This paper was written by Morgan Jones, from the Investment Banking Division at Merrill Lynch South Africa and Chipo Mlambo of the UCT Graduate School of Business & AIFFA. Find the full report here.
This study set out mainly to explore the reasons for the lack of early-stage VC in South Africa and to provide some proposals for its development. A number of proposals are made that could be used to help accelerate early stage VC funding.
First, the survey participants concurred that VC is a critical mechanism in support of innovation and economic growth. It was established, however, that although South Africa has a later stage VC market and a well-developed PE market, there are very few early-stage VC funds available, whether private or government funded. This presents a problem for entrepreneurs seeking capital at the early-stage as they are faced with a limited set of funding options. This lack of early-stage VC in South Africa is attributed to the difficulty in raising funds targeted at early-stage investments followed by the lack of experienced managers to help entrepreneurs through mentoring and incubation. The latter is critical given the low level of entrepreneurial skill sets in the country, with entrepreneurship more opportunistic than visionary or game-changing.
Here are 5 recommendations needed to promote early-stage VC funding in South Africa:
1) Angel Funds: With regards to raising funds, it was recommended in the interviews that an “angel fund” be created into which high net worth individuals can contribute funds without taking away the opportunity for them to get directly involved in the running of the business. The fund could have a general/limited partnership structure, just like a typical VC/PE fund, with a management team to manage funding applications, deal transactions and for administration. The fund would benefit from a pool of experienced businessmen, either focused on particular industries thus creating industry-specific funds, e.g. a tech fund or a healthcare fund, or interested in investing generally, either way maximising the breadth and scale of mutual networks and contacts. In addition, potential investments could be debated amongst angels thus offering a greater level of due diligence for the investment.
2) Promote Entrepreneurial Fund Managers: In response to the lack of specialised early-stage fund managers, the respondents alluded to the fact that more successful entrepreneurs need to be directly involved in setting up their own funds. It was also highlighted that universities can establish their own VC fund to target university inventions which are considered to be of a significantly higher quality than non-university inventions, thus offering a completely different risk profile for investors.
3) Formalize VC Networks: To address the lack of entrepreneurial skill sets, the respondents pointed out the need to find ways to formalise the VC-business networks in order to tap into the skills available in South Africa through mentorships, and possibly through incubators. The government‟s role could be to direct funding into the “incubation of start-up businesses, mentoring & coaching of new entrepreneurs and for provision of business support to start-up companies during the first years of their lives.” (Interviewee)
4) Engage Universities: Many respondents also pointed to the need to alter learning at schools and universities to encapsulate business management and other skills likely to aid entrepreneurs. For example, Science, Technology and Business Skills could be made compulsory at school, and lessons could be learned from China, South Korea, Ireland and other growing economies with regards to their education systems (Interviewee). The respondents also called for a shift in the entrepreneurial culture in South Africa so that failure and learning can be better accepted.
It was argued that universities can help educate inventors with regards to creating realistic and investable business plans. One university interviewee indicated that their university has started to employ retired businessmen and professors to scout or survey PhD work being done to find what might have the potential for realistic commercial applications and providing this perspective to those undertaking the research.
5) Government Legislation: Where government is concerned, the respondents suggested that legislation regarding tax incentives needs to be drawn in line with other countries overseas (such as the UK) where such incentives exist. This would significantly contribute to an enabling environment for VC. Respondents also recommended that the government‟s funding should be done through private sector VC. The government should seek to de-risk private sector investments, instead of pursuing the good returns for itself, and should stop “making all sorts of development demands that cannot be met” (Interviewee). This appears to be in-line with the literature (Gilson, 2003 and Dossani & Kenney, 2002) where, in the case of Israel, the government merely provided funds as an anchor investor to a privately managed fund.
What are your thoughts on these 5 recommended proposals, what is not being considered in this list and or do you see other ways we can unlock early-stage VC funding in South Africa and elsewhere on the continent?