The private equity (PE) universe – of which venture capital (VC) is technically a subset - covers businesses in every sector and almost every stage of life.
WRITTEN BY: AMRISH NARRANDES | DATE: 19/04/2019
While investments in established companies form the bread-and-butter of most PE portfolios, it’s in early-stage ventures that many delicacies can be found. Not only do these provide an irresistible high-risk/high-return infusion, but, more importantly, investments in early-stage companies (including but not limited to VC) are essential in building the growth of an economy – and South Africa can do with an extra helping of this right now.
Studies have found that such investments foster innovation, promote research and development (R&D), enhance the efficiency of early-life businesses, and increase both domestic and international trading opportunities and the competitive capacity of the economy as a whole. Two prime examples spring to mind: India and Israel.
India has emerged as one of the fastest growing major economies in the world. Accordingly, PE and VC investments in India reached a record US$20.5 billion in 2017 and grew to US$28 billion by June 2018. Its GDP is estimated to have increased 7.2 per cent in 2017-18 and a further 7 per cent in 2018-19. Net employment generation in India also reached a 17-month high in January 2019.
Due to its concentration of VC, Israel is one of the most resilient and technologically-advanced market economies in the world. With a population below 9 million, one would never guess that Israel, after China, has the second largest number of companies on the NASDAQ (the global electronic marketplace for buying and selling securities). It has the highest density of start-up companies per capita in the world, and approximately 4.3% of the country’s GDP is invested in R&D, far exceeding that of most other nations.
According to Southern African Venture Capital and Private Equity Association (SAVCA), more than R1 billion was invested in start-ups and early-stage companies in South Africa in 2017. Businesses backed by PE investment grow faster than comparable companies backed by other kinds of finance. Over the foreseeable future, these businesses are set to renew the southern African economy.
These days, institutional investors are playing a bigger role in the PE/VC ecosystem, and are making more strategic investments that can propel their growth and extend their reach. The Futuregrowth Development Equity Fund (one of the most diversified funds in the industry) is one such example where this is happening. When the fund was set up in 2006, the founders had the foresight to ensure that the mandate allowed for an allocation to early-stage/VC deals.
While the core of the fund is made up of investments in established traditional PE companies across various sectors (including transport, infrastructure, housing, agriculture, development finance, renewable energy, health, education and SMME development, amongst others), there has been an increased push – with the underlying ethos of economic empowerment and development – towards financing younger, smaller (early-stage) ventures with viable growth potential.
An example is the fund’s investment in Yoco, an innovative technology-driven point-of-sale payments provider (the fund was the first South African institutional investor in the company). Yoco was launched in November 2015, and has been able to increase its active base to over 20 000 SMEs across South Africa, with plans to expand into the rest of Africa.
When making the decision to provide VC funding to a company such as Yoco, many factors are taken into consideration. Most important of these is the person/people running the company, and what makes them ideal to execute their idea: rather invest in an A-team with a B idea than in a B-team with an A idea. And the younger the company, the more important the quality of the people. The size and nature of the company’s market, revenue potential, scalability, barriers to entry, as well as the company’s key differentiator in terms of their product or solution, and the reasons the business could fail - all form part of the investment decision.
South Africa can learn many lessons from the Indian and Israeli examples. With a national unemployment rate of 27.1% last year, there is a lot to gain from investments that not only empower business development but also allow entrepreneurs to create employment opportunities. The South African VC industry is evolving, with an ever more sophisticated understanding of how social impact can be integrated into the investment process without compromising financial returns, and, as such, it has a compelling opportunity to transform the ways in which South Africans live their lives.