will require time, coaching and training.
In May, Parliament’s portfolio committee on trade and industry adopted a Democratic Alliance (DA) proposal to establish a venture capital fund for startups within the National Empowerment Fund. DA MP Dean Macpherson says the committee urged Trade and Industry Minister Rob Davies, in consultation with the minister of finance, to consider pursuing the fund’s desire to establish a venture capital fund with public and private sector support.
THE DA wants the state to channel funding through the agency and to startups via specialist fund managers, who can pool this with enterprise development funding and private sector risk capital, says DA MP Toby Chance.
National Empowerment Fund spokesman Moemise Motsepe says he can’t disclose whether the agency is discussing any such fund.
He says the empowerment fund has been involved in venture capital funding since its inception in 1998, and has made sizeable investments of about R700m in 20 deals.
The Technology Innovation Agency’s latest CE, Barlow Manilal — its fifth head since its launch in 2010 — says it is still considering the idea of establishing a fund-of-funds.
But with the agency’s allocation from the fiscus having been cut by a quarter for the current financial year, and several top staff leaving in July in a voluntary retrenchment process, it is unlikely that resuscitating the idea is at the top of Manilal’s mind.
A 2013 report by J Brander, Qianqian Du and Thomas Hellmann, published in the Journal of Financial Economics, found that firms that received investment from a mixture of private and government venture capital entities tended to receive more capital and exit with higher returns than did those backed by private or government funding only.
The best evidence of how governments can catapult venture capital investing remains Israel’s Yozma programme, which saw the state contribute $100m in 1993.
Foreign investors were required to partner with a local Israeli to access state funding. For every dollar the state put in, investors were expected to contribute a further $1.50. Yozma helped establish 10 funds, each capitalised with more than $20m. In 1998 the Israeli government phased out its involvement, auctioned off its direct co-investments in 14 companies and sold its interest in nine Yozma funds to co-investment partners.
As a result of the programme, the amount raised by venture capital funds in Israel rose from $27m in 1992 to $2.7bn in 2000.
This helped increase the number of Israeli startups from 300 in 1992 to 2,500 by 2000, notes Morris Teubel in a 2013 paper on the programme.
Key to Yozma’s success, experts point out, is that Israel had in place the necessary conditions for a thriving hi-tech sector — including good academic and science institutions, a significant amount of government research and development spend, and a risk-taking and pioneering culture.