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Small Business Venture Capital Investments: What You Should Know

Section 12J investment funds are an attractive option for investors. When first created during the mid-1990s as part of the Income Tax Act, Section 12J was a well-intended, but unwieldly, piece of legislation. During 2010, we gathered collaborators – including SAICA, the Banking Council, SAVCA, and more, to work on re-engineering the legislation. Eventually, amendments to Section 12J were gazetted and, nowadays, it’s hugely improved. On this week’s The Money Show with Bruce Whitfield, we outlined the ins and outs of Section 12J and put together some guidelines for how you can spot the good, and the bad, small business venture capital investment opportunities:

What is Section 12J of the Income Tax Act?

Small business venture capital investments enable investors to enjoy a tax break – they can write off 100% of their investment into a registered company, from their taxable income. There is no cap on how much an investor may commit to a registered Section 12J company and, so long as the investor holds the shares for five years, SARS will not recover the initial tax benefit.

Why was Section 12J of the Income Tax Act Created?

Under Section 12J, investors can only invest in businesses that have an asset value of less than R50million. For SMEs, Section 12J gives them easier access to equity funding, and enables them to avoid getting into a debt trap while trying to grow. Simultaneously, SMEs can access their investors’ insight and experience, using them as a guiding light for their journey from a small, to big, business. For investors, this is an attractive solution, because their investment is somewhat secure within an accredited, registered, and compliant, venture capital company.

What Should You Look for if you Invest?

Small business venture capital investments may seem like a win-win for SMEs and investors, but there are important things to look out for. These include:

  • Compliance assurances: Ensure that the fund you’re looking to invest with is a registered Financial Services Board (FSB) business; registered with SARS and, ideally, registered with an industry body like The Southern African Venture Capital and Private Equity Association (SAVCA). Industry bodies, like SAVCA, are an important part of the business world, because they’re guardians of high standards and provide companies with a level of credibility.
  • Capability assurances: Find out what you can, and can’t, invest in. There are some exclusions – for example, you can’t invest in immovable property, cigarettes, arms and other items.  Remember too, under Section 12J, the business must spend the investment over a certain time period.
  • Underlying investment class: What kind of small business are you investing in? Is this the type of business you believe in, have knowledge of, or experience in?
  • Sourcing, selecting, assessing, and managing, investments: How does the management team make decisions around, and oversee, investments made into the Section 12J fund?
  • Exiting an investment agreement: This is the most difficult part of a small business venture capital investment. Find out about the exit process before you commit, and make sure you’re comfortable with the procedure.
  • Fees and return metrics: What are the management fees attached to making this small business venture capital investment? What kind of returns can you expect, and how difficult will it be for you to collect those returns?

What Could Go Wrong with your Investment Returns?

You wouldn’t buy a car from someone who knows nothing about cars, so don’t invest with a fund manager who doesn’t know about the business or industry you want to invest in. Knowledge is power, and truth is found in action – make sure they know what they’re talking about! For example, a technology business is not a tech business. It’s a business that is involved in tech industry and has developed to a certain level within its business development cycle. Understanding both is the requirement of an investment team before making the investment. Do not be fooled by “this is South Africa’s Facebook or Uber”.

Finally, your investment could turn bad if you’re not able to exit the business, even if it’s successful. It’s incredibly difficult to liquidate the underlying investment portfolio of SME’s making up the fund. The fund must have a robust exit strategy and are well-appraised of the relevant exit points within the business journey. Remember, your investment is a commitment for at least five years.

At Aurik, we help entrepreneurial businesses become successful assets of value. Our Section12j Fund was built on the back of us having built and supported the growth of over 1,000 businesses in South Africa over the last 14 years. If you’re looking to invest in a small business, we can help you make informed investment decisions.

Tags: The Money Show, Growing business value, Building your Business, Business Systems

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