Despite South Africa’s political and economic issues, local start-ups with innovative ideas are catching the attention of international investors who spot an opportunity to scale these businesses in overseas markets.

 

A case in point is GetSmarter, a Cape Town based online education company founded in 2008. It was sold to NASDAQ-listed, 2U, for $103m (plus $20m in cash subject to certain financial milestones) earlier this year and had the privilege of ringing the NASDAQ closing bell on May 22. While the valuation details of this transaction have not been disclosed, the multiple paid on its 2016 financial year revenue of $17m is indicative that investors paid a premium because of GetSmarter management’s expertise and its good business model.

In addition, in March this year three South African start-ups were selected as part of a group of 10 to be showcased in the Start-upbootcamp InsurTech accelerator programme in London. They were selected from 633 global applications, giving South Africa the greatest representation of any country participating in the programme. This kind of profiling gives these companies an edge when it comes to fundraising.

These successes, and others like them, show the tremendous growth potential that South Africa has despite its poor economic prospects. The country has had to bear credit rating downgrades by rating agencies S&P, Fitch and, most recently, Moody’s in June this year resulting in a technical recession and a subdued growth forecast of 1% for Sub-Saharan Africa for 2017. Yet these events have had little impact on the ability of some local start-ups to gain international attention, illustrating the economy’s potential.

Not all start-ups have the potential for scaling up internationally, but still need to attract international capital. It is these companies where South Africa’s global image of increasing risk is dampening international investor interest and increasing investors’ required cost of equity.

The world is currently in the so-called fourth industrial revolution, with artificial intelligence (AI) and data explosion coming to the fore. This is evidenced by five of the top seven listed companies in the world being IT/tech companies. South Africa has over 300 incubators, many of which are the brainchildren of tech innovators. These and other South African start-ups have the ability to kickstart the economy back into gear and to generate the growth that the country has the potential to achieve.

A business-friendly environment for SMEs is critical in solving the country’s unemployment problems. According to forecasts by South Africa’s National Development Plan, SMEs are supposed to contribute 90% of new jobs by 2030. The easier it is for funding to be obtained, the more companies can contribute to the growth and employment of the country.

With the launch of the SA SME Fund, chaired by Discovery Ltd chief executive Adrian Gore, the private sector is already playing an active role in funding and assisting local entrepreneurs. The fund has received R1.5 billion in commitments from 48 companies. In addition to Gore, chief executives who have committed to the fund include Brian Joffe, Jabu Mabuza, Christo Wiese, Dolly Mokgatle, Judy Dlamini, Nigel Payne and Dan Matjila, some of whom, have experience in running successful multinational companies. The fund has yet to make its first investment, but has announced that it will be conducting fund screening due diligence from July 2017.

Despite dissatisfaction that the government failed to match the private sector’s R1.5 billion commitment, other schemes have been implemented by the state to encourage funding to entrepreneurs. For example, the S12J tax legislation gives a tax incentive to investors in SMEs, provided these investments are made through a venture capital company.

There are currently approximately 20 SARS-approved S12J companies for investors to choose from in order to obtain the tax deduction. Many of these require minimum investment contributions ranging between R100 000 to R3m, with fees very much in line with traditional private equity firms. Following the introduction of a 45% rate of tax for individuals with taxable income exceeding R1.5m during the 2017 budget speech, the appeal of a tax relief for those in the upper tax brackets should be attractive.

With over 5.6 million SMEs in South Africa, the start-up economy has the potential to help alleviate both the country’s structural education and unemployment issues. It is therefore essential that both the private and public sector work together to ensure that there is an incentive for these young companies to stay in South Africa and contribute to the economy.

 

–Heleen Goussard

Head of Independent Valuations, RisCura

 

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