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The world of start-ups is a risky choice for an investor. But there is a clever way you can reduce that risk, and that is by investing in a government-sanctioned Section 12J (S12J) fund. The tech industry often laments that government can do more to support small business. Yes, it can do more, but here is an example where it is making a difference.
S12J funds have been around for the past 10 years but have only recently gained traction in the start-up world. The attractive part about these funds is that they are 100% tax deductible if held for five years or longer.
Therefore, if a taxpayer is an individual or a trust with a marginal tax rate of 45%, they can invest R1m and will only pay R550,000 (that is R1m minus tax of R450,000) for the investment. In simple terms it means your start-up investment comes in at about half the price. For companies that invest, the principle is the same, but the calculation looks different because companies are taxed at 28%.
If you are in the top tax bracket, it’s an attractive option for investors with higher risk appetites, especially those who have already maxed out their retirement annuity, pension fund and tax-free savings account contributions.
There is a catch though. When you realise the investment after five years, the base for the capital gain will be zero due to the initial tax benefit received. In effect, the government will recoup some of its tax when you exit the fund. But still, the overall benefit is there.
Kalon Venture Partners CEO Clive Butkow says the government introduced S12J to solve the one key issue all small and medium-sized businesses have: access to equity finance. Kalon is one of the few dedicated tech and start-up S12J venture capital companies (VCCs) out of the 130 or so that have now been registered. When Kalon registered it was number 30, and three years later 100 more rushed online — a sign that investors are waking up to this opportunity. The majority of funds look at areas such as mining, hospitality, renewable energy, student accommodation, movable assets and others.
Butkow’s VCC invests exclusively in “disruptive digital technology” and claims to have raised in excess of R100m. He says his fund has so far invested in four tech companies, with additional deals in the pipeline.
“The VCC is intended to be a marketing vehicle that will attract retail investors. It has the benefit of bringing together fund managers, concentrating investment expertise in favour of the small business sector,” he says. Kalon caters for both the small investor with a minimum investment of R110,000 and big-money investors.
Three of Kalon’s investments include an EFT payments platform, i-Pay, which brings online payments to the masses; a loyalty programme, SnapnSave, allowing consumers to snap their till slip and receive money back in their bank accounts; and an artificial intelligence chatbot called Finchatbot, which helps companies reduce customer acquisition costs through a conversational bot.
S12Js are a step in the right direction, but the government can do much more if it wants to become part of the tech and start-up wave. A good start would be to create a fund that caters particularly for tech start-ups.
Butkow says S12J tech-focused VCCs have certain limitations, such as the time horizon to investment. Typically, a tech fund invests in about “one out of every 100 companies” and could need longer than three years to deploy all its capital responsibly. There is also confusion over whether fintech and insurtech companies are seen as qualifying companies, because S12Js specifically exclude “financial service, insurance and banking companies”. Butkow argues these start-ups are tech companies and not financial services companies.
The government could get more creative and use S12Js or a variant to start attracting sorely needed tech talent into the country. For example, many countries allow residency or citizenship based on start-up investments they make.
In 2021 the S12J regime comes to an end. The government will assess if it has achieved its objective of creating jobs or not. Given the priority on small business and job creation, it’s simply a no-brainer that S12J should continue, be improved, and be intensified.
• Buckland, an investor and entrepreneur, is founder of Ventureburn.com. He is an investor in an S12J fund that is not mentioned in this article.
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