As the end of the tax year approaches, investors may be seeking investments that offset a portion of current tax liability. Carefully selected Section 12 J venture capital investments have an important place for investors seeking tax efficient investments and returns uncorrelated with listed entities.
In 2009 the South African Revenue Service (Sars), on instruction from National Treasury, created a tax incentive through Section 12J of the Income Tax Act, 1962 with the purpose of stimulating growth, and thus making a dent in our woeful unemployment statistics.
Section 12J 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), if made through an approved venture capital company (VCC). Other rules and regulations for investors and qualifying venture capital companies can be seen by clicking here.
Fast forward to February 2019 and according to the Sars website, (click here) there are about 145 qualifying venture capital companies licensed to by the Financial Services Conduct Authority and Sars. Industry sources have it that about R3.5 billion has been invested since the launch of the programme. Minimum investments in 12J VCCs range from R100 000 to R1 million, and the only proviso is that in order for the tax rebate to apply, the investor must hold the investment for at least five years from the date of investment.
So; assuming that this type of investment is a good match for your profile, how do you go about selecting a profitable investment? Look out for the following points:
- Prospective investors should look out for companies offering access to new investments where the business case is sound and able to grow and develop without the investment benefit of 12J.
- Some VCCs do not comply with the letter or (separately) the spirit of 12J legislation. Others start off well but do not remain compliant. In the event that the companies fall foul of 12J requirements, they risk their 12J status being withdrawn. Investors in these projects may be penalised. We favour VCCs that show that they are mindful of the central objectives of 12J legislation (job creation and sustainability) and have met these requirements.
- The liquidity of the investment (or lack of it) is material. VCCs must design exit arrangements for investors who wish to disinvest after five years at the outset of the agreement. Be alarmed if there is no mention of exit arrangements and the future price of your investment.
- If you invest in a 12J project, the law allows the VCC three years to invest your capital. It is up to you to ask when your money will be deployed, and be reassured that it won’t spend three years invested in the VCC money market account while the company looks for investable projects. The management team of the VCC should have deal pipeline; projects lined up ready and waiting for equity investment. At a recent meeting with National Treasury, Sars and VCCs it was emphasised that investments should be allocated quickly and not invested unduly in interest bearing accounts.
- When you are narrowing down your field of potential investments make sure that projected estimates for dividends and capital growth are calculated on the same basis. Estimated returns should be based on gross investment, not post-tax-rebate investment.
- And last but not least; fees. It is the norm for VCCs or their managers to charge fees based on assets under management, performance fees and third party costs. If there are additional fees levied for director’s fees, initial fees or any other kind of expenses, make sure you understand the likely impact on the investment return.
Historically, the calculation of performance fees has been problematic in the 12J companies as they have not all been calculated on the same basis. Some companies calculate performance fees excluding the tax-saving component while others calculate performance fees including the tax saving component.
Put differently, some calculate performance fees based on the net investment (which favours the VCC / manager) while others use the gross investment (fairer to the investor) as the starting point of calculations. This calculation can make an enormous difference to the final returns enjoyed by investors.
Whilst the objective of any investment is clearly to earn reasonable returns, we see the 12J space as a unique opportunity to combine above average returns with making a positive social, economic and environmental contribution to South Africa.
Whilst the range of available investment opportunities is vast, we have singled out three funds operating in interesting parts of the market to demonstrate how the legislation can be applied to high impact parts of the economy such as tourism, high value agriculture and renewable energy.
GAIA Venture Capital
Gaia Venture Capital’s history dates from 2007 when three South African family offices joined forces and started their own private equity investment company. Since then the firm has made investments in agriculture, infrastructure, renewable energy, financial services and mining exploration. According to the firm’s publicity material, it has managed to achieve a growth rate in excess of 50% per annum on capital.
Gaia has a dedicated portfolio of investments that are designed to be compliant with Section 12J tax requirements and investors receive ‘shares’ in different tranches of these portfolios. Gaia’s team includes go-to-person Renier de Wit, who is assisted by Botha Schabort, Leon de Wit, Philip van Rooyen, Mich Nieuwoudt and Kasper van Rooyen. The team is supported by over fifteen additional qualified professionals that operate from the offices in Cape Town, Johannesburg and Nelspruit.
Some examples of investments made by Gaia in their ‘Tranche 1’ portfolio include an investment into an associate of Agristar Holdings and an investment into an associate of Paarl-based IT company Accitrack called Ravenhaven. Agristar Holdings is a vertically integrated macadamia nut business, headquartered in Mpumalanga. The 12J opportunity is a processing and packaging facility designed to market and export packaged nuts.
Ravenhaven Utilities is an IoT company that has designed metering devices for the monitoring, measuring and billing electricity and water consumption in residential and commercial properties. If a single point of water and /or electricity is delivered to a body corporate or block of flats, up till recently the body corporate has had little choice but to divide user fees according to pre-set ratio. Ravenhaven has designed technology that enables individual billing and account analysis as one of its many offerings.
Investment opportunities in ‘Tranche 1’ have closed, but the company has a new portfolio of infrastructure and agribusiness investments under the ‘Tranche 2’ umbrella, which will be open for new investments until the end of February 2019.
Bright Light Solar VCC
Bright Light Solar VCC was launched in February 2018 by entrepreneur Kevin Shames, partnered by a team of appropriately qualified and experienced businessmen including Johnny Wates, Justin Mason and Michael Faber. The company provides fully installed solar solutions to sectional title bodies corporate, commercial and industrial buildings in return for the signing of long term power purchase agreements.
It raises money from investors who buy shares in Bright Light Solar VCC, which then uses the proceeds to invest into qualifying companies; those who supply and install the solar panels. The solar panels remain the property of Bright Light Solar and its investors and customers buy the electricity generated from the solar panels at a cost that is cheaper than they could buy it from Eskom or the local municipality.
Bright Light Solar pays dividends to investors every six months (after deducting withholding tax as required by law) and started in August 2018 with a dividend yield of about 8%. If and when investors sell their shares back to Bright Light, any capital gains will attract 18% capital gains tax. Bright Light Solar’s share buy-back programme enables investors to divest from year six, when they can sell their shares back to Bright Light Solar at about 95% of the value of the initial investment.
Lucid Hotel Funds
The Lucid Hotel Fund was founded by Gidon Novick (ex-Discovery, ex-Kulula) in 2016. After identifying the investment benefits of creating integrated property development and hotel portfolios he partnered with heavyweights Andrew Kuming (Kuming and Staples) and Graham Wood (ex-CEO of Southern Sun Hotels) in order to access in-house property development and hospitality experience.
In the first of Lucid Hotel funds, the group created a geographically diversified portfolio of hotels targeted at discerning business travellers. The company bought into new developments at discounted prices in prime locations and co-developed their own hotels. A new Lucid fund, ‘Lucid Hotel Fund 2’ will emulate this model with a new pipeline of projects throughout the country.
The underlying assets in the Lucid funds are sectional title units. After five years, investors refinance the portfolio or dispose of units. Lucid is working on a third option which is to convert investments in the fund to a Real Estate Investment Trust.
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 outline possible hazards of investing in 12J companies and includes some examples of 12J companies.