- What skills do PE and VC firms need?
- How are PE investments and VC investments taxed in South Africa?
- Trends in PE/VC
As we wrote in our previous article, both private equity (PE) firms and venture capital (VC) firms aim to raise money from investors with the intention of investing in private companies, increasing the value of these companies, and in due course, selling their interest in these companies at a profit.
The firms that raise the money (called general partners or GPs) have to make big investments in human capital; to be successful they must have strong, multi-disciplined, stable teams with specific-sector skills, soft skills and solid investment banking expertise.
Investors who commit capital to the venture capital or private equity firms (limited partners or LPs) should spend as much time doing researching on the GP team as the companies they are investing in. One comforting feature of private equity investing, however, is that GP firms generally invest both their expertise and their own money alongside their clients’ money.
Private equity investments are generally set up as limited partnerships and investors are taxed as if they own the underlying assets directly, according to the tax profile of each individual investor. A limited partnership is also not a separate legal person or taxpayer; each partner is taxed on his or her share of the partnership profits.
Approved VC investments can benefit from a tax incentive through Section 12J of the Income Tax Act. This incentive offers individuals, trusts and companies that are resident in South Africa, a tax rebate on investments (up to 45% for individuals and trusts and 28% for companies).
Three of the most significant barriers to PE investments are the lack of transparency, the long lock-in periods and the high entry level investment requirements. PE firms are responding to these concerns and creating investment vehicles to attract a new generation of investors. A document published by industry body the Southern African Venture Capital and Private Equity Association, ‘Fund structuring: Evolving to meet market needs’, described some of the new fund structures:
- A leading PE firm recently established a new hybrid structure, in which it created its own limited partner (LP) through a listed vehicle. Listed companies are obliged to release annual reports and listed companies are priced daily on the stock exchange. In addition, listed companies offer protection to smaller investors under the Companies Act.
- Fund of funds-type structures enable PE firms to offer a diversified portfolio of unlisted private equity-type investments. This structure attracts unit trust fund managers seeking exposure to unlisted companies. Funds of funds provide access to underlying investments of different vintages (they come to market at different times), exposure to different industry drivers, based in a different countries. BEE compliance is often included for pension funds. Some of these funds have entry levels in the R1 million level; the funds are priced daily and designed to allow easy exits. A further plus is that in some cases the fund of fund GPs will contract to buying back shares if the discount is more than 15%.
Over the last ten years, the combination of low interest rates and a recovering equity environment in global markets has created an environment conducive to PE/VC firms. As of 2019 competition for these opportunities has increased and PE/VC returns may well diminish in this bubble-type scenario.
However, in South Africa, the trend could not be more different. We have relatively higher real interest rates and an underperforming equity market, where arguably the environment for both listed equities and unlisted PE funds are offering better upside at lower risk.
PE/VC is still largely underrepresented in portfolios across the spectrum, from individuals to pension funds. It is likely that legislation in the form of Section 12J will make unlisted investing more accessible and bring it into the main stream.
Disclaimer: Please note that this article should not be construed as solicitation, advertising or sale in any shape or form. Nor is it advice of any description. It is an information-only article of general interest that aims to describe the risks of investing in PE and VC opportunities.